A cautionary tale for directors and officers
The collapse of Storm Financial Limited (Storm) occurred in the wake of the Global Financial Crisis of 2008 (GFC) and reads like a textbook cautionary tale for directors and officers.
Emmanuel and Julie Cassimatis established Storm and at all relevant times held all shares in the company and were the only executive directors. Prior to the GFC Storm was a highly profitable company with annual revenue of $77 million and consolidated gross assets valued at $120 million.
The Storm Model
The Storm model involved potential investors being introduced via a “primer” meeting. This was followed by an “education workshop” and subsequent meetings with a Storm adviser.
Investors were then provided with a Statement of Advice (SOA) which was substantially based on a template and contained generic advice. For the vast majority of Storm’s clients the standard advice was to obtain a loan secured by the client’s home together with a margin loan. These funds were then used to invest in index funds based on the ASX300.
Although largely a template document the advice provided did take into account individual circumstances of particular investors in so far as certain variables could be changed to take into account such things as overall debt ratios, levels of cash reserves and the loan value ratios (LVR).
Once the SOA was prepared an adviser would meet with a prospective client for several hours to explain the advice and provide a hard copy of the SOA and relevant Product Disclosure Statements. Clients then signed the loan documents and loan applications were processed.
Storm encouraged its clients to act on specified volatility movements in the share markets which it called “trigger points”. Each time a client acted on a trigger point or increased their investment it was referred to as a “step” and the SOA was updated. A “build step” encouraged further investment and further borrowing when the market rose and a “recovery step” encouraged further investment in a fallen market.
The Storm model did not provide for any exit strategy for clients. Evidence was given in the proceedings that Mr Cassimatis had been heard to tell clients that they should not aim to redeem their investments but to pass the portfolios and loans on to their beneficiaries and to consider succession planning for that purpose.
The case brought by ASIC
ASIC claimed that by providing investors with advice using the Storm model Mr and Mrs Cassimatis had breached certain provisions of the Corporations Act 2001 (Cth) (Corporations Act) including a requirement that prior to providing any advice an investigation of a client’s personal circumstances must be undertaken and any advice provided to a client must take into account those circumstances.
Pursuant to section 180 of the Corporations Act:
1. A director or other officer of a corporation must exercise their powers and discharge their duties with a degree of care and diligence that a reasonable person would exercise if they:
a) were a director or officer of a corporation in the corporation’s circumstances; and
b) occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.
ASIC ultimately relied on a group of 45 individuals (including some couples) who were retired or approaching retirement at the time they invested. These individuals were especially vulnerable to losses as they had limited superannuation, little income and very few assets beyond their respective family homes.
ASIC alleged that the advice provided under the Storm model, particularly advice that involved borrowing more than these particular investors would otherwise be prepared to borrow, amounted to a contravention of Mr and Mrs Cassimatis’ obligations under the Corporations Act and a breach or their duty of care and diligence.
By causing or allowing Storm to breach the Corporations Act, Mr and Mrs Cassimatis were responsible for exposing Storm to a risk of harm that was of a greater degree than a reasonable director, acting with the requisite degree of care and diligence, would allow.
Findings against Mr and Mrs Cassimatis
It was established that while Mr and Mrs Cassimatis did not have absolute control over Storm’s business they “were intimately familiar with, and exerted control over, nearly every aspect of Storm’s operations” and both Mr and Mrs Cassimatis were fundamental to the development of the Storm model of investing.
The Court found that Storm had breached its obligations under Corporations Act and at the time the breaches occurred a reasonable director in Mr and Mrs Cassimatis’ position would have known Storm’s clientele and the demographic in which the client base sat better than anyone else employed by Storm and far better than anyone outside of Storm. Therefore they should have considered that such breaches were likely to occur.
The Court also found that a reasonable director in Mr and Mrs Cassimatis’ position would have been aware of the strong likelihood of inappropriate advice being provided in contravention of the Corporations Act unless they exercised their power to prevent or prohibit Storm from providing indiscriminate advice.
As a result of these breaches many investors suffered substantial life changing financial losses after the GFC.
Important points to remember
- When considering potential harm a director or officer has a duty to balance any burden (such as the cost or inconvenience) of taking action to alleviate that potential harm against the foreseeable risk of the harm to the corporation;
- The concept of ‘harm’ relates to any risk to any of the corporation’s interests and not just financial harm or loss;
- A corporation is always a separate legal entity from its shareholders and cannot release directors or officers from their duties to the corporation even if the particular individuals are shareholders in the corporation;
- The standard of care that needs to be exercised to discharge a director or officer’s duty of care will depend on the particular circumstances of each corporation, the individual’s position and the scope of their influence, role and responsibilities within the corporation; and
- Any director or officer who assumes broad and significant responsibilities and who also exercises a high level of control within the organisation rather than delegating to other more suitably qualified individuals increases their own level of exposure to any potential breach of the corporation’s obligations under the Corporations Act.
This decision should sound a strong warning bell for all directors and officers particularly those who proactively assume significant control of the day to day and long term strategic operations of a corporation that increased responsibility also means increased risk and far reaching personal consequences for any breaches the corporation may commit.
If you or someone you know wants more information or needs help or advice, please contact us on 08 9422 8111 or email email@example.com