The Matrix.
An overview of corporate governance
February 2013
Contents
This Matrix gives an overview of the principal current and recent legal and regulatory developments in the UK, EU (and other supra-national) and US arenas as they may affect
listed companies in relation to the following:
-
-
-
-
directors’ duties
1
-
shareholder engagement
50
–
general duties
1
–
statutory and regulatory framework
50
–
non-executive directors of listed companies
4
–
stewardship
54
–
rules applicable to directors of financial institutions
7
–
indemnification of directors
10
–
recent developments
63
–
liability for corporate acts
11
–
narrative reporting
65
15
–
liability for reports and other statements
71
remuneration
-
corporate reporting
63
–
current regime affecting listed companies
15
-
corporate social responsibility
74
–
proposals affecting listed companies
18
-
accounting standards
80
–
remuneration in financial institutions
21
–
IFRS
80
27
–
domestic accounting standards
83
–
enforcement
85
corporate governance codes
–
general provisions and guidance
27
–
board diversity
31
–
risk management and control
34
–
regulation of auditors and accountants
87
corporate governance committees
36
–
audit quality
92
-
auditors
87
–
remuneration committees
36
–
non-audit services
98
–
nomination committees
38
–
rotation of audit firm/retendering
102
–
audit committees - constitution
40
–
rotation of audit partner
103
–
audit committees - role
43
–
liability of auditors
104
–
risk committees
47
–
other committees
49
This Matrix has been updated to 14 February 2013.
i
Contents
See the Glossary for an explanation of definitions and acronyms used in this Matrix.
This Matrix is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on the issues presented here,
please contact one of your regular contacts at Linklaters.
© Linklaters LLP. All rights reserved 2013.
ii
Glossary
ABI
Association of British Insurers
Accounts
The Large and Medium-sized
Directives with a single directive on the
Regulations
Companies and Groups (Accounts and
form and content of annual and
2008
Reports) Regulations 2008
consolidated financial statements
AIU
Audit Inspection Unit, previously part of
Accounting
EC proposal for a directive to amend
Directive
and replace the Fourth and Seventh
AIFMD
Directive 2011/61/EU on alternative
the POB, whose functions were
investment funds (known as the
transferred in July 2012 to the Audit
“Alternative Investment Funds Directive”
Quality Review team in the FRC’s
or “AIFMD”)
Conduct Division
Audit Green
APB
Auditing Practices Board, previously one Paper
of the operating bodies of the FRC,
Green Paper entitled “Audit Policy:
the EC (October 2010)
2012 to the Audit and Assurance team
Capital
in the FRC’s Codes and Standards
Requirements as amended, affecting credit institutions
Division
Directives
Accounting Standards Board, previously
CEBS
Council of Institutional Investors
DGCL
Delaware General Corporation Law
Dodd-Frank
Dodd-Frank Wall Street Reform and
Act
Consumer Protection Act of 2010
Exchange Act
Securities Exchange Act of 1934
emerging
As defined in the JOBS Act, issuers with
growth
less than US$1 billion in total annual
company
gross revenue in the most recently
completed fiscal year
Lessons from the Crisis” published by
whose functions were transferred in July
ASB
CII
Directives 2006/48/EC and 2006/49/EC,
and investment firms
Committee of European Banking
one of the operating bodies of the FRC,
Supervisors (whose responsibilities were
whose functions were transferred in July
assumed by the EBA on 1 January 2011)
FASB
Financial Accounting Standards Board
FCPA
Foreign Corrupt Practices Act
foreign
As defined in Rule 3b-4(c) of the
private issuer
Exchange Act (i.e. most non-US, nongovernment issuers)
ISS
2012 to the Accounting and Reporting
Policy team in the FRC’s Codes and
CESR
proxy adviser
Committee of European Securities
Regulators (whose responsibilities were
Standards Division
JOBS Act
assumed by ESMA on 1 January 2011)
BIS
Institutional Shareholder Services Inc., a
Jumpstart Our Business Startups Act of
2012
Department for Business, Innovation &
Skills (the government department
Company
EC Communication entitled
responsible for company law and
Law Action
“Modernising Company Law and
corporate governance)
Plan
Enhancing Corporate Governance in the
European Union” (May 2003)
iii
Model Act
Model Business Corporation Act
Nasdaq
Nasdaq Stock Market LLC
Glossary
CA 06
Companies Act 2006
CA 85
Companies Act 1985
C(AICE)A
Companies (Audit, Investigations and
Community Enterprise) Act 2004
CSR
Corporate social responsibility
DEFRA
Department for Environment, Food &
Rural Affairs
DTR
The rules made for the purposes of Part
VI of FSMA relating to periodic financial
reporting and the disclosure of
Company
EC Communication entitled “Action
Law and
Plan: European company law and
standards as set out in the Rule 5600
Corporate
corporate governance – a modern legal
Series of the Nasdaq Listing Rules
Governance
framework for more engaged
Action Plan
shareholders and sustainable
companies” (December 2012)
Reporting Lab
2011 to encourage investors and
governance framework” published by
and NYSE listing standards
Green Paper
the EC (April 2011)
Council
Council of the European Union
CRD III
Directive 2010/76/EU amending the
Capital Requirements Directives as
regards capital requirements for the
trading book and for re-securitisations,
and the supervisory review of
remuneration policies, affecting credit
institutions and investment firms
CRD IV
EC proposal for a regulation and a
directive to implement the Basel III
Financial Reporting Council
FRC Guidance
