INSIGHT - Law review turns accounting into accountability

The third major consultation document from the Company Law Review Steering Group confirms that, parliament permitting, Britain could be on track to creating a world class body of company legislation and regulation.

While the DTI’s original intention in establishing the committee in 1998 was to address some of the more menial administrative complexities, the steering group has driven a much harder agenda, revolutionising and deregulating company law. (Ironically, though, one part of the administrative tidying up that the steering group wanted to implement – the creation of no par value shares for public companies – has had to be dropped because of European legislation.)

The first consultation document, issued in February 1999, went right back to first principles, examining what companies are for. It engaged in a debate as to whether companies – and their directors – ought to look after the interests of all stakeholders, or whether enlightened self-interest was the correct route, whereby proper stewardship of shareholders’ assets meant that the interests of customers, suppliers, employees and the community can’t be ignored.

But the result of what threatened to be meandering navel-gazing is the establishment of a rigorous intellectual underpinning to everything that the steering group is now doing. Roger Davis, a senior partner at PricewaterhouseCoopers and the ICAEW’s representative on the steering group, paraphrases the underlying ethos. “If we get directors’ responsibilities right and we get directors’ accountability right, then you’ve got the absolute kernel of what needs to be in statute,” he says. “You then have to justify any other prescription of company policy from a zero base. Does it really need parliament to tell shareholders that they’d better be careful before they appoint a director of over 70? Why can’t shareholders make that judgement themselves?”

Two of the most significant elements of the emerging body of regulation are the creation of a new (but regulated) OFR – operating and financial review – and the proposal that much of the regulatory burden be handled by a new Companies Commission modelled on the Accounting Standards Board.

The proposal for the new OFR is a good example of the new approach to company regulation. “The concept (of the new OFR) goes right with the grain of saying that, as long as we’re clear on the accountability of directors, then we can keep prescription out of the law,” Davis explains.

“There’s been a great deal in earlier parts of this consultation about directors’ responsibilities to stakeholders. But legal responsibility to everybody is practical responsibility to no one. Concentrate, therefore on disclosure – and that goes in the OFR.”

Moreover, the growing discrepancy between the historic book values in the accounts and market capitalisation means that there has to be “a properly structured account of the real drivers of shareholder value”, Davis says.

“That is so important to the accountability of companies that we are going to have that underpinned by parliament. It’s in the interest of the economy.”

But the idea of a regulated OFR – as opposed to the much more lax current practice – sounds as though it may take UK reporting down the highly-regulated route of the US-style MD&A, the management discussion and analysis. Davis is at pains, however, to explain that there are fundamental differences in approach between the two countries, and for good reason.

“Arguably there is more risk-taking in the US,” Davis says. He adds that he and his colleagues were very aware of this when he served on the Turnbull committee. “We were very conscious that we didn’t want to be a dead hand on British risk-taking – just the reverse: the calculation of risk not the avoidance of risk. Therefore, there’s more caveat emptor in the States and hence you have more legalistic disclosure in the MD&A. The US investor has pages and pages and pages to go through – but he’s on his own. There’s no investment bank sponsoring the issue as there is here.”

Davis doubts that the OFR will become like the MD&A – “lawyers scrambling all over the MD&A doing due diligence rather than accountants doing due diligence. I’d like to think we’ll have a less legalist document in the UK just the same way as I like to think we have less legalistic accounting standards. All this stuff is common sense.”

There’s still a distinct possibility, however, that OFRs will degenerate into mundane, boilerplate statements, much like the current directors’ reports on things such as the value of employees. The OFR may turn out to be little more than the accounts with verbs.

“A lot of us – including the accounting profession, the standards committee and companies – are going to have to work very hard to make this work,” he says. “I think this is a bigger challenge to the accounting profession than some of the technological stuff. For the accounting profession, is this something that we want to keep as our own province, or is it something that we want to hand over to the lawyers? The accounting profession is to my mind the natural profession to take this forward. The accounting profession never seemed to me to be about how you add up numbers – it means accountability.”

