The jury’s out…

Rudy Giuliani, the outspoken former mayor of New York, is better know for his
attitude towards fighting terrorism than taking on corporate governance issues.
But at a recent conference he told delegates that European and Far Eastern
governance regulation was set to become much tougher and more in line with that
of the Sarbanes-Oxley Act in the US.

Such comments may raise an eyebrow, but little more, as they fly in the face
of perceived wisdom. It is more likely that listed companies in the UK and the
rest of Europe would have greater sympathy for the views of Alan Greenspan, the
ex-head of the US Federal Bank.

At the same conference, Greenspan predicted that it would be US corporate
governance legislation that would have to change. His major concern was that the
US capital markets were no longer attractive to foreign companies, in part
because of the cost of complying with the Sarbanes Oxley.

This is a view echoed by Deloitte’s Martyn Jones, who says: ‘There are
increasing signs that in relative terms the number of initial public offerings
in the US has reduced.’ He also suggests that all eyes will be on the foreign
private issuers – those non-US companies that are listed in the US who will
begin reporting under Sarbanes-Oxley this summer.

So against this background, how likely is it that we will see US style
disclosure in the UK and the rest of Europe? And if we do see it, will it be
through legislation and regulation or will it be from market pressure?

The infamous section 404 of the Sarbanes-Oxley Act requires companies to make
disclosures on the adequacy of their internal financial controls. This is the
requirement that has caused so much concern, particularly over costs, and this
is the requirement that many would not like to see replicated outside the US.

But arguably, the signs are already here. As Jeremy Dickens, the co-head of
global capital markets at law firm Weil Gotshal Manges, says: ‘I think it is
relatively unlikely that we will see section 404 in Europe, but when the
Financial Services Authority adopted new listing rules there was a provision
setting out the responsibility for a company to have adequate internal controls.
Will it lead to disclosures around the systems that are put in place? It’s a
step in that direction.’

Another step in this direction would have come through the operating and
financial review, had it not been scrapped as a mandatory requirement late last
year by chancellor Gordon Brown. Instead, UK-listed companies will be required
to report under the business review as set out in the European accounts
modernisation directive.

And, of course, there are dual-listed UK and European companies required to
report under Sarbanes-Oxley. The companies might not like this obligation but it
is the price they pay for access to the US capital markets.

Experts argue however that moves towards a formal system of disclosure
similar to Sarbanes-Oxley will probably come from market pressure rather than
government legislation.

‘It is much more likely to be a market driven desire to see greater
visibility and greater transparency in the information that people are sharing,’
says Fiona Sheridan, a risk management partner at Ernst & Young. ‘The
pulling of the OFR sent a signal that we are not comfortable in mandating this
kind of reporting.’

She also says her firm has been approached by a number of companies that are
interested in understanding what the benefits have been for those companies that
have gone through the US’s stringent internal controls process.

The implication is clear. Companies want to know if they can gain a market
advantage if they go down the route of further disclosure. ‘They are weighing up
how to get 80% of the benefits with only 20% of the costs,’ Sheridan says.

The benefits are intangible, ‘not ones that you can put pound signs on’,
according to Sheridan. These include greater transparency and increased

‘Individuals are having to say that they own the process,’ she says. There w
ill also be enhanced processes and improved systems. ‘But I don’t think
companies are going to disclose all the benefits,’ Sheridan says.

Neil Lerner, global head of regulatory issues at KPMG, believes the jury is
out on the benefits of Sarbanes-Oxley disclosure.

‘Opinion is very mixed as to whether the changes, in particular 404, have
produced improved financial reporting or not, and certainly whether the cost has
been commensurate with this improvement.’

Like Sheridan, he could see market driven adoption of some aspects. ‘I would
agree that any demand is likely to come from the markets but we see no signs of
that demand yet,’ Lerner says.

This might change if there were to be a financial scandal equal to Enron.
Much of the current corporate governance framework, certainly in the UK, was
born out of earlier issues, such as the Mirror pensions scandal, in the early
1990s. This led to a system based on broad principles, a ‘comply or explain’

But another scandal could shift this attitude. Even if such events never come
to pass, a smart company might already be thinking of adopting a more robust
disclosure policy.

Such a policy could make sound business sense. Dickens argues that, ‘as a
matter of simple economics’ disclosure of risks to a company sooner rather than
later ‘results in a less dramatic decline in a stock price if a foreseeable
event occurs than if the disclosure is made only at the time the event occurs’.

Even though the business review requires an element of disclosure, and EU
directives are adding to corporate responsibilities, the indications are that a
US-style system of disclosure is unlikely to come to pass this side of the
Atlantic, yet.


What pushed the price up?

PwC recently published research with Sarbanes-Oxley project team leaders from
foreign private issuers, which showed there was a danger that the considerable
costs and efforts associated with year one compliance were likely to be repeated
unless steps are taken to address a number of problems.

The majority of respondents (61%) said they had identified excessive numbers
of key internal controls in their businesses – this had a direct bearing on the
amount of work required to document them efficiently. Half were struggling to
identify and fix control deficiencies in a cost-effective and considered way.
This meant that teams were allocating resources in an intensive manner, which
was pushing costs higher.

But more than eight out of ten companies said they had identified
opportunities to automate process and controls further.

Source: PricewaterhouseCoopers

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