News Analysis - Putting a cap on liability.

‘Radical, revolutionary and fit for this century’, is how one observer described the latest recommendations from the Company Law Review steering group when they were announced last week. If the recommendations are adopted, company law – from the liability of auditors to the responsibilities of directors – will never be the same again. Take the group’s proposed extension of the right to sue auditors for negligence. It wants shareholders and creditors who rely on company accounts to have the same rights as existing shareholders. These revolutionary proposals would reverse the landmark Caparo judgement, which restricts auditor liability to current shareholders, and open the door to claims on auditors from future owners of a business. It is a move described with some understatement as a ‘significant change’ by Roger Davis, senior PricewaterhouseCoopers partner. But the package of proposals goes wider than just audit liability. The independent panel of experts on the group – drawn from across the whole range of expertise – was appointed by the Department of Trade and Industry. Their proposals, the latest in a string of consultation exercises, are designed to revamp legislation introduced by William Gladstone more than 150 years ago. The review is a response to large payouts by audit firms such as the #67.6m settlement last year which followed Coopers & Lybrand’s work for the business empire of media tycoon Robert Maxwell. Earlier this year Ernst & Young in the US agreed a $335m payout to shareholders of the Cendant Corporation following audit failures. E&Y was auditor of Cendant’s predecessor company, CUC International, and provided a clean audit report on three annual reports, seven quarterly reports and as many as 20 registration documents, according to the Californian Public Employees’ Retirement System (CalPERS). CalPERS said each of the reports was subsequently found to include or incorporate grossly overstated financial statements, including a $500m overstatement of CUC’s operating income during 1998 public statements. These and other high-profile cases have persuaded the Financial Reporting Issues Group that auditors’ liability needs to be capped. Chaired by Deloitte & Touche chairman Martin Scicluna, the group includes finance directors, lawyers and regulators. Scicluna acknowledges that what the group is proposing is radica, but he adds: ‘There is no reason why auditors should not cap their liability. The guy with the deep pockets ends up with a disproportionate share of the damages award.’ The English ICA welcomes the idea that auditors should reasonably be allowed to cap their liability. But it warns that where the company or others are insolvent, the risk remains that the auditors continue in effect to be the credit insurer for those parties. ‘This risk is not part of the auditors’ professional liability,’ says deputy president Graham Ward. ‘We have been pressing for seven years to introduce some element of justice into auditors’ liability. This is a very large step in the right direction.’ Ward’s views are echoed elsewhere in the profession. PwC’s Davis, who also represents the English ICA on the DTI steering group, believes ‘a narrow interpretation of the audit role is unlikely to be sustainable, legally and otherwise, in the 21st Century’. Along with others, he applauds the proposed widening of the auditors’ role which would see an independent professional review replace the full audit for companies with a turnover of less than #4.8m. But, with the audit exemption debate still raging, the group’s ideas have not met with a favourable response from all quarters of business and the profession. Many smaller firms rely on SME audits for much of their income. Group members want the full statutory audit to be abandoned for companies with a turnover of less than #4.8m, while those between #1m and #4.8m would get a review instead. Company Law Review project director Jonathan Rickford says: ‘We have suggested that the audit requirement should be relaxed. Companies with a turnover under #1m should have no audit requirement imposed. For those mid-sized companies with a turnover of between #1m and #4.8m, we suggested an independent financial review which would be less indepth and cheaper than the full audit.’ Additionally, an operating financial review would cover all that is material in the directors’ review to make a proper assessment of the performance, future plans and prospects of the business. Davis believes that if auditors are to remain at the top table of business and society, they should be prepared to go with the grain of the law review on future-based information and accountability of companies to a wider community. Which is where Scicluna’s enthusiasm for electronic reporting comes in. It is a shift which could lead to the death of the annual report. One of the group’s major concerns is shareholders’ inability to access financial information before City institutions. ‘This is a major overhaul in financial reporting,’ Scicluna explains. ‘In years to come, the preliminary statement should go out to all and sundry electronically and at the same time. That would be the main financial statement.’ Aside from the delivery method, the group’s plans to make financial information more widely available would see the emphasis shift from the annual report – which is normally published four to five months after the year end – to the preliminary financial statement, which tends to catch newspaper headlines and influence the market. Under the plans, preliminaries would be published within 70 days of the year end, and a full report would be sent out no later than 90 days from the year end. ‘The aim is faster reporting, more transparency and more immediate information,’ says Scicluna. All comments on the consultation document must be submitted by 15 June. The steering group is due to present its final report to ministers in Spring 2001. After that it is the government’s taste for radical reform that will count. Recommendations of The Financial Reporting Issues Group to the Company Law Review Directors The consultation document: – Proposes an ‘inclusive statement of duties requiring them to consider all their relationships and actions; – Recommends amendments to conflict of interest rules; – Examines rules on directors and their relationships with the company, third party liability, training and qualifications; – Examines the roles of non-executive directors and the Combined Code on Corporate Governance; assesses economic evidence on the relationship between company governance and economic success, and considers the role of capital markets. Shareholders The group wants to: – Strengthen relationships between companies and beneficial holders of shares who are not registered as members; – Improve and modernise the rules governing the conduct of agms; and – Simplify and clarify the law on the rights of minority shareholders. Reporting and accounting for large companies Listed companies should prepare: – A set of statutory accounts based on present preliminaries sent to shareholders; – A full report and accounts, filed at Companies House and available to shareholders on request; and – An operating and financial review prepared as part of the full accounts to cover all material available for users to make a proper assessment of company performance and future plans. Small company reporting All small companies should prepare and file accounts tailored to their needs; – The option to file ‘abbreviated accounts’ should be removed; – Small companies below #1m turnover threshold need not have their accounts audited; – Other small companies (those between #1m and #4.8m turnover) should have an Independent Professional Review to provide a degree of independent assurance while being less burdensome than a full audit. Additional proposals to: – Introduce a new form of corporate body designed specifically for use by charitable companies; – Simplify procedures for restoring previously dissolved companies to the company register; – Simplify requirements as to how companies must register information and make it publicly available; and – Introduce changes to the rules on acceptability of company names.