“Guidance on Audit Committees”, as
Requirements Directives, affecting credit
on Audit
amended from time to time. The latest
institutions and investment firms
Committees
version (September 2012) applies for
1 October 2012, with early adoption
encouraged
NYSE corporate governance rules, as set
Governance
FRC
financial years commencing on or after
NYSE Rules
out in the NYSE Listed Company Manual
companies to develop pragmatic
solutions to corporate reporting
New York Stock Exchange
Green Paper entitled “The EU corporate
trading on a regulated market
The project established by the FRC in
NYSE
Corporate
holdings of securities admitted to
Financial
Nasdaq Rules Nasdaq corporate governance listing
reforms and replace the Capital
EBA
European Banking Authority. It took
over the responsibilities of CEBS on 1
January 2011
iv
PCAOB
Public Company Accounting Oversight
Board
SEC
Securities and Exchange Commission
Securities Act Securities Act of 1933
SOX
Sarbanes-Oxley Act of 2002
US GAAP
US generally accepted accounting
principles
Glossary
FRC Guidance
“Guidance on Board Effectiveness”
on Board
(March 2011) developed by ICSA on the
Effectiveness
FRC’s behalf, which replaces the good
EC
European Commission
EFRAG
The European Financial Reporting
practice guidance (as amended 2006)
Advisory Group, a group that assists the
from Sir Derek Higgs’ review of the role
EC in the endorsement of IFRS pursuant
and effectiveness of NEDs (January
to the IAS Regulation by providing
2003)
advice on the technical quality of IFRS
FRC Guidance
“Going concern and liquidity risk:
Environmenta Directive 2008/99/EC on the protection
on Going
Guidance for directors of UK
l Crime
of the environment through criminal
Concern
companies” updated by the FRC in
Directive
law
ESMA
The European Securities and Markets
October 2009
FRC Guidance
“Internal Control: Revised Guidance for
Authority. It took over the
on Internal
Directors on the Combined Code”
responsibilities of CESR on 1 January
Control
October 2005 (formerly known as the
2011
“Turnbull Guidance”)
FRRP
ESME
European Securities Markets Expert
Financial Reporting Review Panel,
Group, a group of market practitioners
previously one of the operating bodies
and participants established by the EC
of the FRC, whose functions were
in March 2006 to consider how EU
transferred to the Conduct Committee
securities directives are being applied.
of the FRC in July 2012. The FRRP
Its remit expired at the end of 2009
continues to exist as an advisory panel
of experts appointed by the Conduct
Committee
FRS
Financial Reporting Standard
FSA
Financial Services Authority
EU
European Union
FEE
Fédération des Experts comptables
Européens, the representative
organisation for the accountancy
profession in Europe
v
Glossary
FSA 2010
Financial Services Act 2010
FSMA
Financial Services and Markets Act 2000
HMRC
HM Revenue & Customs
ICAEW
Institute of Chartered Accountants in
England and Wales
ICSA
Institute of Chartered Secretaries and
Administrators
IMA
Investment Management Association
ISC
Institutional Shareholders Committee
(renamed the Institutional Investor
Committee (May 2010))
Kay Report
Financial
Green Paper entitled “Corporate
Institutions
governance in financial institutions and
Green Paper
remuneration policies” published by the
EC (June 2010)
Fourth and
Directive 2006/46/EC amending, among
Seventh
others, the Fourth and Seventh
Amendment
Directives
Directive
Fourth and
Directives 78/660/EEC on the annual
Seventh
accounts of certain types of company
Directives
and 83/349/EEC on consolidated
accounts
FSB
Financial Stability Board, the body
established in April 2009 as the
The Kay Review of UK Equity Markets
successor to the Financial Stability
and Long-Term Decision Making: Final
Forum. The Financial Stability Forum
Report (July 2012)
was founded in 1999 by G7 finance
ministers and central bank governors to
Listing Rules
The rules made for the purposes of Part
enhance co-operation and promote
or LR
VI of FSMA relating to the admission of
stability in the international financial
securities to the official list
system
NAPF
National Association of Pension Funds
NEDs
Non-executive directors
OFT
Office of Fair Trading
IAASB
The International Auditing and
Assurance Standards Board, an
independent standard-setting body
under the auspices of IFAC
IAS
International Accounting Standards
vi
Glossary
POB
Professional Oversight Board, previously
IASB
International Accounting Standards
one of the operating bodies of the FRC,
Board, an independent standard-setting
whose functions were transferred to the
body
Professional Oversight team in the
FRC’s Conduct Division in July 2012
IAS
Regulation (EC) No.1606/2002 of the
Regulation
European Parliament and of the Council
Prescribed
The Supervision of Accounts and
of 19 July 2002 on the application of
Body Order
Reports (Prescribed Body) and
international accounting standards
2012
Companies (Defective Accounts and
Directors’ Reports) (Authorised Person)
ICGN
International Corporate Governance
Network, an organisation of about 500
Order 2012
members, mainly institutional investors,
quoted
UK-incorporated companies that are
companies
UK, EU or Nasdaq/NYSE listed (but not
AIM quoted companies)
based in 50 countries
IESBA
The International Ethics Standards
Board for Accountants, an independent
Recognised
Bodies recognised by the Secretary of
standard-setting board under the
Supervisory
State which maintain and enforce rules
auspices of IFAC
Bodies
regarding the eligibility of persons
appointed as statutory auditors and the
conduct of statutory audit work
Sharman
Going Concern and Liquidity Risks:
Report
Lessons for Companies and Auditors.
