Editor: Professor Ian Ramsay, Director, Centre for Corporate Law and Securities Regulation

Published by LAWLEX on behalf of
Centre for Corporate Law and Securities Regulation,
Faculty of Law, The University of Melbourne
(http://cclsr.law.unimelb.edu.au)

with the support of

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The Australian Stock Exchange (http://www.asx.com.au)

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Centre for Corporate Law and Securities Regulation 2003.

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CONTENTS

1. RECENT CORPORATE LAW AND CORPORATE GOVERNANCE DEVELOPMENTS
(A) UK Corporate Governance Combined Code
(B) IFAC Board proposes changes to code of ethics impacting accountants worldwide
(C) SEC publishes staff report on proxy process review
(D) Microsoft to expense stock options
(E) The world’s largest companies
(F) Settlement of SEC'S claim for a civil penalty against Worldcom
(G) ACCC issues discussion paper on longer-term accounting separation rules for Telstra
(H) Commonwealth DPP to undertake HIH criminal prosecutions
(I) Standards Australia blueprint for good corporate governance
(J) UK survey of company directors’ responsibilities
(K) New guidance on audit reports issued by AuASB
(L) FSA finalises new regime for Alternative Trading Systems
(M) FSA refines plans for regulating general insurance
(N) New US rules require shareholder approval of equity compensation
(O) Expanding the scope of audit
(P) FSA implements reforms on governance of life insurance firms
(Q) CalPERS approves plan to crack down on executive compensation system
(R) Study of CEO pay in Europe
(S) Canadian corporate law reform report
(T) Survey of investment managers
(U) Levels of share ownership
(V) UK Parliamentary Committee releases report on the UK Government’s major review of company law

2. RECENT ASIC DEVELOPMENTS
(A) ASIC acts on conflicts of interest
(B) Guide to organisational competency obligations: responsible officers
(C) Defective prospectuses
(D) Late disclosure of financial statements
(E) ASIC’s interim approach for regulation of mutual risk products
(F) ASIC regulation of promissory notes
(G) Court upholds appeal by Nicholas Whitlam
(H) Court upholds penalties against HIH directors
(I) Tower Australia to repay investors
(J) ASIC guidelines: using past performance figures in investment advertisements
(K) Valuing options for directors and executives
(L) Court hands down Water Wheel penalties
(M) ASIC calls for financial literacy education in schools

3. RECENT TAKEOVERS PANEL MATTERS
(A) Panel decides second PowerTel application
(B) Panel declaration of unacceptable circumstances in relation to the affairs of Trysoft Corporation Limited
(C) Panel declines to commence proceedings in relation to PowerTel Limited

4. RECENT CORPORATE LAW DECISIONS
(A) Water Wheel No 2 – imposition of penalties
(B) Chairman not exercising director’s duties when voting proxies
(C) HIH appeals by Adler and Williams
(D) Application for summary dismissal of a claim for insolvent trading because of delay
(E) Application for leave to enforce a guarantee given by a director of a company in administration
(F) Privilege against exposure to a penalty
(G) The availability of the privilege against self-incrimination
(H) Opposition to extension of time for meeting of creditors
(I) Abuse of process in an examination summons made under section 596A of the Corporations Act
(J) Partnerships, joint ventures and the appointment of receivers
(K) Application for removal of liquidator, appointment of liquidator and power for liquidator to appoint himself as administrator

5. RECENT BOOKS BY CENTRE FOR CORPORATE LAW MEMBERS

6. CONTRIBUTIONS

7. MEMBERSHIP AND SIGN-OFF

8. DISCLAIMER

(A) UK CORPORATE GOVERNANCE COMBINED CODE

At its meeting on 23 July 2003, the UK Financial Reporting Council (FRC) agreed the final text of a new Combined Code. The new Code will come into effect for reporting years beginning on or after 1 November 2003.

The new Code is based on the draft revision of the existing Code that Derek Higgs suggested in his report on non-executive directors published in January 2003, which also incorporated the recommendations of Sir Robert Smith’s report on audit committees. The agreed final text reflects extensive consultation by the FRC since January.

The Code’s overall aim is to enhance board effectiveness and to improve investor confidence by raising standards of corporate governance. Its main features are:

- new definitions of the role of the board, the chairman and the non-executive directors;
- more open and rigorous procedures for the appointment of directors and from a wider pool of candidates;
- formal evaluation of the performance of boards, committees and individual directors, enhanced induction and more professional development of non-executive directors;
- at least half the board in larger listed companies to be independent non-executive directors, with a definition of independence of non-executive directors;
- the separation of the roles of the chairman and the chief executive to be reinforced;
- a chief executive should not go on to become chairman of the same company;
- closer relationships between the chairman, the senior independent director, non-executive directors and major shareholders; and
- a strengthened role for the audit committee in monitoring the integrity of the company’s financial reporting, reinforcing the independence of the external auditor and reviewing the management of financial and other risks.

As with the existing Code, in order to meet their obligations under the Listing Rules, listed companies will have to describe how they apply the Code’s main and supporting principles and either confirm that they comply with the Code’s provisions or provide an explanation to shareholders. The new Code emphasises that companies and institutional investors should enter into dialogue based on trust and mutual understanding. Companies should give helpful and informative explanations, and institutional investors should take a considered approach when evaluating them.

The Code published on 23 July incorporates the substance of Derek Higgs’ and Sir Robert Smith’s proposals. The detailed drafting reflects the consultation process. The main areas of difference are:

- modification of the Code’s structure to include not only main ‘principles’ and ‘provisions’ but also ‘supporting principles’, allowing companies greater flexibility in how they implement the Code;
- the board chairman to be able to chair the nomination committee;
- clarification of the roles of the chairman and the senior independent director (SID), emphasising the chairman’s role in providing leadership to the non-executive directors and in the communication of shareholders’ views to the board;
- for smaller listed companies below the FTSE 350, relaxation of the rule on the number of independent non-executives to 'at least two' instead of 'at least 50%'; and
- particularly rigorous review rather than special explanation when non-executive directors are re-elected beyond six years.

The intention is that provisions should be as clearly defined and verifiable as possible, so that companies can report unambiguously whether or not they have followed them. The supporting principles are cast in more general terms and leave the detailed method of implementation for companies to decide. Companies will be required, as at present, to make a statement on how they have applied the main principles, and this requirement will extend to the supporting principles as well.

The new Combined Code is available on the FRC website at http://www.frc.org.uk/combined.cfm

(B) IFAC BOARD PROPOSES CHANGES TO CODE OF ETHICS IMPACTING ACCOUNTANTS WORLDWIDE

On 21 July 2003 the International Federation of Accountants (IFAC) recommended significant changes to its Code of Ethics for Professional Accountants, expanding both the guidance and authority of the Code, which is applicable to all member bodies and to accountants worldwide.

An exposure draft of the revised Code, posted on IFAC’s website at http://www.ifac.org/EDs, proposes that the Code be elevated from a “model code” on which to base national requirements to a “standard,” requiring IFAC member body compliance. This change is part of IFAC’s overall efforts to work with its member bodies to raise the quality of practice by accountants worldwide.

The proposed revised Code specifically expands guidance for all individual accountants addressing integrity, objectivity, professional competence, confidentiality, and professional behaviour. Clearer identification of threats and safeguards are set out for professional accountants in public practice in the areas of second opinions, fees and remuneration, and custody of client assets.

The revised Code also provides new and in-depth guidance for professional accountants in business by addressing issues such as potential conflicts, preparing and reporting information, financial interests, inducements, and disclosing of information.

The exposure draft extends the principles-based approach, consistent with that used in Section 8 on Independence issued in November 2001, to the entire Code, addressing accountants both in practice and in business.

Because these proposals call for significant changes for member bodies and individual accountants, the exposure period has been extended to 120 days. Comments are requested by 30 November 2003. They may be submitted to Edcomments@ifac.org or faxed (+1-212-286-9570) to the attention of the IAASB Technical Director.

Comments may also be mailed to the Technical Director’s attention at IFAC, 545 Fifth Avenue, 14th Floor, New York, NY 10017, USA.

IFAC is the worldwide organization for the accountancy profession. Its 155 member bodies are located in 113 countries and represent over 2.4 million accountants employed in public practice, the private sector, education, and academia.

(C) SEC PUBLISHES STAFF REPORT ON PROXY PROCESS REVIEW

On 15 July 2003 the United States Securities and Exchange Commission published a report prepared by its Division of Corporation Finance concerning the Division's review of the Commission's rules and regulations regarding the nomination and election of directors. The staff report notes the need to improve the existing proxy process and recommends action in two areas: improved disclosure and improved shareholder access to the director nomination process. The report recommends the following actions:

- Require more robust disclosure of the nominating committee processes of public companies, including the consideration of candidates recommended by shareholders.
- Require specific disclosure of the processes by which shareholders may communicate with the directors of the companies in which they invest.
- Require that major, long-term shareholders (or groups of long-term shareholders) be provided access to company proxy materials to nominate directors, where there are objective criteria that indicate that shareholders may not have had adequate access to an effective proxy process. Examples of events that would trigger this access could include situations where the results of the proxy process are not acted on by companies or where there is substantial shareholder dissatisfaction with the operation of the proxy process.

SEC Chairman William H Donaldson said, "An effective proxy process has never been more important to restoring investor confidence. We have worked and continue to work with the markets to put in place listing standards and rules that increase both the role of independent directors and the voice of shareholders. The next step is to assure that the proxy process reinforces these important advances. The staff is to be commended for its work in gathering the views of the public and preparing timely and responsible recommendations. I have asked them to prepare rule proposals that would effect each of the recommendations in the report. I hope that the Commission will be able to consider such proposals as early as August with regard to the disclosure recommendations and as early as September with regard to the proxy access recommendation. I look forward to the Commission's deliberations and to public discussion regarding those proposals."

The staff report may be found on the Commission's website at http://www.sec.gov

(D) MICROSOFT TO EXPENSE STOCK OPTIONS

On 8 July 2003 Microsoft Corp announced changes in employee compensation. Starting in September 2003, employees will be granted Stock Awards instead of stock options. The Stock Award program offers employees the opportunity to earn actual shares of Microsoft stock over time, rather than options that give employees the right to purchase stock at a set price.

While many companies provide stock awards, commonly known as restricted stock units, to executives, Microsoft is one of the first major corporations in which every employee will be eligible to become a direct owner of the company through Stock Awards.

As a result of the changes in its compensation approach, Microsoft indicated that starting with its 2004 fiscal year, the company will begin expensing all equity-based compensation, including previously granted stock options.

"Because Stock Awards must be expensed as they vest, we will include the cost of all equity-based compensation in both future and prior years' financial statements to preserve year-over-year comparability," said John Connors, senior vice president, finance and administration, and chief financial officer at Microsoft. "We agree with others in our industry that there's no one-size-fits-all approach when it comes to equity compensation programs and the resultant accounting for them. Every company has a unique set of circumstances, and this is the appropriate accounting treatment for our new compensation plan."

