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Regulators failing to stop corporate collapses

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Regulators failing to stop corporate collapses

ASIC

ASIC and its predecessor regulatory bodies have been slammed for “ineffective policing of the rules” which, according to academic research, may have directly contributed to high-profile company failures.

Dr Richard Lane, a chartered accountant and PhD graduate from James Cook University, used his research thesis to examine the factors that contributed to unexpected corporate collapses over the last 50 years, in a bid to unearth similarities and trends between them.

His findings serve as a wake-up call for regulatory bodies: Dr Lane determined that while ASIC, in particular, has adequate laws and powers to protect Australians from reckless and irresponsible company directors, those powers have consistently been underused.

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According to Dr Lane, ASIC, which he noted was formed in 1998, and other regulators have presided over company laws that are “not totally enforced at the investigative level and not always at the judicial level, where the penalties do not necessarily fit the crime”.

“I found five main causes of corporate collapses, roughly falling in two groups of either mismanagement or fraud,” Dr Lane said.

“The significant finding was that despite the strengthening of legislation, regulations and standards designed to combat them over the past 50 years, the five main causes continued to occur.”

Dr Lane noted the recent banking royal commission’s findings, which criticised the regulator for taking a negotiable approach to compliance.

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He quoted the commission as stating that “negotiation and persuasion, without enforcement, all too readily leads to the perception that compliance is voluntary. It is not”.

Enhance, rather than abolish, ASIC

Despite his findings, the researcher poured cold water on suggestions that ASIC should be scrapped and a new regulatory body created in its place for a fresh approach to company regulation and oversight.

“This is nothing new. Attempts to institute and reform corporate regulators have been going on since the early 1960s. There have been Senate inquiries, special committees and changes of name for the watchdog. In my view, it’s just more of the same window dressing,” Dr Lane said.

Instead, he petitioned for additional government funding for ASIC as well as “a more critical investigative approach by ASIC [and] the imposition of the existing penalties by the courts” as a more favourable outcome.

“My research clearly shows a need for a strong corporate watchdog. I would urge the federal government to provide the funding and resources to enable ASIC to do their job for the protection of all Australians,” he said.

ASIC response

Approached for comment on the findings, ASIC referred My Business to its previously published ASIC update on implementation of royal commission recommendations, dated 19 February 2019, in which it noted “the royal commission identified ASIC’s enforcement culture as the focus of the change needed at ASIC”.

The royal commission also identified that ASIC had acknowledged the need for that change and had already initiated action to do so,” the update said.

In October 2018, ASIC adopted a ‘why not litigate?’ enforcement stance and publicly committed to that posture going forward.

The regulator also referred to ASIC chair James Shipton’s presentation to the Senate Economics Committee last week which outlined the establishment of a separate Office of Enforcement within ASIC” to boost its enforcement action, as well as a recent speech delivered by commissioner Sean Hughes, who said that ASIC will have a greater focus on court-based outcomes to provide strong public denunciation and punishment of wrongdoing”.

Reasons for corporate collapse

Dr Lane’s PhD thesis — seen by My Business — explored eight high-profile corporate collapses over the five decades to 2010:

  • Reid Murray Holdings Ltd
  • Stanhill Development Group
  • H.G. Palmer Ltd
  • Mineral Securities Ltd
  • Cambridge Credit Corporation Ltd
  • Bond Corporation Holdings Ltd
  • HIH Insurance Ltd
  • ABC Learning Centres Ltd

In determining what caused their failures, he looked at the official reports and results of formal investigations by “court-appointed inspectors, receivers and managers, liquidators [and] administrators”, as well as academic and industry literature.

The research identified a total of nine primary factors that caused these collapses:

  • Lack of provision for bad debts and bad debt write-offs
  • Misleading statements in the prospectus or financial statements
  • Excess borrowings and lack of a repayment strategy
  • Conflicts of interest or related party transactions
  • Borrowing short, investing long
  • Incorrect valuation and allocation of assets
  • An active Ponzi scheme
  • Lack of disclosure
  • Rapid expansion that lacked structure

Five of those factors were found to be common to all eight case studies. They were:

  • Misleading statements in the prospectus or financial statements
  • Excess borrowings and lack of a repayment strategy
  • Conflicts of interest or related party transactions
  • Lack of disclosure
  • Rapid expansion that lacked structure

Dr Lane’s report noted that the commonalities appeared despite the fact that their failures took place over the span of 50 years, “thus clearly demonstrating that although legislation, regulation and standards strengthened over the 50 years covered by the case studies, the five main causes continued to occur”.

“In all of the eight case studies in this thesis, the agent strongly deviated from the principal’s interest. The more the corporate entity moved closer to collapse, the more agents were acting in their own self-interest,” the report said.

“If the agents thought they would be detected promptly and punished severely, it could be argued that the outcome may have been different. However, in the summaries of the case studies regarding legal and professional changes, the indication is that while there have been some changes, the underlying causes of collapse remain.”

The report concluded by calling for further research into three key areas:

  • A more detailed look at commonalities present among the causes of corporate failures
  • A look at Transitional Control Loss (TCL) and whether founders or CEOs undermine the overall performance of the company
  • The method used to appoint auditors
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Regulators failing to stop corporate collapses
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