Final Report and Recommendations of
IFAC
International Federation of Accountants
IFRS
International Financial Reporting
Standards (also comprising IAS)
IOSCO
Commissions
the Panel of Inquiry led by Lord
Sharman (June 2012)
International Organization of Securities
ISAs
International Standards of Auditing
vii
Glossary
UK Corporate
UK Corporate Governance Code, as
MiFID
Directive 2004/39/EC on markets in
Governance
amended by the FRC from time to time.
financial instruments, affecting
Code
The latest version (September 2012)
investment firms
applies for financial years commencing
on or after 1 October 2012, with early
MiFID
EC proposal for a directive to revise
adoption encouraged
Amendment
MiFID
Directive
UK GAAP
UK generally accepted accounting
principles
Modernisatio Directive 2003/51/EC amending, among
n Directive
UK
UK Stewardship Code, setting out good
Stewardship
practice on engagement between
Code
institutional investors and investee
Directives
OECD
(September 2012) applies from 1
October 2012
Walker Report
Organisation for Economic Cooperation and Development
companies, as amended by the FRC
from time to time. The latest version
others, the Fourth and Seventh
public
Public interest entities include, for the
interest
purposes of EU audit legislation, EU-
entities
incorporated companies listed on an
“A review of corporate governance in
EU-regulated market, credit institutions
UK banks and other financial industry
and insurance undertakings
entities”, the report by Sir David Walker
setting out 39 recommendations to
improve corporate governance
(November 2009)
Shareholder
Directive 2007/36/EC on the exercise of
Rights
certain rights of shareholders in listed
Directive
companies
SMEs
Small and medium-sized entities
viii
Glossary
Statutory
Directive 2006/43/EC on statutory
Audit
audits of annual accounts and
Directive
consolidated accounts, amending the
Fourth and Seventh Directives and
repealing Council Directive 84/253/EEC
TOD
Directive 2004/109/EC on the
harmonisation of transparency
requirements in relation to information
about issuers whose securities are
admitted to trading on a regulated
market (known as the “Transparency
Obligations Directive”)
TOD
EC proposal for a directive to amend
Amendment
TOD
Directive
ix
Directors’ duties
General duties
CA 06 contains a statutory statement of duties that
The Company Law Action Plan set out a proposal for a
Directors’ duties are generally governed by the laws of
directors owe to the company in place of the common
directive in the medium term to introduce a right for
a company’s state of incorporation. No general federal
law and equitable rules. There are seven duties set out
shareholders to call for a special investigation into the
codification of directors’ duties exists.
in Sections 171 to 177:
company’s affairs and rules on wrongful trading and
-
to act within powers conferred
-
to act in the way the directors consider most likely
directors’ disqualification.
Under the common law of Delaware (where more than
50% of US public companies and more than 60% of the
The EC published a consultation on future priorities for
Fortune 500 are incorporated), directors owe duties of
the Company Law Action Plan (December 2005) and a
care, loyalty and good faith to their corporations. By
summary report of the results (July 2006). Respondents
statute, Delaware corporations are permitted to include
generally opposed the adoption of rules on wrongful
in their certificate of incorporation provisions limiting or
trading and directors’ disqualification, although a slight
excluding the liability of directors for breaches of their
majority was in favour of a special investigation right.
duty of care (but not of loyalty or good faith).
community and the environment, the company’s
The EC published a Financial Institutions Green Paper
In addition, under Delaware case law, directors are
reputation for high standards of business conduct
on ways to improve corporate governance in financial
presumed to have acted on an informed basis, in good
and the need to act fairly as between members
institutions (June 2010). It sought comments on a
faith and without personal interest in a matter.
(which the explanatory notes to CA 06 call the
number of questions in relation to the duties of
principle of “enlightened shareholder value”)
directors, including:
-
to exercise independent judgement
-
-
to exercise reasonable care, skill and diligence
-
to avoid conflicts of interest
-
not to accept benefits from third parties
-
to declare an interest in a proposed transaction or
to promote the success of the company for the
benefit of its members as a whole. Directors must
have regard to the long term and wider factors,
namely employees, suppliers, customers and others,
the impact of the company’s operations on the
arrangement with the company.
Other statutory or common law duties, which are not
-
not second-guess directors by holding them personally
should a specific duty be established for a board of
liable for any action attributable to a rational business
directors to take into account the interests of
purpose (the so-called “business judgement rule”). If a
depositors and other stakeholders during the
plaintiff succeeds in rebutting the presumption, a
decision-making procedure?
director may have the burden of demonstrating that a
is it necessary to increase the accountability of
members of boards of directors?