(E) THE WORLD'S LARGEST COMPANIES

In its 14 July 2003 issue Business Week published its list of the top 1,000 companies based on the share price of these companies as at 31 May 2003. The list excludes companies from what Business Week refers to as emerging markets. About 100 companies from emerging markets (such as China, Korea, Russia, Taiwan, South Africa, Brazil and Mexico) would have made the list based on their market capitalization.

Companies from the following countries make up the top 1,000 list (2002 figures are in brackets):

Australia - 27 (19); Austria - 2 (1); Belgium - 9 (10); Britain - 77 (85); Canada - 41 (39); Denmark - 6 (6); Finland - 5 (6); France - 48 (51); Germany - 35 (35); Greece - 7 (3); Hong Kong - 18 (15); Ireland - 4 (5); Italy - 24 (24); Japan - 129 (142); Netherlands - 19 (19); New Zealand - 1 (1); Norway - 5 (5); Portugal - 4 (3); Singapore - 6 (6); Spain - 18 (15); Sweden -17 (17); Switzerland - 17 (20); and United States - 488 (473).

(F) SETTLEMENT OF SEC'S CLAIM FOR A CIVIL PENALTY AGAINST WORLDCOM

On 7 July 2003 the United States Securities and Exchange Commission announced that the United States District Court Judge Jed Rakoff issued an Opinion and Order approving the SEC's settlement with WorldCom, Inc.

In its Opinion and Order, the Court concluded that "the proposed settlement is not only fair and reasonable but as good an outcome as anyone could reasonably expect in these difficult circumstances." The Court noted that the civil penalty to be paid by WorldCom, would be "75 times greater than any prior such penalty." The Court wrote that "the Court is satisfied that the Commission has carefully reviewed all relevant considerations and has arrived at a penalty that, while taking adequate account of the magnitude of the fraud and the need for punishment and deterrence, fairly and reasonably reflects the realities of this complex situation."

In its Opinion and Order, the Court stated that the Court will enter the Final Judgment as to Monetary Relief in the form submitted by the parties. That Final Judgment provides that WorldCom is liable for a civil penalty in the amount of $2.25 billion. The Final Judgment also provides that in the event of confirmation of a plan of reorganization of WorldCom by the Bankruptcy Court, WorldCom's obligations under the Commission's judgment shall be deemed to be satisfied by the company's payment of $500 million in cash and by its transfer of common stock in the reorganized company having a value of $250 million to a distribution agent to be appointed by the District Court. Under the terms of the settlement, the funds paid and the common stock transferred by WorldCom to satisfy the Commission's judgment will be distributed to victims of the company's fraud, pursuant to Section 308 (Fair Funds For Investors) of the Sarbanes-Oxley Act of 2002. The proposed settlement remains subject to review and approval of the United States Bankruptcy Court for the Southern District of New York.

The Commission has alleged that WorldCom misled investors by overstating its income from at least as early as 1999 through the first quarter of 2002, as a result of undisclosed and improper accounting (Litigation Release No 17829).

The Commission filed its case against WorldCom on 26 June 2002, the day after WorldCom announced that it intended to restate its financial results for five quarters-all quarters in 2001 and the first quarter of 2002 (Litigation Release No 17588). The Commission also sought the appointment of a corporate monitor for WorldCom, and on 3 July, US District Judge Jed S Rakoff appointed former SEC Chairman Richard Breeden to that position.

On 26 November 2002, the Commission obtained a judgment against WorldCom through which the Commission obtained the full injunctive relief it sought against WorldCom. In addition, the judgment ordered WorldCom to undertake extensive reviews of its corporate governance and internal controls, as well as required the WorldCom to establish a training and education program for WorldCom officers and employees to minimize the possibility of future violations of the federal securities laws. The 26 November 2002 judgment explicitly left open the determination of monetary penalties to be imposed on WorldCom (Litigation Release No 17866).

Since the Commission filed its action against WorldCom, the company has made a series of announcements expanding its anticipated financial restatement due to the fraud, both in dollar amount and in time. In addition, the Commission has brought civil actions against four former employees of WorldCom. The Commission filed civil actions against former WorldCom Controller David F Myers on 26 September 2002 (Litigation Release No 17753); former WorldCom Director of General Accounting Buford "Buddy" Yates, Jr, on 7 October 2002 (Litigation Release No 17771); and Betty L Vinson and Troy M Normand, former accountants in the WorldCom's General Accounting Department, on 10 October 2002 (Litigation Release No 17783). All of these actions are pending.

In determining to enter into the settlement, the Commission considered remedial acts promptly undertaken by WorldCom and cooperation afforded the Commission staff.

The Commission acknowledges the assistance and cooperation of the US Attorney's Office for the Southern District of New York and the Federal Bureau of Investigation.

(G) ACCC ISSUES DISCUSSION PAPER ON LONGER-TERM ACCOUNTING SEPARATION RULES FOR TELSTRA

On 4 July 2003 the Australian Competition and Consumer Commission (ACCC) issued a Discussion Paper on new record keeping rules to implement a longer term accounting separation regime for Telstra. The paper raises a number of issues which need to be resolved in order to ensure a more transparent, accountable and informed regulatory market by improving the provision and disclosure of information on Telstra's operations to the ACCC, industry, the public and the Government.

The paper seeks comment on issues relating to the development of the current cost accounting and imputation testing frameworks which will apply to Telstra's longer term (post-2003) reporting under the new accounting separation regime.

The paper is available from the ACCC website at http://www.accc.gov.au under Telecommunications or from John Bahsevanoglou on (03) 9290 1949 or Carl Toohey on (03) 9290 1872.

(1) Background

On 24 September 2002 the Minister for Communications, Information Technology and the Arts, detailed a range of measures aimed at increasing the level of competition and investment in the telecommunications market to benefit consumers and business.

One of the key measures announced was the encouragement of a more transparent regulatory market by requiring an augmented system of Accounting Separation (AS) of Telstra's wholesale and retail operations. AS was seen as a means of addressing competition concerns arising from the level of vertical integration between Telstra's wholesale and retail services and improving the provision of costing and price information to the ACCC, access seekers and the public.

The Telecommunications Competition Act allows the Minister to give a Ministerial Direction to the ACCC about Telstra's wholesale and retail operations. It also provides the Minister with a power to direct the ACCC to prepare or publish reports using its existing broad record-keeping rule powers under Part XIB of the Trade Practices Act 1874.

On 10 June 2003, the Minister issued a Ministerial Direction instructing the ACCC to use its existing powers under Part XIB of the Trade Practices Act 1874 to ensure that:

- Telstra prepares current cost accounts, as well as existing historical cost accounts to provide more transparency to the ACCC about Telstra's cost as an ongoing sustainable business;
- Telstra prepares reports for the ACCC on current cost and historic cost key financial statements in respect of 'core' interconnect services;
- Telstra's reports be disclosed by the ACCC with an accompanying assessment statement by the ACCC;
- the ACCC publishes an ‘imputation’ analysis (based on information provided by Telstra, which assumes that Telstra purchases the ‘core’ interconnect services at the price that it charges external access seekers);
- Telstra prepares reports for the ACCC comparing its actual performance in supplying ‘core’ services to itself and to external access seekers in terms of key non-price terms and conditions;
- the ACCC prepares and publishes a six-monthly report on competition in the corporate segment of the market.

The discussion paper deals with the first four points noted above. A separate discussion paper on key performance indicators (KPIs) for non-price terms and conditions (fifth point) was issued in April and a more comprehensive monitoring system for KPIs will be implemented over a similar time-frame to that being proposed for CCA and imputation testing.

A discussion paper competition on the corporate market report is currently being prepared and will be issued in due course.

(H) COMMONWEALTH DPP TO UNDERTAKE HIH CRIMINAL PROSECUTIONS

On 3 July 2003 the Australian Treasurer, Peter Costello and the Australian Attorney General, Daryl Williams announced the Government's decision that the Commonwealth Director of Public Prosecutions (CDPP) will undertake criminal prosecutions relating to the financial collapse of the HIH Insurance Group. This will include criminal prosecutions under the Corporations Act and the Crimes Act (NSW).

A key task of the HIH Royal Commission was to inquire into the possibility of breaches of law and whether possible criminal or other legal proceedings should be referred to the relevant agency. In releasing the Commissioner's report on 16 April 2003 the Government immediately referred all possible breaches of the Corporations Act to the Australian Securities and Investment Commission (ASIC) and breaches of the NSW Crimes Act to the NSW Director of Public Prosecutions.

The Government sought the advice of the CDPP and ASIC and has accepted their recommendation that the CDPP is the most appropriate and effective body to undertake HIH criminal prosecutions.

The powers of the CDPP are extensive and provide the best opportunity for the efficient prosecution of HIH cases. The CDPP has the power to prosecute offences against the Corporations Act, to grant indemnities to witnesses, to appeal against sentences and other matters following completion of the prosecution and, under arrangements with the States, to prosecute State offences.

A specialised unit will be established within the CDPP and will be staffed by people experienced in the prosecution of complex commercial cases. The unit will be dedicated solely to the pursuit of HIH matters. The specialised unit will be assisted by two Senior Counsel and two Junior Counsel retained from the bar who will advise on matters referred to the CDPP by ASIC. A taskforce has already been established within ASIC to examine prosecutions and prepare briefs for possible proceedings. The Government expects these two agencies to work closely on investigating and prosecuting possible breaches arising from the failure of the HIH Insurance Group.

The Government intends to allocate additional funding of $14 million over three years to the CDPP to undertake criminal prosecutions. ASIC has already been provided with additional funding of $17.5 million in 2003-04 and $10.7 million in 2004-05 to undertake this task.

The Government has also ensured that ASIC is able to efficiently and expeditiously investigate possible breaches of the law by legislating to transfer the records of the HIH Royal Commission to ASIC. The legislation maintains key protections that currently attach to the Royal Commission records, such as the protection of individuals against self-incrimination and rights to claim legal professional privilege.

(I) STANDARDS AUSTRALIA BLUEPRINT FOR GOOD CORPORATE GOVERNANCE

On 3 July 2003 Standards Australia published a series of five new Australian Standards to help organizations develop and implement effective corporate governance practices.

The Chief Executive of Standards Australia, Mr Ross Wraight, said: “Unlike other governance guidelines these Australian Standards are non-prescriptive and have been designed as an easy to understand framework for small, large, public, private and not-for-profits. As a national framework they also pull together a number of the key elements in the corporate governance including the OECD Principles of Corporate Governance and guidelines produced by IFSA, ASX Corporate Governance Council.”

According to Standards Australia’s Director of Business Standards, Mr Mark Bezzina: “These Standards are the first national consensus based guidelines for corporate governance in the world and were developed with the involvement of all major Stakeholders.”

“During the public comment process in January the draft Australian Standards were reviewed by an extensive cross section of the Australian business community and the business governance committee incorporated the extensive feedback before the publication of the full Standards today.”

