Identity check needed to stamp out fraudulent phoenix activities: research

A three-year joint research project between Monash Business School and Melbourne Law School recommends new company directors should undergo a 100 point identity check to stamp out fraudulent company phoenix activity.

Construction site workers

The new report, Regulating Fraudulent Phoenix Activity (or the Phoenix Project) find the practice is "easy, cheap, profitable and largely invisible, as a result of which there is little enforcement even where actions are available".

Phoenix activity is when one company takes over the business of another company that has been wound up or abandoned in circumstances where the controllers of both companies are the same people or their associates. The intention is to defraud creditors, employees and the tax office.

The Phoenix Project makes 25 recommendations designed to assist in the detection of this activity, disrupt those who seek to engage in it and to punish those who succeed in doing so.

It recommends company directors undergo a 100 point identity check and be issued with a Director Identification Number ("DIN") before they are allowed to start a new company or act as a director. This would make it more difficult for people to register companies under false names.

"Our recommendations are designed to deal with harmful and illegal phoenix activity while at the same time allowing genuine entrepreneurs to start new companies, even after previous corporate failures," said Monash Business School's Professor Michelle Welsh, who co-authored the report.

The Productivity Commission estimates that around 2000 businesses are involved in illegal phoenix activity across Australia, costing the economy and government between A$1.8 billion to $3.2 billion per year.

This activity essentially involves one company taking over the business of another company that is wound up or abandoned in circumstances where the controllers of both companies are the same people or their associates, and the intention is to defraud creditors, employees and the tax office.

"A number of directors who engage in this sort of activity do so on a repeated basis," says Prof Welsh, who is Monash Business School's Head of Business Law and Taxation.

The complexities regulators face in interrupting this activity are compounded because it is difficult to differentiate between undesirable and illegal phoenix activity and a genuine business rescues.

Currently there is no requirement for a person to supply any identification before registering as a director for a company. It is harder to open a bank account than it is to register as a director for an Australian company.

Professor Michelle Welsh

Though this behaviour has been of concern to regulators such as the Australian Securities and Investments Commission and the Australian Tax Office for some time there has been limited success in addressing the problem.

A 100 point check system would allow the regulator, the Australian Securities and Investment Commission (ASIC) to track directors who have been involved with failed companies and to more quickly disqualify certain directors from managing corporations.

"Currently there is no requirement for a person to supply any identification before registering as a director for a company," says Professor Welsh.

"It is harder to open a bank account than it is to register as a director for an Australian company."

Other key recommendations include encouraging more transparency by allowing people to search existing ASIC company databases for free and the creation of a new, freely searchable public register of disqualified directors.

The report recommends the introduction of 'restricted directorships' for people who have been involved in five or more failed companies over a ten year period. More stringent reporting requirements should be imposed on 'restricted directors and they should be limited to holding no more than five directorships at a time, the Report finds.

The report recommends that ASIC should make monitoring phoenix activity a higher priority and should be far more forceful in prosecuting pre-insolvency advisors.

Other recommendations include increases in penalties available for breaches of director duties which occur where there is deliberate liquidation of companies; directors who withhold company books and records from liquidators; and people found guilty of managing companies while disqualified are recommended.

It is recommended increasing the period ASIC is able to ban people from managing corporations from five to 10 years.

Previous reports released by the project team find it is unclear exactly how often this behaviour occurs or how much it costs. A lack of data does not allow for an accurate estimate of its enforcement.