-
If a plaintiff fails to rebut this presumption, a court will
challenged transaction meets the more exacting “entire
fairness” standard, requiring a showing that the
transaction was both the result of a “fair process” (i.e.
should the civil and criminal liability of directors be
procedural fairness) and was at a “fair price” (i.e.
reinforced?
substantial fairness). Note that a breach of the duty of
restated in the codified provisions, will also apply in
The Financial Institutions Green Paper (June 2010)
loyalty may be found if a plaintiff can show that a
certain circumstances, e.g. to deal with duties to
stated that sanctions may be needed to change
director (or director who approved the matter) was
1
Directors’ duties
creditors.
BIS published a collection of ministers’ statements on
directors’ duties to assist interpretation of the codified
duties (June 2007).
corporate governance behaviour. The summary of
responses showed that most respondents were
opposed to this on the basis that existing rules
imposed sufficient liability on directors. Ways to
implement the rules more effectively should be
The Walker Report (November 2009) rejected the idea
analysed before any harmonisation was decided at EU
of extending the duty of directors (of banks and
level.
the directors’ duty of good faith, particularly in
instances where violations of the duty of care were so
egregious that they rose to the level of bad faith. This
development is made more significant by the fact that
terms of a corporation’s certificate of incorporation
employees, depositors and taxpayers. It concluded that
from liabilities arising out of breaches of the duty of
any dilution of the duty of a director to shareholders
good faith. A complete abdication of responsibilities is
would introduce uncertainty for shareholders and
viewed as non-feasance on the part of the director and
distract directors from
is a breach of the director’s duty.
General duties (continued)
important strategic concerns.
The GC100 (a group representing the general counsel
and company secretaries of FTSE 100 companies)
published:
best practice guidelines for compliance with
directors’ duties (February 2007). This recognises
the diverse ways in which decisions are taken by
directors and argues that the default should not be
to provide written records of every decision, but to
do so only where circumstances make this
particularly necessary or relevant
-
Recent Delaware cases have shown renewed focus on
directors cannot be exculpated or indemnified by the
financial institutions) to other stakeholders, such as
-
interested in the matter.
guidance to directors on exercising their powers to
approve a conflict (January 2008), including an
explanation of changes companies might make to
2
Directors’ duties
General duties (continued)
their articles and suggested procedures for
directors to authorise conflict situations.
ICSA published a guidance note on the statutory duties
(January 2008) for directors of public companies.
Fears that the derivative claim procedure set out in
Sections 260 to 264 CA 06 would lead to increased
litigation against directors have so far proved
unfounded. Only a small number of claims have been
given leave to proceed since the procedure took effect
in October 2007, e.g. Kiani v Cooper and others [2010]
EWHC 577, Robin Stainer v Gerard Alan Lee and others
[2010] EWHC 1539, Phillips v Fryer and others [2012]
EWHC 1611 and Hughes v Weiss [2012] EWHC 2363.
ICSA published a note on specimen board meeting
etiquette (September 2009). This provides guidance on
modern etiquette for those attending and participating
in board meetings to help ensure that the meetings are
effective.
The Kay Report (July 2012) emphasises that directors
are stewards of the assets and operations of their
businesses. Their duties are to the company not to the
share price. It recommended that directors should
adopt “good practice statements” to promote
stewardship and long-term decision making. A sample
statement is set out in the Report and includes the
following principles:
3
Directors’ duties
General duties (continued)
-
directors should understand their duties
-
long-term value creation is best served by
strategies which focus on investing for sustainable
performance rather than treating the business as a
portfolio of financial interests
-
corporate reporting should focus on forwardlooking strategy.
In its Response to the Kay Report (November 2012), the
Government indicates support for the concept of good
practice statements and encourages business
representative groups and investment industry trade
associations to review and endorse the statements and
suggest how good practice standards might be further
developed.
The FSA’s consultation “Enhancing the effectiveness of
the Listing Regime” (October 2012) proposes to amend
LR 9.8.6(5) to require the company to disclose in its
corporate governance statement how the chairman has
ensured the directors have a sufficient understanding of
the regulatory requirements applicable to a premium
listed company and the requirements regarding
fiduciary duties that are applicable to directors in the
company’s country of incorporation. When making this
disclosure, the company should have regard to the
listing principle that a listed company must take
reasonable steps to enable its directors to understand
their responsibilities and obligations as directors.
4
Directors’ duties
5
Directors’ duties
Non-executive directors of listed companies
In the wake of the 2008 financial crisis, the Walker
The EC’s Recommendation on independent directors
NYSE/Nasdaq Rules address independence at the board
Report and the House of Commons Treasury
and board committees (February 2005) sets out a
level:
Committee Ninth Report, Banking Crisis: reforming
general statement of independence (freedom from a
corporate governance and pay in the City (May 2009)
business, family or other relationship that creates a
identified the lack of time spent by NEDs on their role,
conflict of interest such as to jeopardise the exercise of
the lack of relevant experience and too narrow a talent
free judgement). Minimum criteria for independence
pool as grounds of concern.
and the suggestion that independent directors should
meet on a regular basis without management or
undertake to maintain their independence of
non-independent directors present.
The recommendations in the Walker Report were
implemented by the UK Corporate Governance Code
and FSA Rules.