The Australian Standards in the corporate governance series include:

- AS 8000 Good Governance Principles
- AS 8001 Fraud and corruption control
- AS 8002 Organizational codes of conduct
- AS 8003 Corporate and social responsibility
- AS 8004 Whistleblower protection programs for entities

The first Standard in the series, AS 8000 Good Governance Principles, defines key aspects of good governance, provides an outline of the major objectives and gives guidance on how to apply the principles. It also gives advice on:

- Developing a governance policy
- Education and training for the Board and senior management
- Strategies for continuous improvement of governance performance
- Dealing with governance breaches – detecting, recording and dealing with governance breaches and complaints
- Record keeping
- Internal reporting – process of identifying, evaluating and managing key risks
- Board Directors induction programs

The Standard outlines the role and responsibilities of the Board including the development of a remuneration policy, development of measurable performance indicators and adherence to a code of conduct.

It provides advice on disclosure and transparency obligations including information on financial and operating results, organizational objectives, shareholder ownership and voting rights, Board and executive remuneration, major organizational risks and annual reporting on governance systems.

It states that the rights and equitable treatment of shareholders should be protected and the rights to vote in general shareholder meetings, the transfer of shares, elect members of the Board and share the profits of the entity. Shareholders should also have the right to participate in decisions concerning fundamental corporate changes and have the opportunity to obtain effective redress for violation of their rights.

The responsibilities of shareholders are also outlined in the Standard and are crucial for effective governance. Shareholders should have a willingness to exercise their right of ownership and express their views to Boards of Directors. As owners of the entity shareholders elect the Directors to run the entity on their behalf and hold them accountable for its progress.

The Standard also defines the term independent director and outlines what is expected of an individual in their capacity as Chairperson, CEO, Director and Company Secretary and has a special informative appendix covering issues for consideration in the governance of not-for-profits.

Copies of the Standards can be downloaded from Standards Australia’s website at http://www.standards.com.au or purchased through the Customer Service Centre on 1300 65 46 46.

(J) UK SURVEY OF COMPANY DIRECTORS’ RESPONSIBILITIES

Shareholders and directors should work together to ensure the system of voluntary codes are effective or run the risk of coming under further pressure, according to the results of a new survey, published on 3 July 2003.

The survey found that although directors recognise their responsibilities, they spend less time determining the strategy and structure of the business or talking to shareholders than they believe they should because of the time spent on complying with regulation and red tape.

Only 3% of all respondents thought that institutional investors looked to generate long-term shareholder value rather than short-term goals

Following from Derek Higgs’ report, the survey also found that:

- Directors continue to prefer voluntary regulation rather than legislation of boardroom activity.
- Only 30% of the FTSE 350 are likely to recruit non-executive directors in the next 12 months and 80% of these will be recruited from the traditional pool of senior management from other companies.
- Nearly half of the FTSE 350 respondents felt that Non-Executive Directors should never be paid in shares, even though both the Association of British Insurers and the Hermes principles on corporate governance recommend this as an appropriate method.
- Although there has been much dissent from shareholders and the Government is consulting over executive pay, less than a fifth of listed company respondents thought their companies would discuss directors’ packages with institutions before they are agreed.

More than 200 directors took part in the joint CMS Cameron McKenna and Institute of Directors survey in April and May 2003. Executive and non-executive directors were asked how they spend their time, what they are worried about and where they turn to for advice. Directors were also asked about levels of remuneration and the implications of recent reports affecting corporate governance and proposed reforms for non-executive directors and audit committees.

The full results of the survey are available at http://www.law-now.com; or http//www.iod.com/underpressure or by emailing samantha.beams@cmck.com or katherine.danby@iod.com

(K) NEW GUIDANCE ON AUDIT REPORTS ISSUED BY AuASB

On 30 June 2003 the Australian Auditing and Assurance Standards Board (AuASB) issued a Guidance Note “Improving Communication between Auditors and Shareholders”, which provides additional guidance for use by auditors for the 30 June 2003 year-end reporting period.

Mr Bill Edge, Chairman of the AuASB said, “There is demand for an alternative form of audit report by users of audited financial reports in the Australian marketplace. This Guidance Note represents a step towards improving the quality of communication between auditors and shareholders, particularly in light of the recent reform proposals within the CLERP 9 Discussion Paper and the HIH Royal Commission Report.”

The Guidance Note is available on the website of the AuASB at http://www.aarf.asn.au/

For further information, please contact:

Mr Bill Edge
Chairman
Auditing and Assurance Standards Board
Tel: (03) 8603 3649

Mr Richard Mifsud
Executive Director
Auditing and Assurance Standards Board
Tel: (03) 9641 7433

(L) FSA FINALISES NEW REGIME FOR ALTERNATIVE TRADING SYSTEMS

On 30 June 2003 the United Kingdom Financial Services Authority (FSA) issued its final rules for alternative trading systems (ATS) which will increase the level of transparency available to market participants and improve market monitoring of trading platforms. Currently, the rules for ATSs are the same as those for ordinary securities firms, an anomaly which is addressed by the proposals. Both market participants and consumers will benefit from the improved standards which will limit the scope for market abuse and provide greater price information to the market.

The proposals in the policy statement include:

- Enhanced transparency provisions for ATSs will lead to improved visibility of prices for investors. This will enable them to make informed investment decisions.
- A requirement that ATS operators introduce arrangements to monitor trading undertaken on their systems and report potentially abusive trading to the FSA. This will help prevent abusive trades at the expense of ATS users or other consumers.
- Enhanced information about systems to be given to retail and intermediate customers who sign up to use them. This will mean that clients are aware of the way in which their deals will be handled.
- ATSs to ensure that markets are properly informed about the instruments traded, where there are retail or intermediate customers using their systems.

The European Union is currently considering proposals revising the Investment Services Directives. This includes transparency and market monitoring rules for ATSs. The standards which the FSA has proposed are in line with the provisions currently under discussion.

The policy statement is on the FSA website at http://www.fsa.gov.uk

(M) FSA REFINES PLANS FOR REGULATING GENERAL INSURANCE

On 30 June 2003 the United Kingdom Financial Services Authority (FSA) published its revised proposals for regulating the sale of general insurance, which begins on 14 January 2005. In response to feedback on CP160 and separately commissioned independent research on costs, the FSA has amended its plans to ensure that regulation properly reflects the risks in the general insurance sector.

This consultation paper (CP187) contains draft rules which will raise the standard of advice consumers receive, reduce the likelihood of consumers buying inappropriate cover and improve service standards for handling claims and complaints. The main policy changes are:

- Critical illness, private medical insurance and income protection insurance will not be subject to a specifically tailored regime for higher risk products, as proposed in CP160. Instead, there will be requirements aimed at addressing particular risks, which can arise across all types of insurance products. For example, all firms will be required to disclose significant and unusual exclusions to their customers. So, for medical insurance, consumers must be told up-front what medical conditions and types of illness will be excluded from a policy.
- Small businesses will be classified as commercial customers, rather than private customers as proposed in CP160. Only private individuals will be classified as retail customers.
- Long-term care insurance will be regulated as an investment product. A separate consultation paper will follow in the autumn.

As part of CP187, the FSA is also putting forward proposals for some changes to the regime for exempt professional firms which covers solicitors, accountants and actuaries in connection with insurance and mortgage business.

The FSA welcomes feedback to this consultation by 30 September 2003. Final rules are expected to be published in January 2004.

The consultation paper is available on the FSA website at http://www.fsa.gov.uk

(N) NEW US RULES REQUIRE SHAREHOLDER APPROVAL OF EQUITY COMPENSATION

On 30 June 2003 the United States Securities and Exchange Commission approved new rules proposed and adopted by the New York Stock Exchange and the Nasdaq Stock Market requiring shareholder approval of equity compensation plans, including stock option plans. The new rules will also require approval for repricings and material plan changes.

The new rules will provide for the first time comprehensive shareholder approval requirements for these plans for companies subject to the listing standards of the NYSE and Nasdaq. The NYSE's new rules will replace its current pilot program, which exempted "broad-based" equity compensation plans from a shareholder approval requirement.

The Commission also approved a change in the NYSE rules for voting shares held in "street name" on equity compensation plans. The change will permit a broker that is a member of the Exchange to vote for or against those plans only when the broker receives instructions from the beneficial owner of the voting securities.

The release approving the new rules may be found on the Commission's website at http://www.sec.gov

(O) EXPANDING THE SCOPE OF AUDIT

On 26 June 2003 The Institute of Chartered Accountants in Australia (ICAA) identified a need for Australian businesses to work with the auditing profession to improve investor confidence by expanding the scope of audit, following the release of the paper “Financial Report Audit: Meeting the Market Expectations”.

Chief Executive of the ICAA Stephen Harrison said: “The Institute is challenging the business community to improve the financial information they provide to investors. Financial audits are a key component of this information.”

Stephen Harrison said: “The profession has failed to close the so-called ‘expectation gap’ of what an audit does. The audit expectation gap has not significantly narrowed and the Institute’s Financial Report Audit is proposing a different approach – changing the scope of audit so it better lines up with community expectations.”

The ICAA’s Financial Report Audit paper provides a series of short-term steps to improve the audit product, while looking at what is needed for longer term change to take place.

The report is available on the ICAA website at http://www.icaa.org.au/index.cfm

Following is a summary of the proposal contained in the paper.

(1) Proposals for expanding the scope of audit

The paper presents opportunities that exist to expand the scope of services currently being provided by audits as well as additional areas that could be undertaken as part of an extended audit.

The options presented raise implementation issues that will need to be addressed, such as:

- Format of the expanded report
- Criteria and measurement of extended services
- Determination of who the report is prepared for
- Determination of presentation as plain english vs legally worded
- Education of the profession – current and future
- Education of the community
- Legislative requirements – auditing standards and indemnity issues

There are a number of areas of the audit that need to be reviewed for systemic change:

(a) Core audit services

Extensions could be made to existing core audit services to add further value to the financial report audit.

This would create an opportunity to further reduce the expectation gap by redesigning the audit report to clarify what the audit does and does not cover.

(i) Internal control

Current: There has been a trend to ‘unbundle’ audit of internal controls from the standard audit of financial statements.

Proposal: Management should report on internal control process and the auditor should report on those assertions.

Challenges: Should it only cover financial reporting internal controls? Should it be broadened to other internal controls eg risk management and corporate governance?

(ii) Fraud detection

Current: Greater public education needed regarding financial report audit – currently it only reviews financial statement fraud.

Proposal: Audit should thoroughly investigate fraudulent financial reporting

Challenges: Need to develop tests for forms of fraud other than financial statement eg defalcation. Need to develop methods of reporting on the finding of those tests and the controls in place to prevent such frauds.

(iii) ‘Going concern’

Current: Expectation that the audit opinion provides assurance of the ongoing viability of an entity via verification of financial statements.

Proposals: Auditors prepare an assurance report with respect to going concern.

Challenges: Management identifying a set of performance indicators pointing to the health of the so the auditor can offer commentary. The auditor identifying and reporting on key non-financial indicators that can impact corporate failure. Auditors providing commentary on the company’s financial health.

