Application of Corporate Law in Regulation of Financial Institutions: Bankisa Financial Group - Case Study Example

Application of corporate law in Regulation of Financial Institutions: Bankisa Financial Group Executive Summary Immediately after the First World War and the Great Depression (1930-1933) more than nine thousand banks failed in the United States. It was at this period that the role of the banks both economically and socially was discovered and as a recommendation corporate governance and regulation was made mandatory for financial institutions. The role played by financial institutions are very important and they include; safeguarding the savings of depositors, financing other institutions, boost the domestic bond, equities and securities markets and support the growth of the economy. In 2007 Australia experienced a downfall of more than half of its shadow banks and the main concern was how secure the investors and shareholders of the company was. The goal of corporate governance is to ensure there is sufficient protection of investors, the shareholders, potential residual claimants on the assets acquired and to maximize the value of the firm. It is on the premise of corporate governance that the paper will highlight the role of directors in corporate governance, who is accountable for fraud and unconscionable conduct of the company as well as management concerns that were highlighted as being the major cause of the downturn of Bankisa Financial Group. The efficiency of corporate governance can only be measured by the success of a company as well as the satisfaction of its shareholders, investors and creditors. Keywords: Australian Securities and Investment Commission (ASIC) Table of Contents Executive Summary 2 Introduction 4 What is the Situation at Bankisa Financial Group? 4 The Legal Nature of Bankisa financial group 5 Participation of Members in Internal Management of a Financial Institution 10 Introduction The most natural question to any person intending to start an organization or an institution is the place of corporate law in the financial institutions especially banks. Can an institution manage its business independent of any management structure? Persuasively corporate law cannot be diffused from management because it provides an adequate means to govern an organization or financial institution in a way acceptable to investors and controlling shareholders. A company according to the Corporations Act 2001 (Cth) is defined as a "separate legal entity independent from the promoters and shareholders". The separation of businesses into public or private institutions necessitated emergence of corporate law to regulate sectors that the state was not in direct control to ensure investor and shareholder confidence. A financial institution manages proprietor’s funds, investments, appointment of directors and executives as well as accountability to investors and shareholders. What is the Situation at Bankisa Financial Group? A class action suit against the Bankisa Securities and the Cherry Fund finance companies against the company directors and auditors were commenced in 2012. The Bankisa Investment Financial group was an unlisted debenture issuer that required investors to loan money for a fixed term at a specified interest rate with a trustee appointed to protect investor interests. Further Greg Medcraft, the Australian Securities and Investment Commission (ASIC) chairman announced the creation of a taskforce to check why shadow banks or financial institutions fail (ASIC, 2012). The failure of Bankisa can be attributed to non-disclosure of financial information to investors to make appropriate investment decisions. The debenture trustees appointed failed to monitor the investments, protect investor interests such as bad loans and liquidity problems. The loss incurred was about $650 million following the demand of its assets the investors and shareholders can only hope for compensation from the institution. Bankisa is just among other shadow banks and institutions that flopped in 2007 with more than half of debenture taking over $2 billion of ordinary investors’ savings (Klan, 2013). ASIC sought declarations to state that the institution breached its duties and obligations under the Corporations Act 2001 in exercising its duties and failure of being a responsible association as a Prime Trust institution. The directors are listed as defendants since they failed to act in the best interest or bona fide interest of the members of the Prime Trust. The directors failed to amend the company's constitution to pay a fee if the Prime Trust was listed on the Australian Securities Exchange (ASX) and failing to pay $33 million a listing fee out of the entire scheme asset. The other allegations are abuse of office by the directors in their official capacities leading to the collapse of the institution (Klan, 2013). The Legal Nature of Bankisa financial group A company in its legal definition is a separate and legal entity as was a rule developed in the case of Salomon v A Salomon & Co Ltd. The case establishes legal principles that a business once incorporated it becomes independent from the individuals who formed it (Hanharan et.al ,2012). This principle therefore implies that a company attains the same status as an independent human being. Bankisa therefore is a corporate institution since it has shareholder, even though it is unlisted, it is incorporated under the Corporations Act 2001. This can be seen in Bankisa's case that the shareholders are not liable for the debts and liabilities of the company hence no proceedings can be instituted against them by creditors to the bank (Salomon v Salomon). A company is liable for its debts, but where fraudulent conduct and corrupt practices are proved then the directors would be held personally liable as stated in Re Equitable Fire Insurance Company . This is limited if an individual recovers from a shareholder where there is proof that he was acting on behalf of the company. Liability is unlimited as opposed to its member’s liability which is limited and a member is only liable to the company and not to any individual creditor. The directors of Bankisa are sued because they acted on behalf of the company in financial transactions and the payment of listing fees. The failure to act by a company cannot be imputed on an abstract entity but the individuals who are vested with the powers of running the company (Tomasic, 2011) that is directors and managers. A financial institution can own assets and property since it is a legal entity. However the shareholders cannot directly claim any right in relation to the share of