Capital Markets Volatility - Assignment Example

BULAW5915 Name: Lecturer: Course: Date: [WORDS 3027] [REFERENCING APA] Question 1 (a) In instances of capital markets volatility and problems related to corporate debt disclosure by listed companies, there is a need to revise and strengthen corporate governance frameworks with the view of solving these issues. This is pursuant to s292(1) of the Corporations Act 2001 (Cth) that specifies that all public companies and disclosing entities must prepare and present financial report for each financial year. In broad sense, corporate governance defines a set of systems applied in directing and controlling companies or listed entities. In a narrow sense however, it defines the rule and regulations used in governing capital markets with relation to public disclosure of accounting or investments in listed entities (Anon, n.d.). Based on this background, weak regulations of the capital markets allow organisations to engage in unorthodox practices in order to survive during share market volatility (Teen, 2012). Poor governance frameworks and lack of transparency increase uncertainty in share market (Mugaloglu & Erdag, 2013). Strengthed corporate governance frameworks give the board the mandate to oversee how managers run a listed entity as well as how members of the board should be accountable to the shareholders and investors hence underpinning the efficiency and integrity of financial markets (Transparency International, 2009). Under the common law, corporations are considered to have no mind of their own mind and hence must have persons who direct its mind and who disclose the circumstances underlying its governance as was held in the case Lennard's Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915]. In addition, competent price formation is essential for control of share price volatility (Mugaloglu & Erdag, 2013). In this sense, having a strengthened corporate governance and transparency are critical for better performance of stock markets. In particular, having transparency and a strengthened corporate governance framework enable investors to engage in competent share price discovery, where all related information instantaneously reflects to the share prices (Mugaloglu & Erdag, 2013; Sabri, 2002). As the court explained in the case In the Matter of Caterpillar, Inc SEC Rel. No. 34-30532 (1992), information must be presented to investors that give them a complete picture of the organisation as well as allow them to see the company through the eyes of the management. In all, there is a need to strengthen and revise corporate governance. (b) The principle of disclosure and transparency is essentially concerned with ensuring proper disclosure of material matters of a listed company such as information on financial performance and status, company governance and investment. In a sense, there should be more stringent regulations with disclosure requirements. Indeed, directors owe shareholders the duty to disclose corporate finances as was demonstrated in the case law Malone v. Brincat 722 A.2d 5 (Del. 1998), where the court held that directors have a fiduciary duty to communicate honestly -- both directly or publicly -- to the shareholders on matters concerning corporate matters with honesty. A survey by Leuz and Wysocki (2006) found that substantial advantages of corporate disclosure such as ensuring market liquidity and transparency justify the need for stringent disclosure requirements even when policy regulators are convinced that the costs could outweigh the benefits of stringent regulations on disclosure requirements. Indeed, stringent requirements ensure that corporate governance is implemented ensuring disclosure. Strengthened corporate governance is also able to create conditions conducive to the success of corporations. In addition to private cost-benefit of firms, it could be argued that stringent regulations promote economy-wide cost saving. For instance, subsistence of externalities that arise from company’s individual disclosure can lead to disclosure levels that are sub-optimal. Stringent regulations with disclosure can work as a commitment device. Lack of commitment to disclosure on the part of listed companies may be an incentive to withholding or manipulating information in situations when they face economic hardships or poor performance (Rbidocs, n.d.). Accordingly, the companies are expected to benefit from the disclosure as they will ultimately bear the cost of non-disclosing or withholding information. Based on this perspective, the benefits of stringent regulations for disclosures are obvious (ASIC, 2001). Lack of stringent regulations on disclosure requirements have been blamed for the collapse of eminent firms. In Australia for instance, the key reasons cited for the fall of HIH insurances was lack of disclosure and accountability of performance (LongDog & Associates, 2011). Based on these reasons, it is critical that policy makers should come up with stringent regulations to encourage efficient governance practices and transparency. Such regulations should demand that companies comply with principles of corporate governance. When such companies achieve high corporate governance ratings, they become more transparent and as a result act in accordance with the regulations for public debt disclosure (Das, 2011). To conclude, there should be more stringent regulation with disclosure requirements. Question 2 General defence should be introduced for directors and company officers to replace the statutory business judgement rules existing under Section 180(2) of the Corporations Act 2001 (Cth) to ensure realistic, effective and rational utility of defence. According to this section, business judgment is defined as any decision to be taken or not, regarding issues relevant to the operation of a corporation. In this respect, it appears apparent that there is a need to have a subject element to the section in preference to the objective comparison of a person who is considered to be reasonable. Such provisions can be provided by a general defence (Adams, 2004). Statutory business judgment rule seeks to provide directors with a defensive shield in ascertaining whether they made a decision in good faith. It provides that directors need not consider legal uncertainties of the decisions and actions they take continuously. Rather, they should focus on carrying out rational decisions that facilitate responsible taking of risks and innovation (Byrne, 2006). Despite the well-intentioned rationale, statutory business judgment has limited judicial coverage at common law given its stringent objective nature in addition to its imperious requirements. It dependence on “hypothetical reasonable person” positions a director in a similar judicial position such as specified under Section 180(1) of the Act. In effect, this means that defence is not used effectively and realistically. Therefore, there is a need to introduce general defence to ensure realistic, effective and rational utility of defence. Indeed, under the provisions of Section 180(2)(c) a director should be informed on the subject matter of a decision to a level that can be believed to be appropriate reasonably. A Court will often be willing to consider the rationality of “care and diligence that company officers and directors undertook in making a decision as well as to determine rationally whether the action was appropriate. In narrow sense, it should be viewed that it is difficult to consider that the Court will favourably examine executed decisions that are linked to risks. In this sense, there is a need to introduce general defence (Byrne, 2006). In addition, it can be argued that such difficulty indicate the deficiency of statutory business judgement as the intrinsic nature of risk-taking in entrepreneurship call for an assessment of accessible information ahead of undertaking such risks (Anon, n.d.). Clearly, the creation of objective assessment of a director’s decision-making process serves to solely indicate the procedures undertaken in coming up with a decision. Towards this end, it is arguable that such has essential component of “hindsight review” that question the rationality of an undertaken decision in view of an unfavourable outcome. Such only serve to offer no practicability to a company director or officer seeking to resolve liquidation through entrepreneurial risk capable of saving a company from an imminent collapse. In most cases, corporations facing financial hardships or which are experiencing steady financial decline often need a high degree of entrepreneurial risk to save the company from falling or to sustain shareholder value. Due to this, undertaking statutory business judgment would make such actions or decisions to seem irrational or nonsensical (Byrne, 2006). Further, statutory business judgment serve to create great assumption that favour a corporation’s board of directors and hence liberating members from likely liability in cases where actions or decisions that are harmful to a company are taken. Section 180 considers that when directors make decisions that do not involve their direct interest, then they are acting in good faith and in the best interest of the corporation. In brief, this implies that directors or company officers are not to suffer any legal consequences even when they make or undertake harmful decisions (Leuz & Wysocki, 2006). However, a key concern is that the doctrine may operate as a “safe harbour” for directors who are careless and negligent of the duty of care. General defences could however avoid such scenario. In this case, general defence should be introduced as it can guard against the possibility of director making honest business decisions that may be harmful. General defences perceive all actions and decisions should be subject to scrutiny despite one’s position in the corporation (Byrne, 2006). To a large extent however, business judgement is too objective making the Court’s decision to be less realistic. Therefore, there is a need for general defence to be introduced to replace the statutory business judgement as this will ensure realistic, effective and rational utility of defence. Question 3 The decision by the House of Lords in the matter of Regal Hastings v Gulliver [1942] should be disputed as it omitted the arguments on the conflict of interest and duty of directors and equitable principles. Several facts were also overlooked. In the case, the directors were able to escape liability for negligence because of the provisions for director’s duty of care at that time. Further, unsuccessful claim was also made against the directors for money that they