(b) Extended audit services

These would be valid extensions given the substantial knowledge auditors already have.

(i) Business risks

Proposal: Board of Directors report on the risks an entity faces and the controls in place to handle those risks and auditors should provide assurance on that report.

Challenges: There will be a need to have a Framework in place for identifying typical business risks across Industries so that there is consistent and comparable reporting.

(ii) Management Discussion and Analysis (MD&A)

Proposal: MDA should disclose information on a company’s performance according to core businesses, strategy, critical success factors and key performance indicators.

Challenges: Need to determine the form of the subsequent audit report and the level of assurance.

(iii) Quality of accounting policies

Proposal: Management should reveal accounting policy choices that disclosure should be audited. The auditor should attest to the key accounting policy choice options, the impact of the choice on financial statements and their views on the appropriate choice.

Challenges: This is a dual reporting function with the auditor attesting to management’s assertions on where accounting policy choices have been made.

(iv) Corporate governance

Proposal: Provide assurance on compliance with the ASX Corporate Governance Council recommendations.

Challenges: Developing performance criteria. Maintaining auditor independence when considering some of the recommendations.

(v) Continuous disclosure

Proposal: Provide assurance on company’s disclosures to the ASX under continuous disclosure requirements.

Challenges: What level of assurance is required? Should reports be to shareholders, board of directors or the audit committee?

(vi) Performance audits

Proposal: Expanding scope of audit to incorporate performance audits

Challenges: Developing appropriate criteria and ensuring criteria remain current and can be measured. Determine the appropriate instances where a performance audit is required

(vii) Continuous audits

Proposal: Use XBRL technology to facilitate easier application of continuous audits on continuous financial reporting.

Challenges: Commitment from Boards that a continuous financial reporting framework is required. Development of continuous auditing tools allowing the Auditor to report on the Board’s Financial Information, made assessable on the Company’s website.

(P) FSA IMPLEMENTS REFORMS ON GOVERNANCE OF LIFE INSURANCE FIRMS

On 26 June 2003 the United Kingdom Financial Services Authority (FSA) announced it is pressing ahead to implement its far-reaching plans to improve the governance of life insurance firms. These include making the use of discretion in with-profits funds more transparent and making directors and senior management of life insurers explicitly responsible for all decisions of their business, including those taken on actuarial advice.

The Policy Statement sets out the timetable for implementing the new arrangements as follows:

- firms to define and make available to with-profits policyholders their "Principles and Practices of Financial Management" (PPFM) by end March 2004 - the PPFM documents how firms exercise their discretion in managing with-profits funds;
- firms to put in place any changes in governance arrangements and reporting to with-profits policyholders by end March 2004; and
- following the decision to discontinue the Appointed Actuary regime, the actuarial function and with-profits actuary will assume their roles by the date when the Integrated Prudential Sourcebook (PSB) takes effect for life insurers during 2004.

The policy statement is available on the FSA website at http://www.fsa.gov.uk

(Q) CaLPERS APPROVES PLAN TO CRACK DOWN ON EXECUTIVE COMPENSATION SYSTEM

In June 2003 the California Public Employees’ Retirement System’s (CalPERS) Board of Administration approved a comprehensive action plan to crack down on what it refers to as abusive executive compensation plans in corporate America and hold compensation committees more accountable for their actions.

The plan calls for CalPERS to publicly scrutinize companies with the worst and best trends in executive compensation, and outlines a model executive compensation policy statement for companies to use as a blueprint to develop their own policy. It also unveils specific areas where CalPERS will vote its shares against compensation issues.

Under the plan, CalPERS will identify 10-15 companies with bad and good compensation practices using an analysis tool that compares CEO compensation to its corporate peers and the performance of the company versus its peers. The analysis takes into account total CEO compensation as well as base salary, incentive plans, restricted stock, options, and other compensation factors.

CalPERS analysis will be used to decide how CalPERS will vote its proxies on compensation issues and to highlight poor and good compensation practices on the pension fund’s web site.

In addition to the analysis, CalPERS will vote against any compensation plan that does not prohibit repricing, include a significant portion of performance-based components and vesting periods of at least four years for a significant portion of overall grants.

CalPERS also plans to vote against compensation plans that contain evergreen provisions that automatically increase the shares available for grants on an annual basis, and those that provide reload options allowing an optionee who exercises a stock option using stock already owned to receive new options for the same number of shares used.

CalPERS model executive compensation policy encourages companies to design programs that provide alignment of interests with shareowners and include a combination of cash and equity-based compensation. The pension fund also wants programs to be transparent and fully disclosed. Plans should include the parameters of the employment contract provisions, severance packages, and the overall compensation philosophy.

CalPERS expects to fully implement its plan by Fall 2003 and will use it to vote its shares in the 2004 proxy season.

A copy of CalPERS Executive Compensation Plan can be found on its website at http://www.calpers.ca.gov, click CalPERS Board Meeting Information, then Investment Committee, then item 7C.

CalPERS is the United States’ largest public pension fund with assets of $138 billion. It provides retirement and health benefits to 1.3 million State and local public employees and their families.

(R) STUDY OF CEO PAY IN EUROPE

Europe's highest paid CEOs are in France according to a study of pay practices among FTSE Euro top 300 companies published in June 2003 by the European Corporate Governance Institute. French CEOs earn on average EUR1.85 million. This is 16% more than the average EUR1.55 million in pay and performance-based bonuses of UK CEOs, and much more than Dutch CEOs (EUR1.37 million), German Executive Board members (EUR1.18 million), Italian CEOs (EUR1.05 million) and Swiss CEOs (EUR0.98 million). The study found that 47% of CEO pay in France is variable or performance related, 47% in Germany as well, 41% in the Netherlands, 38% in Italy and 33% Sweden. The UK's 31% of performance related pay jumps to 70% if long-term incentives and pension benefits are included.

The study is available at http://www.ecgi.org/remuneration/index.htm

(S) CANADIAN CORPORATE LAW REFORM REPORT

In June 2003, the Canadian Senate Standing Committee on Banking, Trade and Commerce published a report recommending measures to restore investor confidence following recent corporate collapses. The report is titled "Navigating Through 'The Perfect Storm': Safeguards to Restore Investor Confidence". Following are the recommendations of the Committee.

(1) Legislation be introduced that would require a majority of the members of the board of directors to be independent, recognizing the special circumstances that may be faced by closely held corporations and small and medium-sized businesses. As well, the independent directors should be required to meet in camera on a periodic basis. Moreover, legislation should require the development of a code of ethics to be followed by all members of the board of directors. Finally, the federal government should encourage provincial/territorial governments and private sector stakeholders to develop specifically tailored education and training initiatives that would enhance the knowledge of members of the board of directors in areas that are outside their expertise.

(2) Legislation be introduced that would require all audit committee members to be independent and financially literate; moreover, at least one member should be a financial expert. The audit committee should also have the ability to select and take advice from an independent audit advisor. As well, legislation should require in camera meetings between the audit committee and the auditor. Finally, the federal government should encourage provincial/territorial governments and private sector stakeholders to develop specifically tailored education and training initiatives that would enhance the level of financial literacy among boards of directors in Canada, particularly among audit committee members.

(3) Legislation be introduced that would prohibit compensation committee members from being a member of management and would require them to have a level of expertise in the areas of compensation and human resource management. The compensation committee should also have the ability to select and take advice from an independent compensation consultant.

Moreover, legislation should require in camera meetings between the compensation committee and the company's compensation consultant.

(4) Legislation be introduced that would limit the non-audit services that auditors can provide to their audit-clients. These restrictions should not necessarily apply to small and medium-sized businesses. The rules developed by the Canadian Public Accountability Board should be used as a guideline.

(5) Legislation be introduced that would require the audit committee to oversee the auditor selected by the company's shareholders.

(6) Legislation be introduced that would require rotation of the lead audit partner every seven consecutive years.

(7) Relevant laws and regulations be reviewed with a view to ensuring that the accounting profession benefits from modified proportionate, rather than joint and several, liability.

(8) Legislation be introduced that would obviate real or perceived conflicts of interest by financial analysts.

(9) The federal government review current legislative and regulatory provisions regarding fraud, insider trading and other offences, including the adequacy of any penalties, with a view to implementing any needed changes as expeditiously as possible. It should also examine the extent to which existing procedures and resources are adequate to ensure that instances of corporate corruption are properly prosecuted.

(10) Legislation be introduced that would establish whistleblower protection for employees with respect to the reporting of financial irregularities and failed corporate governance.

(11) The role of Chief Executive Officer and Chair of the Board of Directors be split, bearing in mind the special circumstances that may exist with closely held companies and small and medium sized businesses.

(12) The federal government take a leadership role and work with Canadian stakeholders in undertaking discussions with the US Financial Accounting Standards Board, the International Accounting Standards Board and others that will result in all relevant parties working expeditiously toward the development of global uniform accounting standards.

(13) The federal government convene a meeting of all stakeholders to discuss the entity that should have responsibility for the setting of - and, importantly, revisions to - accounting standards and rules. The government must take a leadership role in ensuring that the entity to which responsibility is given has the necessary independence, accountability and transparency to safeguard investor confidence.

(14) Legislation be introduced that would require an organization's Chief Executive Officer and its Chief Financial Officer to certify that the annual financial statements fairly present, in all material respects, both the results of the organization's operations and its financial condition.

The report is available at: http://www.parl.gc.ca/common/committee_Senhome.asp?Language=E&parl=37&Ses=2&comm_id=3

(T) SURVEY OF INVESTMENT MANAGERS

In June 2003 KPMG published a report titled "Revolutionary Shifts, Evolutionary Responses: Global Investment Management in the 2000s". The report presents the results of a survey of 185 investment managers in 20 countries (with a total of Euro 19 trillion under management) as well as interviews with 60 CEOs and CIOs from these firms. The report aims to:

(a) identify the nature and scale of changes that have occurred in the global investment management industry;

(b) highlight the responses of individual firms to massive falls in business volume and profits; and

(c) underline further actions that can help executives of these firm manage their businesses.

The report is available at http://www.kpmg.com/

(U) LEVELS OF SHARE OWNERSHIP

The Australian Stock Exchange has released a report on levels of share ownership in 2002 in 10 countries. Of the 10 counties, those with the highest levels of share ownership among the adult populations are:

Australia - 50%
USA - 50%
Canada - 46%.

Other countries included in the report are Germany (18%) and Switzerland (25%). The share ownership percentages for these countries includes both direct and indirect share ownership. Indirect share ownership refers to ownership of shares through managed funds. In terms of direct share ownership, 37% of adult Australians own shares directly.

Although absolute comparisons are difficult (due to different data collection periods, sources, methodologies, weighting treatment, etc), the findings show that total share ownership in Australia has grown by 47% since 1997. Only Germany among the 10 sample countries has grown faster, increasing, from a low base, by 100% over the same period.

The report also provides details on the profile and behaviour of the shareowners from the featured countries. It found that share ownership increases with rises in education, and household income and assets, and that financial planners and the media are among the most popular sources for share information and advice for Australians.