the company. In Macaura v Northern Insurance Co it was held by the court that a shareholder has no legal interest in the company's property and cannot insure it against theft damage or any other risk. Bankisa transacted business on behalf of its shareholders and acquired property, however the shareholders can during winding up or dissolution claim a share of the property by virtue of their legal interest. It is material to state that by Bankisa appointing a trustee, the trustee was to hold the property on behalf of the shareholders as beneficiary of the trust. The capacity to contract is important since banks and financial institutions once incorporated can initiate and make contracts in its own name. The bank can be made liable in negligence however a shareholder cannot be made liable for negligence of a bank unless he was also personally negligent. It can be implied that each and every penny deposited into Bankisa created a contract between the investor and company and failure to repay the amounts owed to them amounted to a breach of contract. The next question is to what extent does corporate law apply to criminal convictions? In the case of Thames Borough Council v Pinn & Wheeler it was stated that a company can be convicted of a crime except one that requires actual performance like driving a car and one in which the available remedy is imprisonment. Purpose and Lifting of the Veil of Incorporation Corporate governance has been understood as a concept whose aim is to protect investors vis a vis the company management (Shleifer & Vishny, 1997).Companies as well as banks are shielded by the corporate veil that operates as a shield and courts would not look beyond the facade of the company unless in some circumstances . This concept applies to financial institutions and that it can only be pierced through a statutory provision or common law provision such as fraud, sham and shame (Jones v Lipman) (Tomasic, 2011). The veil of incorporation in most occasions necessitates fraudulent conduct by companies because they know that they cannot be prosecuted unless a suit is filed hence acting as a shield and not a sword. The directors of a company are not usually known to investors unless the articles of association and memorandum are provided to the public. The directors are protected by the law however in the case of Bankisa the directors names were made public due to the unconscionable manner they handled the management and financial planning leading to a class action suit. The Corporations Act 2001 stipulates instances when a statutory instrument can be used to lift the corporate veil of incorporation. A critique to the concept of the veil of incorporation being used as a shield is that it fails to protect specific investors and shareholders because the directors are shielded by the veil unless certain conditions present it. On the other hand a major failure in the law in protecting investors is that it depends on the ownership structure that of protecting investors from managers or controlling shareholders (Bebchuk and Hamdani, 2009). Corporate law makes it difficult to differentiate between ownership and control and management depends on investor protection and the interference by shareholders (Cools, 2005). Who manages the company and who is liable for loss? Application of corporate governance is adopted from the agency theory that the shareholders act as principals and that they cannot monitor the actions and conduct of their agents (managers) effectively (Shleifer & Vishny, 1997). The agency relationship contemplated gives the managers discretionary powers to act but that they must act in the best interest of the company. One can argue that since a company is a separate legal entity then no individual can be held liable for any omission or breach. ' These individuals include directors, executives, non-executives who act on behalf of the company. The entire management though protected by the constitution of the company, they have duties and obligations imposed on them as the managers of the company. The duties are binding upon them and any form of breach would amount to a civil suit against them. It is important to state that those who act on behalf of the companies are entitled and given major powers to act in the best interest of the company. For instance a director is given powers to manage the business of the company and if he supersedes the powers (acts ultra vires )then he will be held liable for losses incurred by the company their action is satisfied by the shareholders as held in Bamford vBamford. The Bankisa directors are sued for failing to act in the best interest of the company even though the court do not usually have an interest in the internal management of the company. It is through the application of corporate law principles that corporate governance is achieved. The directors owe a fiduciary duty to the company and not to the individual shareholders of the company. Therefore a company can bring a suit as a plaintiff against its directors for failing to act according to their powers and duties. The duties include that of acting in the best interest of the company as a whole as stated in Re W & M. Roith Ltd , a duty to use their powers for purposes they were conferred. The most important duty is that of ensuring that a director avoids a conflict between his own interest and those of the company as held in the case of Aberdeen Railway Co, v Blainke Bros. The regulators have a duty to oversee management of banks and a breach of the duties creates individual liability for losses incurred due to those actions even though Bankisa was not regulated. A duty that is important to any financial institution is that the director must not make any profits personally in connection with the company. A director must be able to account to the shareholder for any amounts that are earned and the director has a duty not to retain any profits as stated in Cook v Deeks. Corporate law has raised standards for financial institutions to provide measures to deter improper conduct by directors of the company. The directors being sued for the failure of Bankisa include Geoffrey Grenville Skewes, Patrick John ,Godfrey, Nicholas Livingston Carr, Neil Stewart, and Peter William Keating. Participation of Members in Internal Management of a Financial Institution An institution cannot be managed arbitrarily because there needs to be an accountability mechanism to the members of that entity. It is stated that a member is one who is ascribed to the memorandum and whose name has been entered on the register. In Re Sticky Fingers Restaurant Ltd that one can call a meeting as per the