had received. This further shows inconsistency of the ruling as fraud had to be established to determine a common law claim to the profits of the directors as the directors had received the funds through a form of fraud. In any case, fraud was not proved or pleaded (Nolan, n.d.). In the case, there was an omission of argument based on equitable principles. The House of Lords failed to consider that company directors are like any agent of a company and where they cannot be allowed to make any profit through their position of being agents without the consent of their principal. Indeed, such an argument was ignored without any reasonable explanation. However, such an argument could have had a weighty influence on the course of the case. Additionally, the ruling seemed to have omitted the argument on the conflict of interest and duty of directors. Such conflicts of interests seemed to have been overlooked basing on the duty of the directors of Regal to organise finance for the company by subscribing shares worth of £5,000 in Amalgamated and their personal interests in investing for their personal gains in Amalgamated. Similarly, such argument could have had profound impact on the course of the case (Nolan, n.d.). There was also conflict of interest in the selling the cinema to Oxford & Berkshire Cinemas Ltd. The total sale that was allocated between the shares in Amalgamated and Regal on the basis that the leases that Amalgamated held were valued at £15,000 free of burden and that that Regal held was valued at £77,500 free of burden, there was no explanation on where the £15,000 originated. However, the judges acknowledged that it originated from Colonel Burton who was expected to purchase some cinemas and that the directors accepted the money on behalf of the Amalgamated and Regal. However, it may as well have been the other way round. Such arguments were also overlooked (Nolan, n.d.). The ruling also appears to have failed to involve the question of authorisation for alleged conflict of interest of the directors. Although this concern had been raised in the initial pleading, it was omitted in the written judgment. Consideration of such conflicts of interest has the potential to influence the course of the case. Although they may seem harsh to apply, it can be argued that they do not restrict a director from making profit in isolation. Rather, they restrict him from making unauthorized profit. Indeed, based on the principle of business judgment, a court will not impede an honest business judgment as held in the case Shlensky v. Wrigley (1968). Although it may have appeared harsh to restrict a director from profiting personally from the circumstances where they had conflict of interest or where the profit originates from their position, it is actually not harsh to restrict such activities where there is an absence of authorization or permission. Indeed, under the common law, such rules on conflict of interest are intended to protect the principal of the director in situations where the principal appears to be at risk: Smith v. Van Gorkom (1985). Based on this argument, it is indeed clear that the judgement on the Regal case failed to take into account the issue of authorisation. Additionally, the question of the significance of authorisation method in the fiduciary doctrine was also overlooked (Nolan, n.d.). Additionally, in the defences of the initial directors or Regal, they cited Article 22 of the company where it was observed that the House of Lords would make reference to the article. However, the pleading was misconstrued. For instance, in the correct creation of the article, it gave the directors authority make contracts acceptably with Regal as well as to participate in the profits of such a contract on condition that certain procedures were taken. However, such was irrelevant to what turned out in the offing since the directors were not contracted with Regal (the plaintiff). Additionally, the directors did not participate in the profits of contract. However, the judges failed to take this argument into account in their judgment. Therefore, the decision of House of Lords in the matter of Regal Hastings v Gulliver (1942) is disputed. Question 4 In the case Sons of Gwalia Ltd v Margaretic (2007), the High Court held that shareholders who had claimed to have been persuaded to purchase shares just before its insolvency through misrepresentation and insufficient disclosure had the right to bring an action for damage claims as creditors “external in the administration of a corporation”. However, the Court narrowly construed the provisions of statutory subordination of s563A of the Corporations Act 2001 (Cth). The ruling in the case offers significant protection to shareholders and their rights as it paves the way for shareholders to make claims in company insolvency by depending on provisions for misrepresentation and general statutory market disclosure. The judgement however elevated the shareholder claims against corporations that are insolvent allowing them to rank evenly with creditors who are unsecured hence may have adverse effects on handling damage claims (Hargovan & Harris, 2007). This essay disagrees with the High Court ruling as it has various adverse implications. The challenges that faced insolvency administrators as a result of the ruling in the case