Case Study Of Corporate Governance

1 Introduction The Australia corporate world has been shaken by the demise of another major company, the third such collapse in a matter of weeks. “One.Tel”, the country’s fourth largest telecommunications company (telco), ceased trading on the Australian stockmarket on May 28 and was put into the hands of an administrator after an investigation of the company’s financial situation showed it to be insolvent (Cook. T, 2001). The One.Tel collapse has lay off its 1,400 workers and also impacting on a host of small creditors owed thousands of dollars for goods and services. Many faced bankruptcy and, according to the reports, will receive nothing from the company windup. The fact that workers’ entitlements are under threat while the major creditors and company executives are protected is a further embarrassment to the government which is trying to overcome the hostility engendered by its big policies over the last five years (Cook. T, 2001). This assignment embarks on the issues leading to the collapse of “One.Tel” ; breaches of the corporate governance and persons involved; and how the breaches could have been avoided.

1.1

Company Background

One.Tel is the generic term used to describe a group of Australian based telecommunications companies, including principally the publicly listed One.Tel Limited (ACN 068 193 153) established in 1995 soon after deregulation of the Australian telecommunications industry (Media Coverage). The company was established by Jodee Rich and Brad Keeling who had secured large investments from Murdoch and Packer business empires (Media Coverage). One.Tel attempted to create a youth-oriented image to sell their mobile phones and One.Net internet services, with a slogan “You’ll tell your friends about One.Tel”, to draw the connection between the brand and personal communication. One.Tel also has a mascot

known as “The Dude1”. Large murals were printed upon the garishly-painted walls of company’s offices all around the world. Internally, the company had a fondness for applying the One.-prefix to everything relating to the business: One.Dude, One.Team, etc (Media Coverage). Chronological outline of One.Tel One.Tel was listed on the Australian Stock Exchange (ASX) not long after it was founded in 1995 to 2001. It went into voluntary administration on 29 May 2001 and into liquidation, upon a decision made by creditors in the administration on 24 July 2001. It began business in May 1995 with a total initial seed capital of approximately $5 million. The ownership structure of the company was: Optus 28.5%; FAI 18%; James Packer 5%; Kalara Investment 50% (approximately). Kalara Investment was owned by Jodee Rich and Brad Keeling (Media Coverage). PBL and New Corp’s support gave One.Tel credibility and cash base to fund it rapid expansion both domestically and overseas (Cook.T, 2001). The original thought process began with a simple initiative: they wanted to start a new telephone company, one that the average person would understand. The company was very people focussed and focussed on the residential market, as opposed to corporate business. They wanted the consumer or everyday person in the street, to have access to the entire suite of telephony products, which is why the company was marketed with the catch phrase “100% telephone Company”. One.Tel had three core product offerings: fixed wire long distance, Internet service provision and mobile telephony (Wikipedia). Its business expanded greatly and included operations in the United Kingdom and several other countries; it came to have 2.4 million customers world-wide including 500,000 in the United Kingdom. One.Tel came to do business reselling Optus Mobile Phone Services, reselling Telstra Local and Long Distance International Calls, reselling Telstra 1

The Dude was a cartoon-like depiction of a rather stupid man in his early twenties. His main role was to inform the public in television and print advertisements that even a stupid and lazy person such as himself could get a mobile phone with One.Tel (Media coverage)

Internet Services, selling pre-paid phone cards for long distance calls; and set about but did not complete constructing a mobile phone network of its own. A huge expansion of activities and liabilities was involved in constructing the network, including contracts committing expenditure of more than $1.1 billion with lucent Technologies. The Group associated with One.Tel employed 3000 persons throughout the world and had many subsidiaries. In 1999 News Ltd and Publishing and Broadcasting Ltd made investment around $1 billion in One.Tel. One.Tel experienced huge trading losses and reductions in net realisable value in 2001 up to 29 May 2001. During this period One.Tel incurred net trading loss of at least $92 million. In these months the liquidity position of One.Tel worsened by very large amounts; from a deficiency of $24.5 million on February 2001 to a deficiency of $98.7 million on 29 May 2001. The deficiency in liquidity precipitated the failure of One.Tel’s business. Facts were established on the deterioration which occurred in the financial position and performance of One.Tel from 1 January 2001 onwards. By 28 February 2001, One.Tel actually requires a cash injection at least$270 million to continue its existing operations and meet current and reasonably foreseeable liabilities, and the requirement for cash injection was at least $287 million by 31 March 2001. One.Tel would also incur additional indebtedness to Lucent Technologies of approximately $365 million for capital works relating to the construction of the network (NSW Supreme Court, 2003). At its peak, One.Tel’s strengths were recognised in consumer marketing and information systems, intuitive platforms and resources based on R&D in the Australian Next Generation Network, One.Tel continued to build quality, value for money telephony products and services while remaining a low cost provider (Wikipedia).