The International Share Ownership report can be viewed at:
http://www.asx.com.au/about/pdf/ASXInternationalShareOwnershipSummary03.pdf

(V) UK PARLIAMENTARY COMMITTEE RELEASES REPORT ON THE UK GOVERNMENT’S MAJOR REVIEW OF COMPANY LAW

The UK House of Commons Trade and Industry Committee has released its report on the UK Government's major review of company law in that country. The Government White paper was published July 2002 and titled "Modernising Company Law'" (see the July 2002 issue of this Bulletin for a summary of the White Paper). Since the publication of the White Paper, the Higgs Report on the Role and Effectiveness of Non-Executive Directors was published (see the February 2003 issue of this Bulletin for a summary of the Higgs Report) and this report was also considered by the Trade and Industry Committee. Following are the conclusions and recommendations of the Committee. The report is available at:

http://www.parliament.uk/commons/selcom/t&ihome.htm

(1) Directors' duties

We consider that the aim of the law should be to provide a framework to promote the long term health of companies, taking into account both the interests of shareholders and broader corporate social and environmental responsibilities. The specific duties of care required of companies to their employees and society at large will normally best be set out in other legislation, covering areas such as health and safety, environmental and employment law. However, the proposed statement of directors' duties in the White Paper does represent a step forward as, for the first time, it explicitly recognises that good managers will have regard to a broader range of considerations than value to shareholders, which on its own may lead to short-termism. The White Papers' formulation leaves the responsibility to make decisions about the company's future where it should be—on the directors, not on the courts (Paragraph 22).

We see no need to include a duty to creditors in the statement of directors' duties. This statement is intended to lay out a broad, generic set of obligations and not a detailed list of the legislation which directors might be required to adhere to under certain circumstances (Paragraph 25).

(2) Higgs Review

We welcome the Higgs Review. The proposals are modest but can contribute to good corporate governance standards in the UK, whilst the 'comply or explain' principle ensures that they should be flexible enough to avoid being seen as overly prescriptive. Interpretation is important, however, and the boards of companies must approach the proposals in an objective and sensible fashion in order to adopt those suitable to them and adapt those that need to be 'tweaked'. Similarly, though, failure to comply should not be taken as a negative sign by investors, providing it is accompanied by an adequate explanation that shows how governance standards are not compromised by the decision. It is important that the proposals are not interpreted so flexibly that they lack substance, nor so rigidly that they become a straitjacket (Paragraph 49).

(3) Non-Executive Directors: multiple directorships

The emphasis on fulfilling the duties of NEDs rather than setting down mandatory limits on their commitments is in keeping with the general approach adopted throughout the Higgs Review and we broadly support this approach. But, it is important that the flexibility built into the Higgs proposals is not abused and this will need to be monitored carefully by the Financial Services Authority as guardian of the Combined Code, and by the Department of Trade and Industry. We are confident that such monitoring will take place, given the concerns about multiple directorships expressed to us by key interest groups (such as the IMA) and the welcome given to the Higgs proposals by bodies such as the ABI and the National Association for Pension Funds (Paragraph 49).

It has been suggested that the Higgs proposals will result in NEDs having to commit more time to their work and that remuneration will need to increase accordingly. The Higgs Review suggestions for increasing the supply of NEDs would help to alleviate the problem. But for the most part Higgs is not proposing much that is not already adopted as best practice by many companies. Given this, it is hard to see how the time commitment of those NEDs who have already been doing their jobs thoroughly will increase significantly. There must be concerns about whether those who feel they cannot meet the time commitments were fulfilling the duties required of them (Paragraph 48).

(4) Non-Executive Directors: recruitment

We believe that there is scope for recruiting NEDs from outside the usual, narrow pool. Some could be found among younger business people with direct commercial experience, others among those with still relevant but broader experience. In fact, it might be that the introduction of those with backgrounds different from those of the existing, thoroughly homogeneous pool of NEDs could introduce fresh thinking and an element of dynamism to company boards (Paragraph 35).

(5) Directors: training

It is important that attitudes towards training of directors change. Relevant experience is clearly fundamental for directors but their professional development should not stop merely because they have reached board level. However, this attitudinal change can only be realised if training provision is available. The Institute of Directors now runs a chartered directors programme, but this is the exception and directors' training (as opposed to training in management, for instance) remains scarce. We hope that the Higgs Review can act as a stimulus to both the provision and take-up of training for all directors (Paragraph 38).

(6) Effect of Higgs proposals on company boards

We recognise that the Higgs proposals could have different implications for larger and smaller fully listed companies. In order to comply with the provision that boards should have a majority of NEDs, smaller listed companies may not be so willing to appoint senior managers to the board. We consider the wider representation of the Executive Directors on the Board to be a particular benefit to companies and therefore suggest that the situation is kept closely under review by the Government. We would be concerned if the effect of the Higgs proposals was to encourage smaller listed companies to relist on the AIM where overall it would be shareholders' protections that would be diminished (Paragraph 47).

(7) Reporting by companies

(a) Environmental and social reporting

The proposed Operating and Financial Review (OFR) would be a marked improvement on current minimum reporting standards. It would help to give a much more rounded, clearer view of both past operations and future prospects of companies. It would be of benefit not only to shareholders and potential investors in companies, but also to all those concerned with wider aspects of company behaviour, whether as employees, local residents, or as interest groups involved in environmental/social issues or general corporate governance (Paragraph 69).

We believe that in practice directors will not be able to get away with assuming that environmental and social concerns are not relevant to their company and can be passed over without comment; we think that, in this area too, companies will be expected by investors and monitoring groups to "comply or explain". We would also be concerned if the effect of these proposals concerning the production of an OFR were to support a 'box ticking' attitude amongst companies. We recognise the concerns expressed by some witnesses over whether the division into "core" and "other" matters would in effect downgrade the latter, but we consider that there will be pressure (from investors and others) for companies to raise their standards of reporting to those set by the pioneers in this area. In this context, we agree with the view expressed by the TUC that company law alone cannot be expected to change corporate culture: without active shareholders and other interest groups, unwilling or incapable directors would be able to nullify the effects even of statutory obligations (Paragraph 70).

There seems to be a discrepancy between what the advocates of greater Corporate Social Responsibility want from the auditing of OFRs and what auditors—and the Government—expect. Given the limitations on auditor responsibility even in respect of financial information, it would be unrealistic to expect auditors to assume greater responsibility for information that is qualitative and even less easy to verify than financial reports (Paragraph 68).

(b) Which companies should be required to produce OFRs?

To date there has been little private sector experience of the production of OFRs in the UK, and a number of companies are clearly anxious about what an OFR will be expected to contain, and the cost and difficulty of producing one. So on balance we prefer a gradualist approach, so that the details of what is required can be worked out with the largest companies and then the key aspects extended to smaller companies. We are therefore content with the thresholds for production of OFRs proposed in the White Paper (Paragraph 75).

(c) Penalties for failure to comply with reporting requirements

We agree that the effect of the law should be to encourage companies to make the proper disclosure in their annual report and accounts rather than merely to punish directors for failing to do this. We note that the current—criminal—sanctions have been little used. We therefore concur with the Government that administrative measures should be more effective in achieving disclosure. We also support the proposal to introduce a clear criminal offence of intent to mislead or deceive the auditors (Paragraph 79).

(8) Audit by the 'Big Four' accountancy firms

We believe that such an audit for many companies was always a status symbol rather than a sign of extra quality, as a number of accountancy firms are equally well qualified to audit most companies. We also think that greater competition in the market for accounting services would promote auditor independence and give a good basis for investor confidence. We therefore hope that institutional investors will not revert to putting pressure on smaller companies to use only one of the 'Big Four' companies on the basis of mere prestige; such an action would contradict many of their efforts in other areas to increase transparency, accountability and effective corporate governance overall (Paragraph 86).

(9) Provision of non-audit services by auditors

Although the evidence is necessarily anecdotal, it seems to us that there is a danger of audit services being used as a loss leader, not least because the lack of competition for auditing big and especially multinational companies must make it very difficult for even the most conscientious audit committee to determine a true market rate for the job. It therefore seems appropriate to limit the types of non-audit services provided by auditors (Paragraph 90).

We do not think there should be a ban on all types of non-audit work by auditors: some tasks could be carried out by auditors without undermining their independence, and potentially more efficiently than by bodies without the inside knowledge of company operations gained by auditors. We consider that the two principles described by the ICAEW are the key tests to determine whether or not non-audit work should be banned (Paragraph 91).

However, particular concerns have been expressed about the supply of expensive IT systems, especially financial control systems; and it seems to us obvious on first principles that external auditors should not also be involved in the provision of internal audit systems. We would therefore recommend a strengthening of the requirements in these areas. Beyond this, we are content that the details of the requirements should be filled in by experts (Paragraph 92).

(10) Regulation of auditors

For reasons of flexibility and maintaining a light-handed approach to regulation, we conclude that it should be the responsibility of an independent body to set standards to uphold the independence of auditors. If such regulation seems to be failing, however, we believe that the Government should re-consider whether it is necessary to impose statutory restrictions on certain types of non-audit work by auditors (Paragraph 94).

(11) Rotation of auditors

We welcome the recent changes to the rules on rotation of audit personnel and on the two year "cooling off" period for auditors. However, we are not confident that by themselves they will be sufficient to restore confidence in the independence of auditors (Paragraph 100).

We agree with the Co-ordinating Group that compulsory re-tendering could simply be an expensive but unproductive exercise. This option depends on the vigilance and independence of the company's audit committee to be effective; but, with a vigilant and independent audit committee, it is not necessary (Paragraph 101).

We are less inclined than some of our witnesses to worry about an increased likelihood of audit failure in the first two years of a new company's tenure. More convincing to us are the arguments about the difficulty of finding a new audit firm that does not have a conflict of interest over the provision of non-audit services, especially in the present uncompetitive state of the market. We therefore do not recommend mandatory rotation of audit firms. However, we do not think that it should be ruled out altogether: if the other measures taken both to increase the scrutiny of auditors by independent directors, and to encourage greater competition among audit firms, prove insufficient to restore confidence in the objectivity of external auditors, then compulsory circulation of audit firms should be re-considered (Paragraph 102).

(12) Audit committees

We agree that audit committees have a vital role to play in corporate governance, and that they should be the main channel of communication between auditors and shareholders via the full board. In order to be "the best practical proxy to the shareholders" for the auditors, such committees should be composed of non-executive directors who are not compromised by having had too close a relationship with the management of the company in the past, who are highly analytical, tough-minded and at least some of whom have had recent financial experience. So that the shareholders are kept as fully informed as possible, such committees should also make a full report to both board and shareholders on how they have exercised their function of scrutinising the auditors. In this context, it also makes sense for the chairman of the audit committee to attend the AGM to answer questions from the shareholders, as already provided for in the Combined Code. Finally, it is important for the members of the audit committee to be fully briefed about their special role, and companies should, where necessary, provide specific training for members of the audit committee to enable them properly to scrutinise external audit and internal control and risk management (Paragraph 107).

