Market Misconduct

In Australia the corporate regulator, the Australian Securities and Investments Commission (ASIC), can institute criminal proceedings or civil penalty proceedings against directors and officers for a range of breaches of the Corporations Act 2001 (Cth) (the Corporations Act). This is the central piece of legislation which governs the duties of those who direct or manage corporations in Australia (beyond the common law and equity) and it imposes a range of sanctions against those who misinform the market and for general corporate misconduct.

In recent times, there has been a spike in criminal prosecutions instituted by the regulator in Australia against individual directors and officers, along with a steady continuation of enforcement action taken by way of civil penalty proceedings. This is a trend we expect to continue. Whilst both enforcement options are instituted in order to establish a contravention of the general law and to obtain the imposition of an appropriate penalty, it has often been said that a civil penalty action is "quasi-criminal". However, the High Court of Australia has recently confirmed that "a civil penalty proceeding is precisely calculated to avoid the notion of criminality as such"1. Irrespective of the form in which such claims are brought, insurers will continue to have to grapple with 'the old chestnut' of whether a conduct exclusion is enlivened, which is a question that depends on an examination of the nature of the conduct and factual findings ultimately made.

We set out below a statistical analysis of these regulatory litigation trends, against the background of the Senate Economics References Committee Report released on 27 March 2017: 'Lifting the fear and suppressing the greed: Penalties for white-collar crime and corporate and financial misconduct in Australia' (the Senate Report).

At this stage it is not clear which recommendations from the Senate Report will be progressed in the Australian Parliament, but significant reform is expected. We expect harsher financial penalties and other sanctions to be imposed on individuals and corporations – particularly for civil penalty offences - to bring Australian enforcement into line with community expectations and trends in global markets.

Lifting the Fear and Suppressing the Greed

The Senate Report is focused on penalties for white-collar crime and corporate and financial misconduct in Australia. It is the product of a referral from the Upper House of the Parliament of Australia for an inquiry into inconsistencies and inadequacies of current criminal, civil and administrative penalties for corporate and financial misconduct or white-collar crime.

A key recommendation from the report is that the Australian Federal Government gives consideration to increasing the current level of civil penalties for market misconduct offences. That recommendation is predicated upon submissions received from the public expressing the view that current monetary penalties are inadequate. A central submission relied upon by the Committee in relation to the inadequacy of penalties was of the Australian Shareholders' Association, which pointed to the disparity between the maximum civil penalty of AUD200,000 for individual directors and officers for breaches of duty on the one hand, and executive remuneration levels on the other. It was also found that current civil penalty levels are out of step with international equivalents.2

Regulatory Litigation Trends

The penalty regime found in the Corporations Act is important to assist in promoting investor confidence and market integrity. ASIC has said that on average it has 96 matters under investigation at any one time.3 Not all of those matters proceed to enforcement action through the Courts. Before going down a civil penalty or criminal prosecution route (the most severe enforcement tool), ASIC has a number of enforcement avenues available to it which range in severity, including education programs, enforceable undertakings and infringement notices. These tools may enable stakeholders to engage with the regulator at an early stage to reach a swift and inexpensive resolution compared with Court action.

Not all matters are capable of such an early resolution. The table below sets out the number of civil penalty matters against individuals that have been commenced by ASIC compared with the number of criminal prosecutions referred to the Director of Public Prosecutions in the past three years,4 up to the end of the first quarter in 2017:

The data demonstrates that Australia has had its fair share of corporate scandals in recent years, and that criminal penalties have overtaken civil penalties as the primary vehicle by which the regulator seeks to combat white collar crime. In those cases, the standard of proof (beyond reasonable doubt) is higher, and as such, only the clearest of cases are likely to be confined to such a vehicle.

The criminal matters in the above table overwhelmingly capture traditional white collar-crime. This was considered in the Senate Report as "financially motivated non-violent crimes committed by businesses or individuals acting from a position of trust or authority."5 They include matters such as insider trading, fraud, engaging in phoenix activity, dishonest use of position to gain an advantage, the making of false and misleading statements to ASIC, individuals acting as directors whilst disqualified, embezzlement, falsifying books and records and so on.

However, the table also includes matters where the regulator has a choice to make as to the vehicle with which to pursue a penalty. For example, ASIC has for many years been keen to ensure market integrity by taking action to deter and punish those involved in making a misleading disclosure to the Australian Securities Exchange (ASX)6 and/or the non-disclosure of material information7 to the market in contravention of the ASX listing rules.8 Whilst both are civil penalty offences, individual directors can also be pursued criminally for aiding, abetting, counselling or procuring the commission of an offence by the corporation which they manage or direct.9 Such matters are also included in the above analysis.