1.2

“One.Tel” Collapse

The company was specifically geared to making money through stockmarket speculation. Reports indicated the bonuses paid to Rich and Keeling were specifically tied to the rise

of the company’s share rather than profit or any other indicator of the overall viability of the company (Cook.T, 2001). One.Tel’s rapid expansion was way beyond its financial capacity coupled with its misguided management decision. It was also badly hit by the changes in the European network providers and more generally, One.Tel was caught up in the international collapse of dotcom ventures (Cook.T, 2001). The company’s high risk, low yield strategy, with generous incentives for new customers could not be sustained in the small Australian market which had six mobile phone providers – the second largest number of any country in the world 2 (Cook.T, 2001). The fatal flaw in the business model of the company was that the telecom services were offered to subscribers at lower than the price the company was paying for them itself. It could only survive as long as it could raise new capital investment more rapidly than it was burning money. Exhibit 1 provides an indication of the rate of worldwide growth that was achieved. However, this remarkable growth was taking place without regard to profitability or returns to shareholders, as Exhibit 2 demonstrates (Avison. D, Wilson. D. & Hunt. S). Exhibit 1: Growth of One.Tel Limited Year Ended 1996 1997 1998 1999 2000

Sales Rev. $ 65.0m 148.0m 207.0m 326.0m 653.0m

Subscribers 80,000 160,000 290,000 642,000 1,840,000

Source: Table 2-An IT Failure and a Company Failure: A Case Study in Telecomuncations (One.Tel Annual Report (2000)

Exhibit 2: Profitability of One.Tel Limited 2

The US, with a population more than 10 times larger than Australia, has seven mobile network providers. The UK and Germany have only three (Cook.T, 2001).

Period Year to June 1999 Year to June 2000 Half-year to Dec. 2000

Profit/Loss $ 9.9m profit* 295.9m loss** 132.0m loss**

Source: Table 2-An IT Failure and a Company Failure: A Case Study in Telecomuncations *One.Tel Annual Report (2000);**newssanviews14780(2001)

The first public indication that the company was in trouble was the resignation of Rich and Keeling. News Corporation and PBL initiated an investigation into company’s books and promised a $132 million cash injection aimed at reassuring the markets. However, the investigation found that the company needed at least $400 million to remain viable, the offer was withdrawn (Cook.T, 2001). One.Tel was declared insolvent in June 2001 and has since been liquidated3.

2 Who Killed One.Tel? The thread leading to the collapse of One.Tel including: inappropriate management compensation; creative accounting; failure of directors and managers to exercise due diligence; lack of adequate regulation; and lack of independence in audit function (Leung, P., Cooper, B.J., 2003).

Jodee Rich and Brad Keeling – Founder & Joint Managing Director Keeling and Rich used their marketing skills and unwavering positive public statements to promote the company and made assurance that One.Tel would have A$103 million at June 30 (Hopkins. N.,2001). Keeling did not fathom the true position of One.Tel; he wholly misunderstood the facts One.Tel’s financial position and performance. Rich, particularly, was misleading the market and shareholders by saying that the company is having big cash surpluses and heading to profits; and the company was on target to meet its subscriber numbers and gross profit projections. Through the last quarter of 2001, Rich gave the board and 3

The decision is reported as ASIC v Rich and Ors [2004] NSWSC 836.

directors James Parker and Lachlan Murdoch repeated upbeat assurances that the company’s cash position and profitability is improving (Exhibit 3) (Lampe A.,2004). Rich and Keeling were very much running the show at One.Tel, and they presented the accounts to Geoff Kleeman as they wanted him to see, large sum of money were being moved around the group between the subsidiaries to disguise the true situation (ABCLateline, 2001). Exhibit 3