The UK Corporate Governance Code was amended in
June 2010 to give greater emphasis to the following:
-
-
-
-
a majority of the board of directors must consist of
independent directors
-
non-management or independent directors must
judgement, remain free of conflicts and clearly express
Nasdaq modified (June 2011) its listing rule that
their opposition if they believe that a decision of the
requires listed companies to disclose in their annual
board may harm the company are included as guidance
proxies those directors that the board has determined
and contained in an annex of the Recommendation.
to be independent. The rule now references the
The Recommendation is expressed to apply to all
disclosure required in Regulation S-K. The disclosure is
the responsibility of the chairman for leadership of
companies with securities admitted to a regulated
substantially similar to the disclosure before the
the board and ensuring its effectiveness (Main
market, including non-EU companies with a primary
modification; however, the modification was made to
Principle A3)
listing.
avoid duplication and confusion.
the role of NEDs in constructively challenging
The EC published a report on Member States’
Nasdaq requires listed companies to certify that they
proposals on strategy (Main Principle A4)
application of the Recommendation (July 2007). This
have adopted a formal written charter or board
the requirement for all directors to allocate
noted “a clear trend towards improving corporate
resolution addressing the nomination process. NYSE
sufficient time to the company to discharge their
governance standards in the EU” and that most
requires listed companies to adopt and disclose formal
duties effectively (Main Principle B3).
Member States had complied with the
corporate governance guidelines which address director
Recommendation “almost fully or to a large extent”.
qualification standards, director responsibilities, access
The main areas of non-compliance were the failure by
to management and independent advisers, director
some Member States to:
orientation and continuing education as well as board
In addition, the preface to the UK Corporate
Governance Code was amended to encourage chairmen
to include a personal statement on the role and
effectiveness of the board.
The FRC Guidance on Board Effectiveness (March 2011)
includes guidance on the role of NEDs taking into
-
recommend a sufficient number of independent
evaluation.
board members in remuneration and audit
Accommodations/exemptions to the corporate
committees
governance requirements of the NYSE/Nasdaq Rules are
6
Directors’ duties
account the 2010 changes made in the UK Corporate
-
Governance Code.
set a cooling-off period before a former CEO of a
available to non-US issuers – see Corporate governance
company could become its chairman.
codes – general provisions and guidance below.
ICSA published guidance on the liability of NEDs
IOSCO published a report (March 2007) on the
The SEC’s Form 20-F requires that any issuer with
(January 2013). It suggests ways in which NEDs can
definition and role of independent directors of listed
securities listed on a US exchange must disclose, in
approach their work in a way that demonstrates to
companies in 18 jurisdictions. This identified the
summary form, any significant differences between its
regulators and the courts that they have taken
dominant trends with respect to the independence of
corporate governance practices and those followed by
appropriate steps to exercise care, skill and diligence. It
boards and described how each jurisdiction addressed
US domestic companies under the listing standards of
considers steps NEDs should take before and on joining
the OECD principle that boards should be able to
the same exchange.
a board and cross-refers to previous ICSA guidance on
exercise objective and independent judgement on
due diligence for prospective directors (May 2011) and
corporate affairs.
guidance on the induction of directors (June 2012).
ISS’s 2012 U.S. Proxy Voting Summary Guidelines sets
forth a narrower definition of “independent director”
The OECD’s report “Corporate Governance and the
than the NYSE/Nasdaq Rules. ISS generally recommends
Financial Crisis: Key Findings and Main Messages” (June
voting for shareholder proposals requiring an
2009) stressed the importance of a competent board
independent
that is capable of objective and independent
judgement. It made the following observations:
Non-executive directors of listed companies (continued)
NAPF’s Corporate Governance Policy and Voting
-
Guidelines (November 2012) state that, where a nonindependent NED upsets board balance, shareholders
might vote against the re-election of that director.
The FSA published a consultation “Enhancing the
effectiveness of the Listing Regime” (October 2012). It
-
-
proposes new rules principally addressed to premium
listed companies with a controlling shareholder, but
some proposals are expressed to apply to all companies
with a premium listing of shares. In relation to directors:
-
companies with controlling shareholders will need
-
board evaluation should be conducted by
chairman unless there is a counterbalancing governance
independent experts on a regular basis
structure.
it is good practice for the role of the chairman and
The SEC adopted rules (December 2009) amending its
CEO to be split
proxy rules to require, among other things:
it is good practice for the board to develop a
-
additional disclosures in a company’s proxy
specific policy for the identification of the best skill
statement regarding director qualifications,
composition of the board
including whether the company uses diversity as a
factor in selecting directors
some form of continuing training is required,
especially in banks.
-
The OECD published its conclusions and emerging
7
disclosures about board structure and risk
oversight, including the reasons for separating or
combining the positions of CEO and chair of the
Directors’ duties
Non-executive directors of listed companies (continued)
-
to have a majority of independent directors and the
good practices (February 2010). This concluded that
shareholders other than the controlling
there was no urgent need to revise the OECD Principles
shareholders will be given a separate vote on the
of Corporate Governance (2004) but that they needed
election of independent directors
to be implemented more effectively.
LR 9.8.6(5) will be amended to require the company
The Corporate Governance Green Paper (April 2011)
instructions by shareholders) in all elections for
to disclose in its corporate governance statement
sought views on whether there should be a limit on the
directors, on executive compensation or on “any
how the chairman has ensured the directors have a
number of mandates a NED should hold and whether
significant matter” as determined by the SEC.
sufficient understanding of the regulatory
listed companies should be encouraged to conduct
Previously, NYSE Rule 452 permitted a broker to vote
requirements applicable to a premium listed
external evaluations regularly and how this should be
on behalf of beneficial owner customers in uncontested
company and the requirements regarding fiduciary
done.
elections of directors if the customers had not returned
duties that are applicable to directors in the
board of directors.
