PART III: Liability for financial reporting

Part III of the thesis examines the liability of directors for financial reporting, specifically the "in control" statement related to the company's interaal risk management and control systems. A comparison is made with U.S. federal securities legislation. In dealing with this subject, special attention is given to the position of the individual director and to the possibilities he has for exonerating himself. The thesis develops a criterion for the liability of individual directors in respect of financial reporting and suggests a modification of Article 2:139 DCC.

Under Article 2:139 DCC directors — in addition to the company — may be liable for publishing misleading financial reports. Parties who may bring a claim under Article 2:139 DCC include creditors and shareholders. Since the claim under Article 2:139 DCC does not accrue to the company, an action under this rule will not automatically accrue to the receiver in the event of insolvency, unlike an action under Article 2:9 DCC. Bannenberg q.q. v. De Bont furthermore shows that in case the receiver only acts for a specific group of creditors in such action, this will fall outside the scope of the authority of the receiver pursuant to Article 68(1) of the Dutch Insolvency Act. The group of creditors who have been prejudiced as a result of the misleading financial reporting may furthermore also be made up of sub groups in the event various misleading documents have been published; not all of these creditors will necessarily have been prejudiced by one and the same publication. Consequently, it is likely that a receiver will be held to have no cause for action in case he brings a claim under Article 2:139 DCC for a specific group of creditors.

In my view, assessment of the question whether a financial publication is misleading within the meaning of Article 2:139 DCC, allows no room for testing the degree of blame of individual directors. The only relevant matter when making this factual assessment is whether a publication gives a misrepresentation, regardless of to whom this may be attributed.

The question of attribution becomes relevant when determining liability. It is clear that the persons who sign the financial statements represent the principal group of persons who are responsible for the content of that publication; this is the case both under Dutch and U.S. law. Under U.S. law they areprimary violators of Section 10(b) Securities Exchange Act. However, non-signatory officers may be equally liable for misleading financial reports or "in control" statements, either as primary violators or as secondary violators/controlling persons.

In the Netherlands the signing directors are not necessarily the sole responsible persons who may be responsible and cannot be held liable for misleading annual accounts either. Article 2:139 DCC has a wider scope. A so-called "bright line" test as applied by certain U.S. courts, whereby it is decisive whether the person involved has personally made the "misstatement", may consequently not be applied in the Netherlands. The circumstance that a director has not signed the annual accounts may be relevant when assessing an exoneration defence. On the one hand the involvement in the preparation of the contents of the document may also be considered (cf. the "culpable participation" test in U.S. law), whereby it is of decisive importance whether the individual director made a major contribution towards the preparation of the misstatement, regardless of whether he has personally made the misstatement. On the other hand the circumstances that led to the director's not signing of the document must be taken into account as well.

It is commonly assumed that due to the fact that the financial policy is one of the core tasks of the board, individual directors cannot easily exonerate themselves from liability due to misleading financial reports. In chapter 6 I make a case for allowing a wide exoneration possibility for directors based on culpability (fault) — intent or wilful recklessness.

The first important thing to note is that the liability of directors under Article 2:139 DCC only exists next to the liability of the company: a secondary liability: the company is principally liable for the misleading reports it has published. In the relationship with on the one hand third parties who relied on the report in good faith and on the other hand on the company, the culpability of the individual directors should not be considered. I argue that this is different in relation to the personal liability of these directors.

As regards the scope of the ground for exoneration it should be realised that the provision of Article 2:139 DCC was introduced at the beginring of the last century, in a time when companies were less extensive and complex than certain contemporary groups of companies and when the financial reporting was much simpler, thus being more transparent and controllable for the directors.

From an international perspective it is furthermore material that the U.S. Securities Exchange Act only imposes liability for misleading financial reporting in case of scienter, which signifies a strict criterion of culpability (kluit). Even the Sarbanes-Oxley regime — which is regarded in the Netherlands as very strict and which, via the Securities Exchange Act, may lead to civil-law liability — does not provide for strict liability. I fail to see why Dutch law should be stricter than U S law in this regard. If it would be desirable to recognise attribution according to generally prevailing opinion in connection with this provision, the text of Article 2:139 DCC should have to be made more explicit in this regard.

A contemporary, realistic approach requires that these developments are taken into account when applying Article 2:139 DCC and when interpreting the ground for exoneration. I have argued that for the assessment of an exoneration defence, a test could be applied whether the individual directors have made sufficient efforts to ensure that the financial reporting is correct. In chapter 7 I further detailed this test for the "in control" statement and indicated which circumstances might in any event be considered when applying that test.

An interesting question in this regard is whether, when assessing the exoneration defence, a distinction can be made between the various individual directors. It would seem likely that a reliance on exoneration under Article 2:139 DCC should also be assessed by taking into account all circumstances of the case. Thus, as part of the test whether sufficient efforts have been made, an individual test can be applied, whereby the tasks of the individual director concerned can be taken into account.

I believe that the basic assumption that the financial policy by definition is one of the core tasks of the board, to the extent that it is assumed that all directors have, or ought to have, equal knowledge of that policy and are therefore equally liable, needs some adjustment. A distinction can be made between the general financial policy and executive tasks related to the financial position. Material when assessing an exoneration defence is the question what may be expected of the individual director given his allocated task.

I also discuss in chapter 6 the relation between the directors' liability towards third parties under Article 2:139 DCC and their liability towards the company under Article 2:9 DCC. The text of the exoneration ground — "unless it cannot be blamed on him" — is included in both provisions. In my opinion, in the event misleading information in financial reporting can be blamed on an individual director within the meaning of Article 2:139 DCC and he is thus liable under Article 2:139 DCC and he is unable to exonerate himself — , this also constitutes serious blame within the context of Article 2:9 DCC.

The individual standard of conduct for a proper performance regarding the preparation of financial reports might moreover be the same as that of Article 2:9 DCC. In this manner the standard of conduct of Article 2:9 DCC might further detail (the ground for exoneration of) Article 2:139 DCC. In practice, this could be effectuated by the courts also applying the criterion of serious blame with respect to Article 2:139 DCC. It would, however, be clearer if the text of the ground for individual exoneration in Article 2:139 DCC is modified in this regard.

In my view, Articles 2:9 and 2:139 DCC should be communicating vessels, so that:

The only margin that exists, in my view, between liability under Article 2:139 DCC and Article 2:9 DCC, is the possible presence of a specific ground for justification of the violation of the standard of conduct of Article 2:9 DCC.

Although Article 2:139 DCC is seldom applied in practice, I believe that no further modification of the rule is required. It seems that plaintiffs consider the threshold for establishing whether the financial reports are misleading and causation too high to overcome it. These elements will have to be further outlined in the case law, possibly with specific attention for reversing the burden of proof where the causation is concerned.

The chances that a stand-alone action based on liability in connection with an incorrect "in control" statement is successful are not very high. On the other hand, the circumstance that an incorrect "in control" statement was issued may support a legal action, for instance if a claim brought on the basis of Article 2:139 DCC also pertains to misleading annual accounts, caused by a faulty interaal control system, or as part of a wider action on the basis of tort.

In practice, the principal use for the prescribed "in control" statement does, for now, not seem to be to hold directors liable, but rather to increase the awareness of directors and emphasise the importance of properly functioning risk management and interaal control systems.