articles of association and a director can apply to the court for a meeting to be held by the company . One of the accusations leveled against directors of Bankisa is failing to amend the constitution to ensure that the Members contributed a listing fee. It can be through these meetings that decision can be made and the failure of a person in authority to call for the meetings amounts to a breach of corporate law. Alteration to company constitutions is what gives directors powers to act as per the majority wishes and toe ensure that the company is effectively managed. Resolutions are an important aspect to any given entity and that any resolution passed must be reasonable in cases where it is held to dismiss a director or replace a director. A director cannot act independently and must act in consonance with the wishes of the members and this amounts to a breach. In corporate law the majority wishes will always prevail and that the courts have reiterated that if a company acts in bad faith then the courts will not interfere with it as was held in the case of Foss v Harbottle. This is because the company is the proper plaintiff for wrongs done to it and that the courts should not interfere with the internal management of the company (Roach, 2005). Further a member cannot say that the wrong was done if majority members consented and that the directors acted within their powers. This however cannot apply because the directors are directly responsible for the loss incurred due to their own faults. In the management of companies an important document "Articles of Association (AA)" spells out the internal management and the organization of the company. The articles once incorporated supplements the memorandum of association and where there are contradictions the memorandum prevails as stated in Re Duncun Gilmore & Co Ltd. The legal effect of articles of association is that it acts as a constitution of the company contract between the company and it member as was held by Hickman v Kent or Romeny Marsh Sheep Breeders Association. Corporate law provides that an individual can bring an action against directors who act contrary to their mandate or official duties in office. Further what is the place of an agency relationship in the banking industry and sector. The directors of Bankisa act as agents of the company and if they act against the relationship created the they would be personally liable for any wrong done by the company. A critique to the corporate law application is that it must be neutral to the ownership structure and give an upper hand to the controlling shareholders and managers to be in control and ensure that it remains committed not to erode investor confidence (Pacces, 2007). Financial Accountability in Banks Companies including banks both private and public have an obligation and duty in relation to financial statements and audits. This must be well written and recorded for purposes of transaction and giving the public the financial position that the company is doing well as well as the books must be well be prepared and audited. Bankisa failed to disclose to the investors the accurate financial position of the company to investors and therefore this was detrimental to the company financial standing. A share is defined as a unit of measure for the determination of a member’s interest in a company. It is a common practice that banks issue shares to Members of the public and investors in return they cede company interest to them. Different shareholders acquire certain rights such as control the company through voting rights, participation in profit distribution as well as in the participating in dissolution and winding up. There exist different classes of shares such as preference shares, and ordinary shares. A bank just like a company gives priority based on the different classes of shares to who has the greater interest in the company. A bank just like a company requires constant financing to meet its obligations of making profits. The shareholders are entitled to dividends out of the profits made by the company however it cannot return any capital to any of the members because it is a permanent liability of the company and protects the creditors. The mere fact that a shareholder exists in a company, a shareholder can sue the company and a directors for breach of obligations and duties. External regulators also can initiate proceedings for failure of a financial institution in protecting its investors. Conclusion In conclusion corporate law principles and concepts developed over the years is what gives institutions a legal status in the financial world. They cannot be diffused from management and applied individually but they are all applicable at all times and when they are breached a member has the right seek an order from the court to enforce the rights. It can be asserted that the courts have no interest in the internal management of the company, however where the decision is ultra vires then the court would act to protect that interest. References Australian Securities & Investments Commission (Wednesday, 31 October 2012( 12-262MR ASIC taskforce to review Banks and Regulation of debentures. ASIC. Retrieved from http://www.asic.gov.au/asic/asic.nsf/byheadline/12-262MR Bebchuk, L.A. & Hamdani, A. (2009) The Elusive Quest for Global Governance Standards. University of Pennsylvania Law Review, p.1263-1317 Bucheit, L. (2008) Did we make things too complicated? International Law Review (27) 3. p24 Cools ,S. (2005) The Real Difference in Corporate Law between the United States and Continental Europe: Distribution of Powers," Delaware Journal of Corporate Law. Corporations Act 2001 (Cth) Hanharan, P., Raksay, I, &Stapeldon G. (2012) Commercial Applications of Company Law, 13th ed, Melbourne:CCH limited Klan, A. (6, April 2013) Bankisia Securities investors recover more than hoped. The Australian Business on the Wall street available at: http://www.theaustralian.com.au/business/financial-services/banksia-investors Pacces, A.M., (2007) Featuring Control Power- Corporate Law and Economics Revised', PHD dissertation, Rotterdam Institute of Law and Economics, available at http://hdl.handle.net/1765/10907 Roach, L. (2005) The Legal Model of the Company and the Company Law Review, Company Law 26 Roman Tomasic (2011) Company Law Modernization and Corporate Governance in The UK- Some Recent Issues and Debates. Victoria Law School Journal Vol 1 Stephanie Ben-Ishai (2009) Bankruptcy in Canada: A Comparative Perspective. Banking & Finance Law Review. Canada 59 Shleifer, M. & Vishny, R.W. (1997) A Survey of Corporate Governance. Journal of Finance. P.737-783 Read More