(13) Institutional investors

Ultimately, the primary concern of institutional investors is to maximise the returns on their investments. Whilst this may bring with it some pressure on companies hoping to attract funds from institutional investors to ensure that they have adequate corporate governance systems in place, there is a limit to the extent to which the institutional investors are willing or able to police the probity of the UK's companies (Paragraph 120).

(14) Revising Company Law in future

We recommend that, when the Companies Bill is eventually drafted in full, particular attention be paid to whether powers are being delegated appropriately, whether to Ministers or to other bodies; and we consider that, to assist in this, all proposed secondary legislation should be published at the same time as the primary legislation. We also recommend that any changes in the exercise of the most significant powers be subject to the Regulatory Reform Order procedure, which ensures both wide publication and more detailed parliamentary scrutiny than other forms of secondary legislation (Paragraph 126).

(15) Public availability of directors' home addresses

We sympathise with those who fear that directors' families may be made the target of extremist campaigning groups; but we are also aware that many people have concerns about unscrupulous company directors who operate on the edge of legality, and the fact that home addresses are on a public register provides some extra assistance in tracking down these people. We hesitate to recommend a further breach of the principle of transparency, not least because it is not yet clear whether the recent legislation to protect 'at risk' directors will be effective. We therefore agree with the Government that the situation should be kept under review (Paragraph 131).

(16) Misuse of registers of shareholders

There are valid reasons for maintaining public access to registers of shareholders; and we agree with the Government that it would be more effective to allow companies to refuse to provide copies of the register than to give them the right to try to recover any financial gain from illegitimate use of the information. We consider that, with the general background of data protection and human rights legislation, the courts will be able in practice to distinguish between appropriate and inappropriate use of information. We are concerned that it should be as cheap and easy as possible for companies to apply to the courts in such cases, and urge the Government to bear cost in mind when drafting these provisions (Paragraph 133).

(17) Disclosure of convictions by companies

We consider that it would be in harmony with the other proposed alterations to company law to increase transparency by requiring disclosure of convictions for breach of company law. We agree that, to ensure fairness, there should be a central register, but we see no reason why in addition companies should not be required to disclose such breaches themselves. Under the proposals on the provision of information in company reports and accounts, any failure by companies to make such disclosure would not be a further criminal offence but could be corrected by administrative measures (Paragraph 138).

2. RECENT ASIC DEVELOPMENTS

(A) ASIC ACTS ON CONFLICTS OF INTEREST

On 22 July 2003 ASIC announced the results of its program of reviewing related party disclosure documents sent to shareholders by public companies.

Under the Corporations Act (the Act), public companies need shareholder approval in order to give related parties a financial benefit that is not ‘at arms length’. The Act requires that a company must dispatch sufficient material to shareholders to enable them decide if it is in the interests of the company to pass the proposed resolution. The documents must also be lodged with ASIC before they are sent to shareholders.

In the 2002/2003 financial year ASIC conducted detailed surveillance on over 52 sets of documents and required amendments to be made in 39 cases.

Related party documents most commonly fail to place a value on options being issued to directors or other related parties. ASIC considers that shareholders must know the value of the proposed benefit in order to make an informed decision about whether or not to approve the related party transaction.

ASIC believes that it is best practice to calculate the value of the options in accordance with the valuation model contained in the International Accounting Standards Board’s Exposure Draft ED 2 ‘Share-Based Payment’. All material assumptions used in the model should be clearly disclosed.

Use of this methodology was recommended in ASIC media release 03-202, issued 30 June, (Valuing Options for Directors and Executives) in the context of disclosure in the directors report of the company.

Other information which is material to shareholders’ decisions about whether to approve a proposed grant of options or issue of shares to a related party will often include:

- details of other remuneration already being received by the related party,
- the extent to which shareholders’ interests will be diluted if shares are being issued or when options are exercised;
- the basis used for valuing any shares to be issued under the transaction;
- shares or options currently held by the related party; and
- the company’s share price history over the last year.

This information enables a shareholder to see the proposed benefit in full context.

It may also be appropriate to include an independent expert’s report on the proposed transaction. Directors should ensure that the expert is adequately qualified to provide the type of report being presented.

Additionally, ASIC has found that disclosure is often inadequate in situations where a company proposes to acquire a business from a related party. In such cases, ASIC considers that the law requires prospectus type comprehensive disclosure to be made to shareholders. This includes disclosure of the risks, the business’ track record, and any assumptions underpinning forecasts or valuations.

For further information contact:

Richard Cockburn
Director Corporate Finance
ASIC
Tel: (03) 9280 3201
Mobile: 0411 549 034

(B) GUIDE TO ORGANISATIONAL COMPETENCY OBLIGATIONS: RESPONSIBLE OFFICERS

On 22 July 2003 ASIC released a new licensing guide “Responsible officers: Demonstrating compliance with organisational competency obligations”.

The guide explains how applicants for an Australian financial services (AFS) licence can demonstrate that they comply with ASIC’s organisational competency obligations in Policy Statement 164 Licensing: Organisational capacities [PS 164]. The guide also explains how ASIC will assess the competency of nominated responsible officers, on whose experience licensees rely to meet these requirements.

PS 164 outlines five alternatives that applicants may use to demonstrate the competency of their responsible officers. This new guide, prepared by ASIC’s licensing analysts, addresses questions raised by different industry groups about how each of these alternatives is applied during assessment of licence applications.

The guide also clarifies that responsible officers for managed investment schemes do not need to meet the requirements of PS 164 unless they are providing financial product advice or financial services unconnected with operating the scheme. These responsible officers are instead required to comply with ASIC Policy Statement 130 “Managed investments: Licensing”.

A copy of the guide is available from the ASIC website at http://www.asic.gov.au or by calling Infoline on 1300 300 630.

(C) DEFECTIVE PROSPECTUSES

On 21 July 2003 ASIC provided an overview of its actions in relation to public fundraisings for the 2002/03 financial year. Since July 2002, ASIC has placed a total of 89 stop orders on defective prospectuses seeking to raise over $383 million from the public by the issue of securities.

ASIC intends that publication of the various defects identified in fundraising documents will assist issuers and the advisers who prepare these documents to adequately discharge their duties.

The most common defect was a failure by companies to clarify how the funds would be applied in the event that the company failed to raise the amount originally sought in the raising where it was not underwritten, nor subject to a minimum subscription condition.

Other common defects related to the adequacy of financial information disclosed in the fundraising document, and a lack of disclosure in relation to other material information, usually, the risks associated with the company’s current activities or the proposed venture. Defects relating to the use of financial forecasts in prospectuses were much lower than in previous years suggesting that most prospectus issuers are now familiar with ASIC’s policy statement on forecasts (Policy Statement 170: Prospective financial information).

ASIC considers inadequate financial information to include a failure to meet the specific disclosure requirements in offer information statements (see Policy Statement 157: Financial reports for offer information statements), and the adequacy of details about intangible assets.

Since ASIC last provided an update on its prospectus actions in April this year, ASIC has issued six final stop orders and revoked a further nine interim orders on fundraising documents that contained insufficient information for investors. Three other companies lodged replacement or supplementary documents, which addressed ASIC’s concerns, prior to the issue of an interim stop order.

Most final stop orders were issued with the consent of the relevant company, after they made the decision not to proceed with the particular prospectus, rather than to address the disclosure deficiencies.

For further information contact:

Richard Cockburn
Director Corporate Finance
ASIC
Tel: (03) 9280 3201
Mobile: 0411 549 034

(D) LATE DISCLOSURE OF FINANCIAL STATEMENTS

On 17 July 2003 ASIC announced the results of its campaign against listed companies that failed to lodge their financial statements on time.

The project was designed to detect and take action against listed companies which failed to lodge their half-year financial statements on time, or companies which failed to lodge their full-year financial statements on time, where they had a December 31 balance date.

ASIC issued 22 orders under section 713(6) of the Corporations Act against companies which were late, or failed to lodge their December half-year financial statements. A further five determinations under section 713(6) of the Act were issued against companies which were late, or failed to lodge their December full-year financial statements.

Orders under section 713(6) have two major effects. The first is that they require the companies to use a full prospectus, rather than allowing them the opportunity to rely on the shorter form of prospectus usually available for a listed company that has been complying with its disclosure obligations to the market.

The second is that companies are unable to avail themselves of some ASIC class orders which would otherwise assist in cheaper and quicker fundraising. Examples of these class orders are CO 02/1276, which allows placement of securities in the listed class to be on-sold within 12 months of the placement, and CO 02/831, which allows companies to offer up to $5,000 worth of securities in the listed class to existing members without a prospectus.

ASIC is considering additional enforcement action against those listed companies which have still not lodged their financial statements. The companies have a right of appeal against the orders to the Administrative Appeals Tribunal.

(E) ASIC’s INTERIM APPROACH FOR REGULATION OF MUTUAL RISK PRODUCTS

On 15 July 2003 ASIC announced its interim position in relation to the regulation of mutual risk products (MRPs).

MRPs are risk products that provide an alternative to conventional general insurance products. Generally, MRPs involve participation in a ‘mutual’ scheme based around particular professions, small business associations, franchise operations or community groups (MRP scheme). MRP schemes may cover a range of risks, such as professional indemnity and public liability risks.

‘In general, ASIC considers MRPs to be financial products for the purposes of the Corporations Act because they represent both facilities for managing financial risk and interests in a managed investment scheme. As such, ASIC generally expects MRP providers to comply with the managed investment scheme and licensing provisions of the Act’, ASIC Executive Director Financial Services Regulation, Mr lan Johnston said.

‘In specific, limited circumstances, ASIC will consider granting relief from the managed investment and licensing provisions of the Act’, he said.

The approach outlined in the information release is intended to provide guidance to industry about:

- the application of the managed investment and licensing provisions of the Act;
- the circumstances in which ASIC will consider granting relief from these provisions, and
- ASIC’s general approach to licensing people who provide financial services in relation to MRPs.

In the event that the law is amended, or its current position changes, ASIC will provide further guidance to industry.

(1) MRPs and MRP schemes

In general, there are two types of MRP schemes - mutual discretionary funds (MDFs) and mutual non-discretionary funds (MNDFs). Both these schemes involve members contributing money, which is then pooled and held by the person operating the scheme (the MRP provider).

The MRP provider uses the pool of money for purposes such as acquiring general insurance products (eg group insurance) to cover specified risks of the members and for paying claims by members up to a certain limit (such as the excess on the general insurance product(s), eg the first $200,000 of any claim).

The two types of schemes differ in that generally, MDFs only provide members with a right to have their claim properly considered - the payment of claims or provision of financial assistance is at the discretion of the MRP provider. MNDFs provide members with a right to have their claim paid, and the MRP provider has a legal obligation to pay members claims.

The approach outlined in the information release will apply in relation to all MRPs, regardless of whether the scheme involved is a MDF or a MNDF.