Pursuant to the Dodd-Frank Act, the SEC approved an
amendment to NYSE Rule 452 (September 2010) to
prohibit broker discretionary voting (i.e. voting without
their voting instructions.
company’s country of incorporation.
The NYSE published an information memo (January
2012) clarifying the application of NYSE Rule 452 to
certain types of corporate governance proxy proposals.
The NYSE has determined that certain proxy proposals
that it previously ruled as “Broker May Vote” will now
be treated as “Broker May Not Vote” matters, including:
-
de-staggering the board of directors
-
majority voting in the election of directors
-
eliminating supermajority voting requirements
-
providing for the use of consents
-
providing rights to call a special meeting
-
certain types of anti-takeover provision overrides.
The SEC adopted rules (August 2010) requiring
companies to allow a qualifying shareholder (or group
8
Directors’ duties
Non-executive directors of listed companies (continued)
of shareholders) to include its nominee(s) for the board
of directors on the company’s proxy statement, but the
rules were struck down by the Court of Appeals for the
D.C. Circuit (July 2011) and the SEC has stated that it
will not appeal the decision.
9
Directors’ duties
Rules applicable to directors of financial
institutions
The FSA extended the scope of its approved persons
The EC published a Financial Institutions Green Paper
regime in August 2009 to cover individuals with
on ways to improve corporate governance in financial
significant influence over FSA-authorised firms. See FSA
institutions (June 2010). It sought comments on a
policy statement 09/14 setting out the FSA’s final rules
number of questions in relation to directors, including:
(July 2009).
-
The FSA wrote to the CEOs of 5,000 regulated firms to
reinforce how its approach applies to approving and
supervising individuals performing significant influence
which a director may sit?
-
should combining the functions of chairman and
chief executive be prohibited in financial
functions (October 2009). It stressed that responsibility
institutions?
for assessing whether a candidate is fit and proper rests
with the firm and that firms should have robust
should there be a limit on the number of boards on
-
should recruitment policies specify the duties and
recruitment, referencing and due diligence processes in
profile of directors (including the chairman), ensure
place.
that directors have adequate skills and ensure that
the composition of the board of directors is
The FSA appointed (November 2009) a panel of senior
suitably diverse? If so, how?
advisers to support its senior influence function
assessments for NEDs proposed for FTSE 100-listed
-
would including more women and individuals from
banks and life assurance company boards (November
different backgrounds improve the functioning of
2009). This follows a recommendation in the Walker
boards of directors?
Report.
-
should a compulsory evaluation of the functioning
The FSA published Policy Statement 10/15 (September
of the boards of directors, carried out by an
2010) setting out final rules to implement FSA-specific
external evaluator, be put in place? Should the
aspects of the Walker Report. The rules amend the
result of this evaluation be made available to
approved persons regime by introducing a more
supervisory authorities and shareholders?
detailed framework of controlled functions to make
clearer the exact role an individual performs within a
-
should the role of supervisory authorities in the
internal governance of financial institutions be
firm and increase the FSA’s ability to vet and track
10
Directors’ duties
individuals as they move role. The rules took effect on 1
May 2011. The FSA also proposed to extend the regime
to capture more individuals from parent companies
redefined and strengthened?
-
power and duty to check the correct functioning of
who exert significant influence upon a UK-regulated
the board of directors and the risk management
firm (including overseas parent companies, but not
function? How can this be put into practice?
including EEA-based parent companies), although the
implementation of the final rules regarding this
should the supervisory authorities be given the
-
should the eligibility criteria be extended to cover
requirement has been postponed pending certain
the technical and professional skills, as well as the
required changes to the FSA’s online notification and
individual qualities, of future directors? How can
application system.
this be put into practice?
The FSA published a consultation (December 2011) on
The directive forming part of CRD IV (July 2011) and
guidance to assist NEDs understand their role in
the MiFID Amendment Directive (October 2011) set out
ensuring the fair treatment of customers by their firms.
proposals to address many of the above. For example:
The FSA expects NEDs to play a pivotal part within the
firm’s governance by ensuring that the firm is meeting
its
Rules applicable to directors of financial institutions (continued)
responsibilities to retail customers. The guidance
-
directors must commit sufficient time to perform
proposes that amongst the issues that NEDs should
their functions. In particular, executive directors
consider are:
must not hold, at the same time, more than one
-
executive directorship with two non-executive
taking a strategic view to treatment of their
directorships. NEDs must not hold more than four
customers; being confident that the firm is
non-executive directorships
identifying, monitoring and mitigating risk to its
customers
-
-
periodically assess its governance arrangements
having the right mix of skills on the board and the
right information to be able to constructively
challenge the executive
the management body should monitor and
-
competent authorities should require institutions to
take diversity into account. In particular, institutions
11
Directors’ duties
Rules applicable to directors of financial institutions (continued)
-
supporting a culture within the firm that takes into
should put in place a policy promoting gender,
account fair treatment of customers.
geographical, educational and professional diversity
(see also Board diversity below).