One observation we can make is that following the regime introduced into the Corporations Act in 2004 allowing ASIC to issue an infringement notice and impose a financial penalty to avoid future action by ASIC, there were very few cases in which ASIC pursued a director for a criminal penalty for breaches of the continuous disclosure requirements. However, that has started to change.

For any individual that has committed an offence of aiding and abetting a continuous disclosure breach, and leaving aside the possibility of a term of imprisonment being imposed, there is no discretionary Court ordered disqualification (as may be the case when civil penalties are pursued). If convicted, the individual will be automatically disqualified from managing a corporation for a period of five years.10 This compares with discretionary disqualification where a director or officer is pursued for a civil penalty breach.

In civil penalty matters generally (irrespective of whether they involve the continuous disclosure provisions of the Corporations Act), the Court is able to exercise a discretion, with orders ranging from life disqualification to much less (for example, between a few months and 3 years).11 Factors which tend toward longer periods of disqualification involve large financial losses combined with dishonesty and intent to defraud. From the insurer's perspective, these are the cases that are easiest to decline cover, but at the other end of the spectrum (e.g. disqualifications of up to three years), the factors can be quite different in terms of personal gain (or lack thereof) and contrition / remorse. These cases can involve contravention over a short period of time, which results from negligent conduct by the corporation or an individual, rather than deliberate or reckless conduct.12 In those cases, an insurer may (depending on the nature of the claim, factual findings and specific policy terms and conditions) be required to indemnify.

The more difficult cases are those which attract the benefit of cover for part of the claim. Those are the ones in which insurers and the insured may find themselves having to consider and attempt to negotiate on what would be a fair and equitable allocation of defence costs. These costs can be financially crippling for the individual defendant and may also involve the insurer having to secure assets at an early stage in case it needs to exercise a clawback right.

Predicted Reforms and Impact on Insurers/Insureds

Significant reform is expected following release of the Senate Report. In the words of the Committee:

"Providing an overall assessment of the adequacy and consistency of current penalties for white-collar crime and misconduct is not straightforward. Just as the types of wrongdoing that might be considered white-collar crime and misconduct are extremely varied, so too are the penalties available in relation to that wrongdoing. However, the committee agrees that, broadly speaking, there appear to be serious inadequacies and inconsistencies in the current penalty framework."13

Those inconsistencies are illustrated by the broad discretion for disqualification in civil penalty matters and the automatic disqualification consequences in certain criminal matters, with the potential for a civil penalty contravention to be met with a longer disqualification period.

One clear expectation we have is that the reform process will address current perceived inadequacies in the penalty framework, including increased financial penalties for non-criminal matters (currently only AUD200,000 for an individual and AUD1million for a corporation). No specific penalty amount has been recommended by the Senate Committee, but it has urged the Australian Parliament to have regard to penalties in other jurisdictions for similar offences.14 The current flexibility for ASIC to pursue civil and criminal proceedings will also remain but tougher civil penalties could equate to an increase in civil penalty actions.

Any increase in the quantum of penalties will also have the consequence of increasing exposures for insurers if such penalties are capable of being indemnified. In the regulatory litigation environment, insurers will continue to have to engage proactively with conduct exclusions and advance defence costs along the way.

This article was written with the assistance of Matthew Blake, paralegal.


1. Joint judgment delivered by French CJ, Kiefel, Bell, Nettle and Gordon JJ on 9 December 2015 in Commonwealth of Australia v Director, Fair Work Building Industry Inspectorate; Construction, Forestry, Mining and Energy Union v Director, Fair Work Building Industry Inspectorate [2015] HCA 46.

2. Other recommendations made in the Senate Report relate to increasing clarity around evidentiary thresholds in litigation procedure in civil penalty proceedings, enhancing accessibility to registered of banned and disqualified individuals and increasing ASIC's disgorgement powers where misconduct has resulted in illegal gains by a company or individual.

3. ASIC's Market Integrity Report: July to December 2015.

4. These are the matters we are aware of sourced from public records. The statistics do not include enforcement proceedings commenced against corporations. For the purposes of our current analysis we have focused only on individual directors and officers.

5. As above.

6. See sections 1309(1) and 1311(1) Corporations Act.

7. Information is material if a reasonable person would expect it to have a material effect on the price or value of the entity's securities.

8. See section 674(2) of the Corporations Act.

9. See s 11.2 of the Criminal Code.

10. Section 206B of the Corporations Act.

11. See ASIC v Adler (2002) 42 ACSR 80.

12. See ASIC v Chemeq Limited [2006] FCA 936 and French J's non-exhaustive list of influential factors in considering penalty.

13. Senate Report, para 2.47.

14. Senate Report, para 6.52.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.