are not similar to the challenges raised by the group of creditors who claimed damages for misrepresentation and which is not linked to share purchases. This is since the judgment in the case recognised that the shareholders suffered loss due to the flawed disclosure practises of the company. This may therefore be allowed to bring an action for “proof of debt”. As demonstrated in the case Henville v Walker (2001), a shareholder who claims for damages must demonstrate that indeed loss or misconduct occurred. In this case, while misrepresentation claims would normally involve individual and fewer claimants, claims for shareholder misrepresentation would normally involve several hundreds of claimants. Such would result to delays. The case of group shareholder claims as noted in the case Sons of Gwalia Ltd v Margaretic (2007) is a proof. This shows the resultant effects on the efficiency of an insolvency system. Hence, the case is likely to delay or hamper the efficient administration of the insolvency laws because of delays and huge expenses. For this reason, this essay supports the amendments to the Corporations Act 2001) (Cth) that are based on the case of Sons of Gwalia to reduce the complexity and costs of insolvency administration and to reduce the potential of abusing the corporate insolvency laws (Hargovan & Harris, 2007). Additionally, this essay agrees with the amendments to the Corporations Act 2001) (Cth) that were provided by the Corporations Amendment (Sons of Gwalia) Act 2010 (Cth). In the case of Sons of Gwalia, the Court established that Section 563A of the Act failed to subordinate some compensation claims by shareholders who are below the claims of other creditors “external in the administration of a corporation” (Parliament of Australia, 2010). It further determined that shareholders who had been exposed to losses and had bought shares induced by misrepresentation or insufficient disclosure should be ranked equally with unsecured creditors. As demonstrated in the case Wardley Australia Ltd v State of Western Australia (1992) there has to be evidence that loss occurred due to the misstatement. Without the amendments, it is likely to hinder the capacity of external administrators to make claims against the corporation efficiently. It is also likely to hinder the effective administration of insolvency laws through delays and huge expenses (Hargovan & Harris, 2007). Under the Corporations Amendment (Sons of Gwalia) Act 2010 (Cth), of section 536A) claims brought by an individual, rather than just the shareholder, against a corporation arising for purchasing or sale of shares is to be deferred in an external administration until all other claims have been paid. These facts were demonstrated in the case TSC Industries, Inc. v. Northway, Inc. (1976). In addition to the adverse effects of the ruling on decision of insolvency administrators, the ruling also has the potential to affect the Australian debt capital markets particularly in price estimation of corporate debt. Indeed, early researches on the effects of the case suggested increased credits on unsecured debt for companies in Australia (Duffy, 2011). In conclusion, although the ruling in Sons of Gwalia offers shareholders greater protection, it has several adverse effects on the insolvency system and should therefore be disputed. In any case, the amendments to the Corporations Act 2001) (Cth) that were provided by the Corporations Amendment (Sons of Gwalia) Act 2010 (Cth) should be preferred. References Adams, M.(2004). Whether to protect or punish: legal consequences of contravening the Corporations Act. Company Secretary, 592-598 Anon. (n.d.). Director’s Duties and ‘Good Corporate Governance.’ MatheyFolbigg Lawyers ASIC. (2001). Annual Insurance Council of Australia Conference. An address by Jillian Segal, Deputy Chair, ASIC, to the “Insurance Council of Australia Conference", Canberra, 9 August 2001 Rbidocs. (n.d.). Equity and Corporate Debt Market. Retrieved: Byrne, M. (2006). The duties and liabilities of persons below board level. Canberra Law Review, 9 (2), 45-64. Das, A. (2011). Can Government Secure your Investment? Retrieved" Duffy, M. (2011). Protection of Companies From Shareholder Class Actions Through Constitutional Amendment: Is This Possible Or Desirable? Bond Law Review 23(1), 69-87 Hargovan, A. & Harris, J. (2007). Sons Of Gwalia Ltd V Margaretic: The Shifting Balance Of Shareholders’ Interests In Insolvency: Evolution Or Revolution? Melbourne University Law Review 31, 591-261 Henville v Walker (2001) 206 CLR 459 In the Matter of Caterpillar, Inc SEC Rel. No. 34-30532 (1992), Lennard's Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705. Leuz, C. & Wysocki, P. (2006). Capital-Market Effects of Corporate: Disclosures and Disclosure Regulation. Canada Steps Up, 2. Retrieved: LongDog & Associates. (2011). How The Collapse Of Onetel And Hih Insurance Changed Corporate Governance In Australia. Discussion Paper 2011 Malone v. Brincat 722 A.2d 5 (Del. 1998) Mugaloglu, Y. & Erdag, E. (2013). Corporate Governance, Transparency and Stock Return Volatility: Empirical Evidence from the Istanbul Stock Exchange. Journal of Applied Economics and Business Research, 3 (4): 207-221 Nolan, R. (n.d.). Regal (Hastings) Ltd v Gulliver (1942). 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