(2) Application of the managed investment provisions of the Act

In general, ASIC considers that MRPs are financial products because they represent interests in a managed investment scheme. As such, ASIC generally requires that MRP providers comply with the managed investment provisions in Chapter 5C of the Act.

ASIC has adopted the interim position that it will consider granting conditional relief from the managed investment scheme registration requirement in section 601ED of the Act, on a case-by-case basis, where:

- the MRP provider holds an AFSL with the necessary licence authorisations; and
- any money received as contributions for a MRP or assets held by the MRP provider as a result of these contributions are held on trust for the members by the MRP provider, only invested in an account held with an Australian authorised deposit-taking institution (AD1) or a cash management trust, or otherwise used to acquire general insurance policies on behalf of the members, pay claims by members or pay any remuneration of the MRP provider in accordance with its agreement with the members.

To qualify for conditional relief, applicants must apply to ASIC in accordance with Policy Statement 51: Applications for relief.

(3) Application of the licensing provisions

ASIC considers that MRPs are financial products because they represent facilities for managing financial risk.

In general, ASIC requires any person who carries on a business of providing financial services in relation to MRPs (such as MRP providers) to hold an Australian financial services licence (AFSL). The AFSL licence authorisations required will depend on the activities of the particular financial service provider.

For example, where ASIC has granted conditional relief from the managed investment scheme registration requirements (as described above), a MRP provider may require authorisations to:

- issue interests in a managed investment scheme;
- apply for general insurance products, deposit taking facilities of an ADI or managed investment products on behalf of members; and
- depending on the particular circumstances, provide custodial services by holding general insurance products, deposit taking facilities of an ADI or managed investment products on trust for, or on behalf of, members.

Applicants for AFSL's will need to consider which authorisations are appropriate for their particular circumstances and, where necessary, seek their own professional advice.

AFSL holders who provide financial services in relation to MRPs will be subject to the standard licence conditions set out in Pro Forma 209 Australian Financial Services Licence [PF209].

MRP providers will also be subject to an additional AFSL licence condition aimed at providing enhanced disclosure for consumers. This licence condition will require MRP providers to warn consumers of any risks related to MRP providers (and MRPs) not being prudentially regulated.

Specifically, this licence condition will require MRP providers, when issuing or offering to’ issue MRPS, to inform consumers:

- that the MRP provider is neither authorised under, nor subject to the provisions of, the Insurance Act 1973;
- that the MRP is not a product regulated by APRA; and
- of the extent to which the MRP provider will ensure that it has adequate financial resources to pay future claims by members.

MRP providers must provide this warning to all retail and wholesale clients.

When applying for an AFSL, applicants should clearly state whether they provide financial services in relation to MRPs and, if so, describe the nature of the ‘financial services and scheme(s) involved. This information will assist ASIC in considering licence applications.

ASIC will only consider granting relief from the licensing provisions in Chapter 7 of the Act to address atypical or unforeseen circumstances and unintended consequences of those provisions.

The criteria that ASIC will apply in considering applications for relief are those set out in Policy Statement 167 Licensing: Discretionary powers and transition [PS 167.3-167.12]. Applications for relief should also comply with Policy Statement 51: Applications for relief.

For further information contact:

Pamela McAllster
Director FSR Legal & Technical Operations
ASIC
Tel: (03) 9280 3450
Mobile: 0402 426 956

(F) ASIC REGULATION OF PROMISSORY NOTES

On 14 July 2003 ASIC announced the release of an FAQ to assist issuers of promissory notes in understanding their obligations under the Corporations Act. The FAQ provides guidance on the circumstances when promissory notes are likely to be regulated as financial products.

A promissory note is an unconditional promise by an issuer to pay an agreed sum of money at a fixed or determinable future time to, or at the order of, a specified person.

Generally, where an offer involves just a promissory note with a face value of at least $50,000 and no other special features, it will not be regulated under the Corporations
Act. However, ASIC notes that some issuers are seeking to rely on the promissory note exemptions under the Act by offering complex investment arrangements involving promissory notes to retail investors. In some cases, although an offer involves the issue of a promissory note, the rate of return and the financial risk to retail investors varies or is dependent on the performance of certain investments.

ASIC believes that these arrangements are likely to be financial products and therefore regulated under the Corporations Act, requiring licensing and disclosure. In particular ASIC is concerned about complex arrangements involving promissory notes that:

- are accompanied by other promises about how the money loaned may or will be repaid;
- may reasonably be considered to express or contain a representation or agreement that the investment returns will be produced by an underlying specific investment or the performance of some specific commercial activity;
- are not liquid, cannot be easily traded and are not designed to raise short term finance to manage day to day liquidity issues; and
- are directed primarily at the retail clients.

For example, an arrangement is likely to involve the offer of financial products if investors’ money (raised through the offer of promissory notes) is used to partly fund the purchase and development of property and investors are led to understand that repayment is dependant on the success of the development.

(1) Promissory notes

(a) Is a promissory note arrangement where each note has a face value of more than $50,000 a financial product?

Generally, a simple promissory note with a face value of more than $50,000 would not be a financial product. Other promissory notes may either be a debenture or another sort of financial product, as set out below.

(b) Is a promissory note with a face value of more than $50,000 a debenture?

A financial product that is just a promissory note with a face value of more than $50,000 is not a debenture.

However, ASIC considers the exclusion of promissory notes from the definition of debenture only includes those instruments that are simple promissory notes or similar debt instruments (such as Negotiable Certificates of Deposit), which do not have any other significant obligations or undertakings arising from the note or other instrument. These types of instruments meet the definition of promissory note contained in the Bills of Exchange Act 1909.

(c) Is a promissory note with a face value of more than $50,000 another sort of financial product?

Even if not a debenture, if the person who is issued the note has been led to understand that the payment under the note will be produced by the use of the proceeds of the note issue in a common enterprise or from a pool to produce those benefits, the note may be an interest in a managed investment scheme. If the managed investment scheme has more than 20 members or the promoter is in the business of promoting managed investment schemes, the interest will be a financial product.

Also if the person who is issued the note, or the issuer intends that the proceeds from the note issue be used to enable the payment under the notes, then the notes could also be a facility for making a financial investment. Generally such a facility will also be a financial product.

For further information contact:

Pamela McAlister
Director FSR, Legal and Technical Operations
ASIC
Tel: (03) 9280 3450
Mobile: 0402 426 956

(G) COURT UPHOLDS APPEAL BY NICHOLAS WHITLAM

On 10 July 2003 the New South Wales Court of Appeal upheld the appeal by former NRMA Limited President Mr Nicholas Whitlam, in relation to findings made against him by Justice Gzell of the Supreme Court of New South Wales in July 2002.

ASIC commenced its action against Mr Whitlam believing that his failure to vote proxies in accordance with members’ directions did not result from mistake or inadvertence.

After hearing the evidence at the trial, Justice Gzell concluded that Mr Whitlam deliberately sought to override the intent of NRMA members and that he had acted dishonestly. These findings, together with His Honour's view that Mr Whitlam posed a risk of repeated misconduct, were factors considered when he imposed the five-year ban and pecuniary penalty last year.

The Court of Appeal overturned the orders made against Mr Whitlam.

‘We are naturally disappointed by [the] result’, ASIC Chairman, Mr David Knott said.

‘The decision appears to hinge primarily on legal questions directed to the capacity in which Mr Whitlam acted when he dealt with the proxies. The Court of Appeal was not satisfied that ASIC adequately established that Mr Whitlam’s conduct constituted a breach of his duties as a director of NRMA. The Court considered that ASIC’s pleadings did not adequately deal with this legal issue’, he said.

‘On the other hand, it is clear that the Court did not rule out the possibility that Mr Whitlam’s failure to sign the poll paper was deliberate’, Mr Knott said.

‘In the circumstances, ASIC will need to carefully review the judgement before determining our future position on this case. Over the next three weeks we will be considering with Counsel whether an application for special leave to appeal to the High Court should be made’, Mr Knott said.

The decision of the Court of Appeal is reviewed in Item 4(B) of this Bulletin.

(H) COURT UPHOLDS PENALTIES AGAINST HIH DIRECTORS

On 8 July 2003 the New South Wales Court of Appeal (Justices Mason, Giles and Beazley handed down its decision on the appeals by former HIH Insurance Limited director, Mr Rodney Adler, and former HIH Chief Executive Officer Mr Ray Williams, against the findings of Justice Santow of the Supreme Court, that Messrs Adler and Williams had breached their duties as directors of HIH Casualty and General Insurance Ltd. The Court upheld Mr Adler’s appeal against the finding that he had breached section 183 of the Corporations Act (wrongly using information obtained as it company officer) but confirmed all other breaches decided by Justice Santow against Mr Adler and Mr Williams.

The Court also upheld the bans, pecuniary penalties and compensation ordered against the defendants, subject to a recalculation of the interest component of the compensation. The Court awarded costs of the appeal to ASIC (which are additional to the approximately $600,000 costs payable to ASIC in relation to the original proceedings).

(1) Background

In March 2002, Justice Santow found that Mr Adler, Mr Williams and former HIH Chief Financial Officer, Mr Dominic Fodera, had breached their duties as directors under the Corporations Act, in relation to a payment of $10 million by an HIH subsidiary (HIH Casualty and General Insurance Limited) to Pacific Eagle Equities Pty Ltd, a company of which Mr Adler was a director.

As a result of the decision, Mr Adler was banned from acting as a director of any Company for 20 years. Mr Williams was banned for ten years.

Mr Adler and Adler Corporation were each ordered to pay pecuniary penalties of $450,000 (totalling $900,000). Mr Williams was ordered to pay pecuniary penalties of $250,000 and Mr Fodera was ordered to pay pecuniary penal ties of $5,000.

In addition, Messrs Adler and Williams were ordered to pay compensation of $7,986,402 to HIH Casualty and General Insurance Limited. The Court of Appeal has ordered that the interest component of that sum be recalculated.

The decision of the Court of Appeal is reviewed in Item 4(C) of this Bulletin.

(I) TOWER AUSTRALIA TO REPAY INVESTORS

On 4 July 2003 the Federal Court of Australia gave judgment and made orders in proceedings brought by ASIC against Tower Australia Limited (Tower). Tower consented to the orders and will reimburse investors who have been underpaid for their investments in Tower’s Blue Ribbon Products.

The Court declared that Tower had engaged in misleading and deceptive conduct since early 1993, by sending:

- annual statements of account to some investors that recorded incorrect redemption or withdrawal benefits; and
- letters (either attaching a cheque or confirming a direct deposit into a nominated account) to some investors incorrectly stating that the amount of the cheque or the deposit represented the sum total of the investors’ redemption or withdrawal benefit.

Tower estimated that the cost of repaying policyholders is about $600,000, and has made provision in its accounts for that amount.

The Court has ordered Tower to send notices (if it has not already done so) to affected investors advising them that, as a result of computer error, they may have received incorrect surrender values and/or withdrawal amounts.