The proposal for a new Companies Commission seems to take self-regulation to unimagined heights. It is expected to be more like the ASB than the American Securities and Exchange Commission. Davis likens it to “a permanent Hampel committee”. Its remit would be to monitor company law and to advise on necessary changes, absorb the ASB’s accounting standard-setting role, look after the Combined Code and other disclosure requirements such as directors’ remuneration and directors’ loans, determine rules for communicating with shareholders and running general meetings, and so on. With statutory backing, the Companies Commission would have teeth as sharp as those of the ASB. (The discussion document notes, in fact, that the ASB’s Financial Reporting Review Panel, which adjudicates on complaints about company accounts, has never actually had to use its powers to take companies to court to enforce proper accounting.)

Discussion of the Companies Commission proposal sparks another tangent on the differences between US and UK regulation. Davis believes that the more formal structure found in the US is not needed here. “In the UK, company headquarters, the government, financial institutions, the Bank of England, all the professional advisers – they’re all within a few miles of the centre of London,” says Davis. “In the US, there are a lot of headquarters in California, the government is in Washington, the financial centres are in New York and Chicago. There are five times as many listed companies. You arguably need something more formal to regulate all that. But, just because of the logistics of the UK, it is much easier to get the networking going.”

One question that no one can answer at the moment – and Davis won’t try – is whether trade secretary Stephen Byers will ultimately be able to find parliamentary time for the considerable amount of legislation that will be needed – ironically – to take a lot of existing legislation off the statute book. Moreover, the proposals are not without controversy, given the amount of self-regulation that a (presumably) Labour government is going to have to sanction.

Certainly, the law review exercise – now entering its fourth year – has taken up a considerable amount of civil service time and effort, to say nothing of the dozens of members of the “great and the good” who have served on all the working parties. And all this is unlikely to be trashed by ministerial apathy. “Sooner or later it has to happen,” Davis says.

“Use the metaphor of a bicycle tyre. You can carry on patching it up until you can’t. The longer you leave it the worse the state of the thing.” Ultimately, the steering group’s aim is to keep company law “internationally competitive and to remain attractive in comparison with other jurisdictions” – and that is likely to be a persuasive argument, whoever the trade secretary is.

ANSWERS PLEASE The Company Law Review Steering Group’s third document, Completing the Structure (November 2000), puts forward dozens of questions on which comment is invited. A sample of these follows:

3: Scope, directors’ duties and the OFR

Q3.5 Do you agree that the relevant standards body should have power to issue non-mandatory guidance on all aspects of preparation of the OFR?

Q3.6 Do you agree that there should be an obligation on directors properly to prepare the OFR and that the propriety of the process used should be a matter for scrutiny and report by auditors, and in an appropriate case, for enforcement action by the FRRP?

6: Reporting, accounting and audit

Q6.1 Do you agree with the principles of these proposals for listed companies:

(i) that summary financial statements should be retained;

(ii) that the timing, form and content of preliminary announcements should not be regulated by statute; but a preliminary announcement, when made, should be immediately published on a website with electronic notification to shareholders who want it;

(iii) that the full annual report (FAR) should be published on a website, with electronic notification to those shareholders who want it, as soon as practicable after the board approves it and the auditors’ report is received?

Q6.10 Do you agree that if the range of the duty of care of auditors is to be extended to potential investors and creditors in their capacity as such, the duty of the company and its directors should be similarly extended, and would you support such an extension?

12: Regulatory and institutional framework

Q12.3 Do you agree with our proposal that there should be a single institutional structure in which a parent body (the Companies Commission) would be responsible for maintaining an overview of company law and corporate governance and overseeing the work of its subsidiary bodies dealing with standards-setting, enforcement and the needs of private companies?

Q12.5 Do you agree that a Standards Committee should have responsibility for making rules on disclosure requirements relating to:

(i) the Combined Code;

(ii) directors’ remuneration; …

Q12.17 In principle, do you believe it would be preferable for the proposed institutional arrangements to be funded: (i) as at present, from a range of public and private sector sources; or (ii) by the state, either by Government grant or some form of levy?

The consultation document is available at www2.dti.gov.uk/cld/review.htm.

Responses should be sent via e-mail to [email protected]. Comments should be submitted by 28 February 2001.

A final report is expected in May 2001.