According to former One.Tel Director James Parker, in August 2000 he asks Rich about One.Tel’s cash position. Rich told him One.Tel would “readily achieve” $115 million in cash holdings by the end of October and that the British operation “will start throwing off large amounts of cash. It will be a jewel and a cash cow” (Lampe A.,2004)

In financial year ended 30 June 2000 One.Tel reported loss of $291 million. The share price plummeted to below $1. Despite the loss, Rich and Keeling each received a $560,000 basic salary and a $6.9 million bonus (Media Coverage). Avison. D, Wilson. D. & Hunt. S contended that, Rich concentrated very much on the big picture. Cadzow (2001), suggested his attitude was “why bother with petty concern like faulty billing systems…when you can be thinking about global expansion”. Paul Budde, communications analyst, put forward two failure of management as the reasons for the collapse. Firstly, the decision to spend $1.2 billion building their own mobile network, which Budde, argued was just ego and macho on Rich’s part. Secondly, the state of the billing and debt-collection system, caused the company to go to the wall (Cadzow, 2001).

Mark Silberman – Finance Director He did not exercise powers with respect to the company with due care and diligence; allegingly misled the board as to One.Tel’s true financial position. One.Tel’s accounts

was kept by juggling the creditors, deferring payments of million dollars repatriating money from overseas subsidiaries.

John Greaves – Chief Financial Officer He fails to exercise his judgement with duty of care of an expert being a Chartered Accountant, with extensive background in finance function of public company and as chief financial officer at One.Tel. As a Chartered Accountant, he should be able to properly assess One.Tel’s financial performance and spot the discrepancies in the books thus alerted the board.

Rodney Adler – Company Director He dumps One.Tel’s stock in the tumbling market. He is known to have sold off 6 million One.Tel shares raising $2.2m after directors meeting on May 17 (Cook.T, 2001).

James Packer and Lachlan Murdoch – Board Directors Stephen Mayne (2001) reported, they are responsible for approving the bonus deals and pumping in hundreds of millions that triggered these very bonus payments which then helped destroy confidence in the company. James Packer sacked PBL chief executive Nick Fallon for questioning the One.Tel investment then hired a One.Tel spruiker in Peter Yates to take over. As board director, they did not exercise their rights looking after the One.Tel as they attended to the major parts of their multi billion empires. They should not have sat on the board when there is no way in the world they had the time to keep an eye on Rich and Keeling and hold them accountable.

3 Breach of Corporate Governance Issues 3.1

Laws Relating to Duties of Directors

Directors’ Duties The directors of a company are responsible for the management of the company’s business.4 Management encompasses not only the day-to-day running of the company’s operations but also the development an implementation of a long-term strategy; ensuring proper balance between the interest of various stakeholders; ensuring any activity concerning the company is carried out in the interest of the company (Kala. A, 2003). Directors, individually and as a board, bear the primary duty to carry out the corporate governance policies of the company. The

ASX’s

principles

of

Good

Corporate

Governance

and

Best

Practice

Recommendations summarises the responsibilities of the board: 1. Lay solid foundations for management and oversight, including its control and accountability system; 2. Structure the board to add value by ratifying, appointing and removing the chief executive officer (or equivalent), and the company secretary; 3. Promote ethical and responsible decision-making, input into and final approval of management’s development of corporate strategy and performance objectives; 4. Safeguard integrity in financial reporting, reviewing and ratifying system of risk management and internal compliance and control, code of conduct and legal compliance; 5. Make timely and balanced disclosure; 6. Respect the rights of shareholders; 7. Recognise and manage risk, approving and monitoring the progress of major capital expenditure, capital management, acquisitions and divestitures, and approving and monitoring financial and other reporting;

4

The actual division of powers is dictated by the internal rules of the company, including the articles of association of the company and the provisions of the Company Act itself (Kala. A,2003)

8. Encourage and enhanced performance, monitoring senior management’s performance and implementation of strategy, and ensuring appropriate resources are available; and 9. Remunerate fairly and responsibly 10. Recognise the Legitimate interest of stake holders (Eric Mayne, 2005 & Kala. A, 2003). Director’s duties can be found in common law and statute law.

