Directors at the self checkout.

29 October 2014 | Reading time: 3 minutes

GBP250 million is a bit more than a rounding error, a bit more than an exaggeration and calling it an overstatement is an understatement. Just ask Tesco shareholders – it has cost them GBP2billion.

Tesco PLC is Britain’s biggest supermarket chain. After Walmart, it is the second largest retailer in the world. Tesco recently made headlines for all of the wrong reasons after alerting markets to a half-year profit overstatement of GBP250 million.

The overstatement.

The overstatement was uncovered by a whistleblower although Tesco claimed in subsequent interviews that their processes picked up the error.  According to Tesco management, multiple factors gave rise to the inflated figure, including the ‘accelerated recognition’ of income. As a result of this gross overstatement, auditor Deloitte has been appointed to conduct an investigation, the UK’s financial Conduct Authority has been alerted, and several executives have been suspended. Now that’s food for thought.

Australia’s statutory duty of care and diligence is not too different from the equivalent duty in the United Kingdom. But uniquely, it has been the focus of the judiciary in recent years. A good time, then, to check out a snapshot of certain directors’ duties in Australia.

Directors. Duties. Disclosures. Discipline.

Australian directors should take notice of the situation that unfolded at Tesco and remind themselves of their duties pertaining to financial disclosures. The Corporations Act 2001 (Cth) (Corporations Act) outlines the duties that directors need to comply with in relation to financial statements of Australian companies.

Section 180 of the Corporations Act provides that directors must discharge their duties with a level of skill and diligence. This provision of the Corporations Act has surfaced in several recent high profile cases in Australia, such as ASIC v Healy & Ors(2011) FCA 717 (Centro case). Let’s take a closer look at the Centro case.

The Centro case.

In the Centro case, the directors had $1.5 billion of current liabilities, but classified them as non-current liabilities and also failed to disclose guarantees for short-term debt. It was argued by Centro that the sheer volume of complex documents that needed to be analysed had an impact on the directors’ ability to spot the error. The Court concluded in Centro that the misclassification was plain to see and that directors should have an objective standard of skill in financial matters.

Relying on advice.

Section 189 of the Corporations Act outlines that directors may have a defence in relying on information or advice provided by others. Interestingly however, it was noted in the Centro case that the inherent complexities associated with financial documents of large ASX-listed companies is not an excuse for the failure of directors to read and arrive at an appropriate level of understanding of such documents.

Ouch, that hurts.

The consequences that directors face, if found to have breached these provisions of the Corporations Act, similar to a Tesco-style overstatement, may include financial sanctions, suspension, disqualification and a compensation payment. Directors who fail to comply with these provisions can also dramatically affect the company, as was the case for Tesco, which had GBP2 billion removed from its market capitalisation only a few days after the news reports emerged.

Directors’ duties 101 – not too much to read.

Directors must comply with the relevant provisions of the Corporations Act, so they do not place their position or the company in jeopardy. It goes without saying that directors must have some form of financial literacy, as after all, they are responsible for directing the company and need to review all documents material to the disclosed financial statements. Furthermore, if directors do not understand certain aspects, they should discharge their Corporations Act duties by making reasonable enquires about the issue in question.

Just as ignorance of the law is no excuse, so too is arguing that the director had too much information to read.