The role of the FSA in delivering effective corporate
governance was discussed by Hector Sants in his final
In addition, the directive forming part of CRD IV (July
speech as CEO of the FSA (April 2012). Among other
2011) provides that:
things, he stressed the need for enforcement to be
credible and suggested that penalties should be raised
-
the CEO unless justified and authorised by the
to provide effective deterrence. Also, there should be a
competent authorities
presumption that if a person is on the board of a bank
that fails, that person should not be allowed to carry on
that role in the future.
Following the recommendations of The Joint Committee
on the draft Financial Services Bill on introducing a
concept of strict liability for executives and board
members for the adverse consequences of poor
decisions, (December 2011), HM Treasury published a
consultation paper (July 2012) seeking views on
proposals:
-
to introduce a rebuttable presumption that a
director of a failed bank is not suitable to be
approved by a regulator to hold the position of
senior executive in a bank
-
to strengthen sanctions for serious misconduct in
the management of a bank.
the chairman should not exercise the functions of
-
competent authorities should carry out a review
and evaluation to check compliance with the
directive, including in relation to governance
arrangements, corporate culture and values and the
ability of the board to carry out its duties. Among
other things, competent authorities should review
agendas and supporting documents from board
and committee meetings and the results of external
evaluation.
The Basel Committee on Banking Supervision issued
(October 2010) its Principles for Enhancing Corporate
Governance. The Principles are intended to provide
guidance
for
bank
supervisors
on
the
corporate
governance principles that should be adopted by the
banking organisations they supervise. They emphasise
the importance of supervisors regularly evaluating a
The Treasury Select Committee published terms of
banking organisation’s corporate governance policies
reference for an inquiry into corporate governance and
and practices as well as its implementation of the
remuneration in systemically important financial
Principles.
12
Directors’ duties
Rules applicable to directors of financial institutions (continued)
institutions (April 2012). The terms of reference cover
The Group of Thirty, a non-profit, international body
matters such as:
composed of senior representatives of the private and
-
whether NEDs should bear greater liabilities than
under current law
-
public sectors and academia, published a report (April
2012) on effective governance of financial institutions.
Based on an examination of governance arrangements
whether executives in FTSE 100 companies should
at 36 of the world’s largest financial services firms, it
be able to hold non-executive positions in other
calls on directors, managers, supervisors and long-term
firms
shareholders to reassess their approach to governance
-
the effectiveness of the FSA approval process
and includes recommendations for what each needs to
-
the effectiveness of board structures and whether
UK financial institutions should consider adopting
alternatives to the unitary board structure
-
the impact of the Walker Report on corporate
governance and corporate behaviour in financial
services.
do to make the governance of financial institutions
function more effectively.
The EBA published guidelines for assessing the
suitability of members of the management body and
key function holders of a credit institution (November
2012). The guidelines set out the process, criteria and
minimum requirements for assessing suitability and
The Treasury Select Committee published written
should be applied by competent authorities and credit
evidence submitted to the inquiry (June 2012).
institutions by 22 May 2013.
The Parliamentary Commission on Banking Standards (a
Consistent with the EC’s Communication (December
joint committee appointed by the House of Commons
2010), which called for more dissuasive sanctions for
and House of Lords) is considering the professional
breach of EU financial services rules, the TOD
standards and culture of the UK banking sector and
Amendment Directive also seeks to ensure that
lessons to be learned about corporate governance,
competent authorities have uniformly tough sanctioning
transparency and conflicts of interest, and their
powers, providing for sanctions of up to 10% of
implications for regulation and for government policy. It
consolidated annual turnover for companies and up to
published a call for evidence (July 2012) seeking views
€5 million for individuals for breach of the periodic
on a broad range of issues, including the role of NEDs,
reporting and certain other obligations of TOD. There is
and has established panels to consider corporate
also a new provision requiring competent authorities to
13
Directors’ duties
Rules applicable to directors of financial institutions (continued)
governance at and below board level. It published its
publish the sanctions that are applied. A similar
first report (December 2012) which focuses on the ring-
sanctions framework is proposed in CRD IV and the
fencing of retail and investment banking in the
MiFID Amendment Directive.
Financial Services (Banking Reform) Bill. Its final report
(expected in 2013) will consider the broader questions
of standards, culture and corporate governance in
greater detail.
14
Directors’ duties
Indemnification of directors
Sections 232 to 238 CA 06 permit companies to
Delaware companies are permitted to indemnify
indemnify directors in relation to liabilities owed to
directors who are subject to civil, criminal,
third parties (i.e. persons other than the company or an
administrative or investigative proceedings and for
associated company). Also, companies may indemnify a
expenses incurred (including legal fees), as well as for
director of a company that is a trustee of an
amounts paid or incurred in satisfaction of settlements,
occupational pension scheme against liability incurred
judgments and fines. A corporation may only indemnify,
in connection with the company’s activities as trustee of
however, in those cases in which it has been
the scheme.
determined that the director to be indemnified acted in
good faith, for a purpose that he reasonably believed
Sections 205 and 206 CA 06 provide that funding for
was in, or not opposed to, the corporation’s best
the purpose of enabling a director to defend himself in
interests, and, in the case of any criminal proceeding,
civil or criminal proceedings or regulatory actions is an
had no reasonable cause to believe that his conduct
exception to the prohibition on loans, quasi-loans and
was unlawful.
credit to directors in Sections 197 to 201 CA 06. To fall
within the exception, the proceedings must be brought
In a third-party action, the corporation may indemnify
in connection with any alleged negligence, default,
for all losses, expenses, judgments, fines and amounts
breach of duty or breach of trust by a director in
paid in settlement.
relation to the company or an associated company.