Fiduciary Duties Common law and equitable duties owed by directors are collectively referred to as general law duties:  to act in bona fide in the best interest of the company – means to act in good faith, honestly without fraud or collusion. It is the obligation which trust law places on someone who must act in the best interest of another;  to exercise powers for their proper purposes – directors are required to exercise their powers for the purpose for which they were conferred. Thus, using a power granted by the legislation or the constitution of company for an ‘impermissible’ reason makes action void as abuse power. This is so even though the director honestly believed the action to be in the best interest of the company. Here the test is objective, not subjective as in the case of common law duty to act in good faith;  to retain their discretionary powers – the board must not, without express authority from constitution, or from statute, delegate their discretion to others. Nor can the directors simply accept the direction of others as to how they will vote at board meetings;  to avoid conflicts of interests - fiduciaries are not permitted to place themselves in any position where there is an actual or potential conflict between their personal interest and their duty to the company e.g. contracts with the company, personal profits and competing with the company; and  to act with care, skill and diligence – this is not a fiduciary duty. The duty of a trustee in respect of the skill and care required a much heavier one than that of a director. A director is expected to run a business aimed at making a profit and therefore must be

in a position to take risks to enhance the prospects of the enterprise. Directors are chosen because of their ability to make good business judgements (CPA). The legislative position of the Corporations Act 2001 (Cwlth) is set up as follows: •

Section 180 requires the Director or Officer to exercise a degree of care and diligence that a reasonable person would exercise in the Corporations circumstances, with a “safe harbour” for those who satisfy the “Business Judgement” rule.

•

Section 181 requires the Director or Officer to act in good faith in the best interests of the Corporation and for proper purposes.

•

Section 182 prohibits a Director or Officer from acting improperly so as to use his position to gain an advantage for themselves or someone else. Or to cause detriment to the corporation.

•

Section 183 precludes a person who obtains information because he is a Director, from improperly using that information to gain an advantage for himself or for someone else, or to cause detriment to the corporation.

3.2

Analysis of the Breach

Rodney Adler – Company Director Adler contravened his directorial duties as an officer pursuant to s. 180, 181,182 and 183 of Corporations Act 2001. He fails to ensure One.Tel make affordable expansion and loans and fails to ensure the company has a proper system of controls and audits in its business to avoid defalcations by other Officers and employees. Immediately after the directors meeting on May 17 2001, he sold off 6 million One.Tel shares raising $2.2 million. He did not care for the benefits of shareholders, company and employees of One.Tel. He is in for getting as much as he can before the company collapse. None of the “Business Judgement” rule nor acting in good faith matters to him. By selling his shares, he is using his position as a director in One.Tel to gain advantage for himself by using the information gained in the board’s meeting. He is using privileged information gained at

the board for trading in his own benefits and gains. It does not matter to him the implications or consequences to the company by his act of dumping One.Tels share.

Mark Silberman – Finance Director He fails to supervise One.Tel’s finances adequately and failed to keep the board informed and he might have fiddle with the accounts by simply juggling the creditors, deferring payments and repatriating money from overseas subsidiaries. And this had mislead the board of the actual cash flow of One.Tel.

John Greaves – Chief Financial Officer Greaves relied on the financial information supplied to him by others, including the executing directors. The financial information supplied to Greaves was limited and inaccurate in material respects. He fails to take reasonable steps to: •

promptly ensure that he and the board were aware of certain financial circumstances, including cash balances and the aging of debtors, in January, February and March 2001;

•

monitor the management of One.Tel to properly assess the financial position and performance and detect material adverse developments;

•

ensure that all material information was available to the board, particularly concerning the adequacy of cash reserves, and the actual financial position of various segments of the business; and

•

ensure that systems (billing and accounting system) (Exhibit 4) were maintained and monitored which resulted in accurate and financial information flowing from management to the board (Jaques.M.S.).

Exhibit 4: Excerpts from IT Failure and Professional Ethics:The One.Tel Case

One Senior accountant suggested that `The place was a joke. There are no structures, no accounting systems, no processes and no control` (Barry, 2002,p185). David Barnes, the group financial controller, finally resigned stating he was not prepared to do what his bosses were asking, and that he considered it completely unethical (Barry, 2002,p.255).

Being a qualified Chartered Accountant and with his expertise he should not rely on the information provided by others. He should take an active role in ensuring the accounts of the company has been correctly reported and the accounting system is in place and alert to Silberman’s act of keeping the accounts simply by juggling the creditors, deferring payments and repatriating money from overseas subsidiaries.

