Written by Paul Brehony‘, Partner at Signature Litigation
The latest chapter in the long running saga which is the Government’s audit and corporate governance reform agenda was published last month and is presently out for consultation.
Regulators have proposed an overhaul of the UK corporate governance code aimed at increasing company boards’ responsibility for accurate accounts and strengthening directors’ accountability for misconduct. The Financial Reporting Council’s (FRC) planned revisions are intended to enhance and modernise the UK’s audit and corporate governance regimes in the wake of scandals that brought down a slew of high-profile companies in recent years, including BHS, Carillion and Patisserie Valerie.
As such, the consultation is in effect the latest articulation of a process started in 2021 by the Government’s project to “Restore faith in audit and corporate governance”. Many commentators take the view that the decision to water down the original proposals – particularly in relation to directors’ personal accountability – represents a missed opportunity to bring about what the project was actually originally intended to achieve.
The Code’s regime operates under a system of “comply or explain”, and whilst capable of causing embarrassment and potentially having a deleterious effect on the share price of non-compliant listed companies, ultimately it is still a voluntary arrangement in most cases. Even for those companies who are bound to adhere to the Code due to their premium listings, directors are still able to choose not to comply by explaining their reasons for not doing so.
Further, a key component of the original proposals was to require all company directors to assess and report annually on the effectiveness of their internal controls and financial reporting procedures, echoing the US Sarbanes-Oxley Act of 2002. These envisaged mandatory measures have now been diluted, following intense lobbying from corporates resulting in what the Government it believes to be a more “business-friendly” stance.
There is a fairly well-established symbiosis between corporate failure and the payment of excessive dividends from highly-questionable distributable profits, such as in the case of failed conglomerate Carillion which collapsed into bankruptcy in 2018. Rules to deal with this issue have been swerved by the FRC, despite all of the risks inherent in not tightening up such a key area of corporate governance.
In its proposals, the FRC suggested inclusion of a duty for audit committees to develop, implement and maintain companies’ audit and assurance policies, with the aim of setting out what independent assurance companies intend to obtain over a three-year timeframe. While the overall Code is only mandatory for “public interest entities”, the audit and assurance policy would be obligatory for all companies to whom the Code applies, including overseas premium-listed companies as well as AIM-listed companies in the UK. The FRC itself has referenced a lack of professional scepticism as being at the heart of most audit failures in combination with a control imbalance between Boards and Auditors.
A new addition to the Code would require companies to list all significant director appointments in their annual report, as well as to explain how each director has sufficient time to effectively perform their role in light of their other commitments. However, the FRC’s proposals do not include a cap on how many outside commitments a company director may have, to the disappointment of critics who believe directors are less able to focus on their work for a company when concurrently performing numerous roles elsewhere.
Far from taking a radical approach to shaking up corporate governance and the duties imposed on directors and boards, the FRC’s consultation is ultimately a triumph for pragmatism given the parlous state of the UK economy and the need to present a “business-friendly” regulatory environment. However, this is perhaps a case of regulatory mixed messaging. Dropping personal liability for directors to vouch effectively for their own anti-fraud systems is not easy to reconcile with the Economic Crime bill which proposes a new criminal offence for failure to prevent fraud, or indeed the House of Lords’ recent report “Fighting fraud – breaking the chain.”
The FRC’s consultation will run until September of this year, with the intention of a new Code taking effect for financial years beginning on or after January 1st 2025. In the absence of heavy lobbying for a more stringent approach to governance, it is likely that the new Code will be waved through in, or close to, the format set out in the FRC’s proposals. As such, its implementation will represent – once again – a wasted opportunity to tighten up scrutiny of companies and crack down on the poor corporate practice that has led to so many costly failures for UK plc in recent years.