The Court also noted ASIC’s acceptance of an enforceable undertaking on 19 June 2003 from Tower stating that Tower will:

- repay any shortfall (plus interest) to investors who have fully redeemed their investments;
- correct the entitlements of investors who have partially redeemed their investments;
- take all reasonable steps to ensure that all redemption advices, and redemption and withdrawal amounts are correct;
- use its best endeavours to rectify the computer error; and
- not take any action against investors who may have been overpaid.

Tower has also undertaken to conduct an internal review to ensure that financial products similar to the Blue Ribbon Products are not similarly affected by computer error.

The orders follow an ASIC investigation into complaints alleging that surrender values shown in annual statements for the Blue Ribbon Products were incorrect. Tower has cooperated with ASIC throughout the investigation, and took steps to address ASIC’s concerns.

(J) ASIC GUIDELINES: USING PAST PERFORMANCE FIGURES IN INVESTMENT ADVERTISEMENTS

On 3 July 2003 ASIC released final guidelines on the use of past performance information in investment advertisements.

Key guidelines include that:

- advertisements using past performance information should include a five-year return figure (or the longest period available for newer funds);
- information about returns should be balanced with information about risks;
- all past performance figures are up-to-date; and
- important information should not be buried in fine print.

Other key guidelines include that:

- promoters should not give undue prominence to past performance information;
- promoters are encouraged to show performance compared to a benchmark or their peers;
- returns should be calculated after all on-going fees have been deducted; and 'simulated' past performance figures should only be used in very limited cases.

Research on the use of past performance information shows that:

- it is used in advertising for many products in the financial services industry, especially when recent returns look good;
- promoters choose varying methods for showing past performance, resulting in poor comparability;
- advertisements rarely include information about the risk or volatility of the promoted investment; and
- academic research commissioned by ASIC indicates past performance is a weak and unreliable predictor of future performance over the medium to long term.

Copies of the guidelines are available from the ASIC website at http://www.asic.gov.au

(K) VALUING OPTIONS FOR DIRECTORS AND EXECUTIVES

On 30 June 2003 ASIC issued final guidelines about the way Australian listed companies should include values of options in the disclosure of directors’ and executive officers’ emoluments in their annual directors’ reports for reporting years ending on or after 30 June 2003.

All listed companies are required to comply with their obligations under section 300A (1)(c) of the Corporations Act.

The final guidelines take account of the comments ASIC received in response to its draft guidelines, which were issued for comment on 7 May 2003.

The guidelines cover the valuation methods to be applied, as well as when to include option values for the purpose of emolument disclosures. ASIC has drawn on the International Accounting Standards Board’s Exposure Draft ED 2 Share Based Payment (ED 2), which provides an appropriate basis for valuing options and allocating their value over time.

The Australian Accounting Standards Board issued ED 2 as an Australian exposure draft (ED 108) and recently announced its intention to issue an accounting standard requiring remuneration disclosures in financial reports to include amounts relating to option values on the same basis as outlined in ED 2.

The ASIC guidelines require the options to be valued at the time they are granted and then to have that value apportioned over the period from grant date to vesting date. The options must be valued at market if they are listed, or by a valuation method that meets the requirements of ED 2 and ED 108 and the method chosen should be disclosed in the directors’ report.

The guidelines do not deal with the expensing of options or other share based-payments in the financial statements. This matter will be resolved by the issue of a final accounting standard by the Australian Accounting Standards Board. The disclosure in the directors’ report is a Corporations Act disclosure requirement that is not covered by Accounting Standards.

The option valuation principles in ED 2 and ED 108 have been applied to facilitate a more consistent approach to option valuations for meeting disclosure requirements under the Act. However, all entities preparing financial reports under the Act are also encouraged to apply the guidelines, in determining the amounts shown as remuneration of directors and executive officers, in their annual financial reports for the purposes of current accounting standards.

The guidelines are available on ASIC’s website at http://www.asic.gov.au

(1) Guidelines to valuing options in annual directors’ reports

These guidelines outline how listed Australian companies should include values of options in disclosures of directors’ and executive officers’ emoluments in their annual directors’ reports for years ending on or after 30 June 2003. They do not deal with the recognition in the financial statements of an expense in relation to options or other share-based payments.

(a) Directors’ report disclosure

All listed companies are required to comply with their obligations under section 300A(1)(c) by disclosing the value of emoluments relating to options in their directors’ reports.

Companies are not relieved of their statutory obligation merely because they regard the calculation or disclosure as being too difficult or onerous. Disclosure ensures that shareholders are properly informed as to the full value of the remuneration of individual directors and executive officers.

These guidelines have been issued to assist companies and directors in discharging their existing statutory disclosure obligations. If companies do not disclose the full remuneration, including option values, ASIC will consider action against the directors pursuant to section 344 of the Act.

Paragraph 60 of ASIC Practice Note 68 New financial reporting and procedural requirements (PN 68) states that listed companies must include options issued to directors and executive officers in the disclosure of emoluments of each director and each of the five executive officers receiving the highest emoluments under section 300A(1)(c) of the Corporations Act 2001 (the Act). Issued in 1998, PN 68 indicated that ASIC did not intend to prescribe methods for dealing with the accounting or valuation methods for options.

The International Accounting Standards Board’s Exposure Draft ED 2 Share-Based Payment (ED 2), released on 7 November 2002, now provides a basis for valuing options and allocating those values over time. It is appropriate to draw on ED 2 for the purposes of the disclosure of emoluments of directors and executive officers under section 300A(1)(c).

The Australian Accounting Standards Board (AASB) is committed to adopting International Financial Reporting Standards (IFRSs) and has issued ED 2 as Exposure Draft ED 108. The AASB proposes that a standard be operative for years beginning on or after 1 January 2004, the same time as proposed for the corresponding IFRS. The AASB has also recently announced it proposes that its forthcoming Accounting Standard ‘Director and Executive Disclosures by Disclosing Entities’ requires the disclosure of an individual’s remuneration for a reporting period include the amount recognised as an expense for that year in accordance with the accounting standard based on ED 108.

(b) Value of options

ED 2 and ED 108 provide clear guidelines on the types of option valuation models that can be applied and ASIC considers that these models can be applied to value all types of options granted to directors and executive officers.

For the purposes of s 300A(1)(c), listed companies should now value exchange-traded options at their market price at grant date, consistent with ED 2/ED 108. Other options should be valued as at their grant date using an option-pricing model that takes into account all of the six factors specified in ED 2/ED 108 and the other guidance on valuing options contained in ED 2/ED 108. The six factors are:

(i) the exercise price of the option;
(ii) the life of the option;
(iii) the current price of the underlying securities;
(iv) the expected volatility of the share price;
(v) the dividends expected on the shares, and
(vi) the risk-free interest rate for the life of the option.

ED 108 says that the expected life, rather than the contracted life, shall be used for non-transferable options.

In determining the amount to be disclosed as remuneration over time, where appropriate, allowance should be made for amounts payable by the director or officer for the option.

It is expected that companies will already know the value of options previously granted. Any decision by directors in relation to the granting of options and the level amount of emoluments provided to directors and executive officers must have been made having regard to some measure of the amount of the emoluments being provided and assessed as appropriate for the level and performance of the services provided by the individuals concerned. Directors should therefore have determined option values at grant date in order to discharge their fiduciary obligations in granting those options. Where Part 2E.1 of the Act requires member approval of the issue of options, ASIC already insists that explanatory material sent to members pursuant to section 218(1) include the value of the options, the terms of the options, the basis of valuation, key assumptions affecting the value and the total remuneration package of the individuals concerned. Where that information is not included, ASIC will issue written comments that it considers the information essential to a decision by members. The company is required to send those comments to the members.

Currently, the valuation methodologies applied for determining emoluments are likely to reflect a range of diverse valuation approaches. To determine whether they need to change their approach, individual companies should benchmark their current valuation models against those in ED 2 and ED 108 to ensure that they reflect these valuation principles. These guidelines, by addressing when options are to be valued, the periods in which the values are disclosed, and referring to the limited range of models that cover the factors identified in ED 2 and ED 108, will result in greater consistency in including option values in emoluments under section 300A.

(c) When to disclose amounts as remuneration

ED 2 and ED 108 propose that an expense be recognised in relation to options over the period from grant date to the vesting date. For options that vest immediately, the value is recognised as an expense at grant date.

ED 2 and ED 108 recognise that some employees in a group of employees participating in an option scheme may not be expected to complete the full period of service required for options to vest. They also recognise that actual service may differ from that originally expected. As a result, certain adjustments are required to the amounts allocated to each financial year from grant date to vesting date using the units of service approach. That approach may be appropriate in the context of the cost of services of a group of employees where differences in the expected service lengths of individual employees may not materially affect the amount expensed in any period.

However, section 300A deals with the remuneration of individuals, and it is usually difficult to estimate when a single individual will cease to be a director or executive officer with any accuracy. Hence, for the purposes of measuring the remuneration of an individual for disclosure in the directors’ report, it should be assumed that the individual directors and executive officers will continue to provide service until the vesting date, unless it is probable that the particular individual will cease at an earlier date.

That is, for the purposes of section 300A disclosures, the value of an option at grant date is to be allocated equally over the period from grant date to vesting date (the vesting period) unless it is probable that the individual will cease service at an earlier date in which case the value is to be spread over the period from grant date to that earlier date. For options that vest at grant date, the value is disclosed as remuneration immediately.

Consistent with ED 2 and ED 108, changes in the value of options after grant date are only required to be included as emoluments when they result from changes to the contracted terms and conditions of the options made by the issuing entity. In that case, emoluments should include the change in the value of the options.

Remuneration should not be reversed if the options are forfeited before vesting or not exercised after vesting.

(d) Other disclosures

Subsection 300(1)(d) of the Act requires directors’ reports of all entities reporting under Chapter 2M of the Act to disclose details of options granted to directors and executive officers as a part of their remuneration and specifies the details to be disclosed.

In addition, listed companies are encouraged to disclose information as to how option values have been determined (including the model used, inputs to the model, historical and expected volatility, the risk-free interest rate, expected dividends, assumptions on vesting, how performance conditions have been taken into account and other significant assumptions affecting the value), a description of the basis of recognising the options over time, and the grant and vesting dates of the options.

(e) Transitional arrangements

These guidelines do not provide any transitional adjustments to amounts to be disclosed as remuneration under section 300A in the first year that the guidelines are applied. Such transitional adjustments would be inappropriate as section 300A is a pre-existing requirement intended to provide information as to the full annual remuneration of directors and executives.

Hence, these guidelines apply to all options, whether granted before or after the guidelines are issued, that had not vested prior to the commencement of the first financial year to which the guidelines apply.

No adjustment should be made to emoluments reported in the first financial year that the guidelines apply:

(i) to exclude amounts reported as emoluments in prior financial years that are required by the guidelines to be reported as emoluments in the current year, or

(ii) to include amounts that would have been reported as emoluments in prior financial years had the guidelines been applied in those prior years but which were not previously reported.

In adopting the guidelines, companies may include option values as emoluments at different amounts or in different financial years compared to their previous approach. This approach may result in some companies reporting amounts as emoluments in more than one year or some amounts n