James Packer and Lachlan Murdoch – Board Directors Both, being otherwise engaged in their other more lucrative business empire. They did not monitor the business and left the running of the business to both Rich, Keeling and Silberman. They did not know the true financial position of the company and make judgement according to information or promises made by Rich. They further approved bonuses of $6.9 million to Rich and Keeling in financial year ended 30 June 2000 despite reporting a loss of $291 million. Packer sacked PBL chief executive Nick Fallon for questioning the One.Tel investment (Mayne S.). As a director, he should have been alert when Fallon question One.Tel’s investment and investigation should be carried out to verify the fact and financial status of the company.

Jodee Rich and Brad Keeling – Founder & Joint Managing Director As joint managing director, both failed to mange their responsibilities including responsibility to properly assess the financial position and performance of the group and detect and assess any material adverse development; and taking reasonable steps in ensuring that the directors are fully informed of all material financial information about the adequacy of cash reserves and One.Tel’s actual financial position and performance.

They did not take steps to either to apprise themselves of the financial situation and the deterioration from about the end of January until about the end of April 2001, or to ensure that the board was aware of them. They also made public statements about One.Tel’s financial position and performance which is entirely incorrect and no reasonable factual basis for them. It is also their duty to notify ASX the actual circumstances of the company’s financial position and performance, which they did not and thus did not comply with their duty. Failures to ensure the establishment of proper system to produce accurate and reliable financial information, failure to maintain cash reserves at a level which ensured liquidity and failure to employ an appropriately qualified finance director. On top of that, the two help themselves to a lucrative salary and bonuses.

4 Conclusion All the directors mentioned above has breach the corporate governance rule as a director of a company one way or another. Adler, Silberman, Greaves, Packer, Murdoch, Rich and Keeling have all failed to carry out their fiduciary duties by acting in their own interest which do not include taking any active participation or interest in caring for the benefit of the company and shareholders’ interest. They are not interested to investigate on the actual financial performance and ensure the correct accounting reporting of One.Tel’s accounts. They failed to employ their expertise to the management of the company and failed to carry out the fiduciary duties as company director: to act in bona fide in the best interest of the company; to exercise powers for their proper purposes; to avoid conflicts of interests and to act with care, skill and diligence. It is obvious from the analysis above that Rich and Keeling pursued their self interest or obsession in building their own mobile network by expanding too fast and investing all the cash in One.Tel without having a thought for maintaining cash reserves at a level which ensured liquidity. They also did not stop to apprise the accounting system used to control the payments and collections system. When being queried, they presented a version of account which is incorrect to the public and ASX. They did not act in good faith and honestly without fraud or collusion. They do not care for the financial

performance of the company instead plays on the share prices by giving baseless statement and expanding the company to push up the share prices so that they can get their director’s bonuses. As a director, they are expected to run a business aimed at making a profit with calculated risk instead they keep expanding beyond One.Tel’s financial capability. They also help themselves to hefty bonuses when the company is at the eve of collapsing. Apart from not carrying out their duties as directors, Packer and Murdoch has also approved bonuses to Rich and Keeling when it is clear from the company accounts that it is facing losses. Bonuses paid to directors should be tied to company performances not assurance and forecast for future earnings. Adler, Silberman, Greaves, Packer, Murdoch, Rich and Keeling each have breach the Corporations Act 2001 (Cwth) section 180,181 and 182 as they failed to exercise a degree of care and diligence, to act in good faith in the best interests of the Corporation and caused detriment to the corporation. However, apart from s.180, 181 and182, Adler has also breach s.183 whereby it precludes a person who obtains information because he is a Director, from improperly using that information to gain an advantage for himself or for someone else, or to cause detriment to the corporation. Adler sold off his shares at One.Tel after attending the directors meeting, apparently he is using the information he gets during the meeting and knows that something is very wrong with the company therefore sold off his shares.

5 Proposed Legislative Response Just because [Directors and senior executives] have personal money invested, or are on the board representing a major investor, does not mean they do not have to worry about other shareholders, creditors or employees. Their responsibilities extend beyond self-interest. “Recent collapses suggest that the dangers of ‘cliqueness’ of directors and senior executives cannot be ignored (RMIT, 2001). Corporate governance is, in its broadest sense, the stewardship responsibility of corporate directors to provide oversight for the goals and strategies of a company and to foster their implementation. The recent collapse of HIH insurance and One.tel suggested that “One size does not fit all” when it comes to corporate governance. The governance structures and practices should be tailored to meet appropriate corporate and governance activities and needs. The ASX has produce its own set of new listing requirements and this was followed by the Federal Government’s implementation of the Corporation Law CLERP9 reform proposals from 1 July 2004 (Rhyn D.v. and Holloway D.A).

ASX Corporate Governance Council (CGC) The ASX took a proactive stance and formed a plenary council (CGC) of a number of stakeholder groups (21 in all) including business, the accounting profession, investor groups, company secretaries, company directors and the Law council resulting in a ten principles and comprehensive guidelines about operationalising ‘best practice’ corporate governance. This has given effective regulatory weight in the same way as the UK “comply or explain” approach. The ASX listing rules were consequently amended so that the listing rule 4.10 now requires company to disclose their annual reports the extent which they have followed or elected not to follow these best practice recommendations (ASX, 2003,p.5). Principle 4 is similar to the requirements of the Sarbannes-Oxley Act in that CEOs and CFOs are required to submit in writing to their boards that the corporation’s financial reports present a true and fair view of the operational results and financial conditions. Whereas Principle 7 covers statements about integrity of risk

management and control compliance is both efficient and effective (Rhyn D.v. and Holloway D.A).

CLERP 9 Requirements Intervention by the Australian federal government has resulted in the Corporate Law Economic Reform Program (Audit Reform & Corporate Disclosure, CLERP 9) Bill being released for comment on 8 October 2003. It subsequently passed through Parliament (late June 2004) and had a commencement date of 1 July 2004. The primary objectives of the Act involve promoting transparency, accountability and enhancing shareholders rights. According to the Department of Treasury (the administrators of corporate law) it will augment auditor independence, achieve better disclosure outcomes and improve enforcement arrangements for corporate misbehaviour (Treasury, 2003). CLERP 9 does, however, propose to extend the reform processes beyond the narrow boundaries of the corporate governance recommendations and principles produced internationally and in Australia. In future, shareholders will be able to comment on, and take non-binding vote on the mandated remuneration disclosures for executives and directors (Dawes, 2003). They are also concerns on the issue of continuous disclosure and associated penalties for companies that do not comply with the requirement (Brown, 2003; Anonymous, 2002). One of the more important provisions, relates to the need for the annual directors’ report to include a more detailed operating and financial review of the company performance. This is to be sufficiently detailed to enable shareholders and others to make informed assessments of the company’s current position and future strategies. In addition, the legislative requirement for CEOs and CFOs to make a formal written declaration to the board of directors that the annual financial statements are ‘true and fair’ takes Australia down the USA path of the Sarbannes-Oxley Act. It would certainly would have a sobering and salutary effect on the company senior executives if, in future corporate failures, some senior management personnel are taken away in manacles in the back of police vehicles if this provision is breach (Rhyn D.v. and Holloway D.A).

Good governance is not guaranteed, however, merely by implementing ‘best practice’ guidelines and recommendations. Organizations needs to ensure that the governing boards meetings does not become ‘rubber stamping’ exercise and implement both ‘form and substance’ changes emanating from the best practices governance recommendations (Rhyn D.v. and Holloway D.A). Sonnenfied (2002) highlights a particularly positive response to the conundrum of managerial prerogative and the adoption of a ‘form over substance’ approach to governance of organizations. He argues that it is not the rules and regulations of the governing process that count but the way people work together is vital. Therefore, what distinguishes exemplary (effective) boards is that they are robust, effective social systems (2002, p. 108). In other words they exhibit a ‘healthy’ boardroom culture. This is the most critical of the additional elements needed to ensure that good governance practice is translated into ‘better’ organizational performance. The role of the chair and that of the independent members (particularly staff members) needs to be expanded to help deliver this ‘healthy’ culture. Such culture is enabled by openness, trust and strong relationship building amongst the differing parties and members. This will allow organizations to reap the benefits from their existing knowledge/intellectual capital and unlock and realise the full potential of the organization (Rhyn D.v. and Holloway D.A).