If a claim is brought as a derivative action (i.e. on behalf
The Listing Rules were amended (October 2012) to
of the corporation by its shareholders), the corporation
extend the list of transactions to which Chapter 11
may indemnify only for expenses. The Delaware statute
(Related Party Transactions) does not apply to loans to
does not authorise reimbursement of settlements paid
directors in relation to the defence of a regulatory
or judgments in derivative actions, which reflects a
investigation under Section 206 CA 06. Before 1
public policy concern with circular recovery – i.e. a
October 2012, only loans granted to directors in
corporation would be paying the settlement or
relation to business expenses and expenditure to
judgment on behalf of the indemnified party to itself
defend civil and criminal claims under Sections 204 and
since the corporation is the nominal plaintiff in a
205 CA 06 were exempt.
derivative action. In addition, if a director is judged to
be liable to the corporation in a derivative action,
The UK Corporate Governance Code refers to the need
15
Directors’ duties
for companies to arrange appropriate insurance cover
indemnification for expenses is subject to court
in respect of legal action against directors (Provision
approval. This lack of indemnification in derivative
A1.3). ICSA published a guidance note on directors’ and
actions has traditionally been mitigated for directors by
officers’ insurance (November 2008) relating to this
the “exculpation provision” in corporate charters and
provision.
directors’ and officers’ insurance.
16
Directors’ duties
Liability for corporate acts
Bribery
Bribery
Bribery
The Bribery Act 2010 came into force in July 2011. It is
The OECD Convention on Combating Bribery of Foreign
The FCPA prohibits bribery of foreign officials and
largely based on the Law Commission’s report on
Public Officials in International Business Transactions
imposes on companies accounting requirements
reforming bribery (November 2008) and replaced the
and related OECD anti-bribery instruments (adopted
designed to provide reasonable assurances that bribery
previous patchwork of law with two general offences of
November 1997) establishes legally binding standards
payments come to the attention of management.
bribery (one for paying and one for receiving bribes), a
to criminalise the bribery of foreign public officials in
specific offence of bribing a foreign public official and a
international business transactions. 34 OECD members
new corporate offence of negligently failing to prevent
and six non-member countries have adopted the
bribery by an employee or agent. The corporate offence
Convention.
is punishable with an unlimited fine; the other offences
are punishable with a fine and/or up to 10 years’
imprisonment.
the non-corporate offences can also be liable for such
offence, along with the company.
The corporate offence applies if a person “associated
with” a “relevant commercial organisation” bribes
-
a Recommendation on the non-tax deductibility of
a Recommendation for further combating bribery of
foreign public officials (November 2009). This
includes good practice guidance on internal
controls, ethics and compliance (Annex II).
another person and the organisation has no adequate
These recommendations now form part of the
procedures to prevent bribery. “Relevant commercial
Convention on Combating Bribery.
organisations” include UK companies and partnerships
The OECD’s 2011 annual report gives an overview of
wherever they carry on business or non-UK companies
the working of the Convention on Combating Bribery
and partnerships carrying on business in the UK.
and includes detailed enforcement data.
“Associated persons” include people who perform
services for or on behalf of a “relevant commercial
organisation” and may include employees, agents,
subsidiaries or joint venture vehicles and/or partners.
commit an act in furtherance of a foreign bribe while in
apply to issuers that have US-registered securities or
bribes (May 2009)
A senior officer who consents or connives with any of
to all US “domestic concerns” and foreign persons who
the United States. The accounting requirements only
The OECD adopted:
-
In general, the anti-bribery provisions of the FCPA apply
are subject to the ongoing reporting requirements of
the Exchange Act.
In recent years, the US Government has become more
aggressive in prosecuting FCPA violations and has
increasingly pursued individuals. The SEC and DOJ
issued (November 2012) A Resource Guide to the U.S.
Foreign Corrupt Practices Act, outlining their approach
to FCPA enforcement.
Whistleblowing
The SEC enacted a new whistleblower programme
(August 2011). The programme was created to provide
monetary incentives for individuals to come forward
The ICGN published guidance on anti-corruption
and report possible violations of the federal securities
practices (March 2009). This places the responsibility on
laws to the SEC. Under the programme, eligible
shareholders to ensure the companies in which they
whistleblowers are entitled to an award of between 10%
invest have appropriate preventative and enforcement
and 30% of the monetary sanctions collected in actions
“Adequate procedures” is not defined but the Act
17
Directors’ duties
contains an obligation on the Secretary of State to
measures to deal with corrupt activities.
publish guidance about the types of procedures
brought by the SEC and related actions brought by
other regulatory and law enforcement authorities.
organisations are expected to put in place. The Ministry
The programme also prohibits retaliation by employers
of Justice published guidance (March 2011) setting out
against employees who provide the SEC with
six principles that, in the Government’s view, should
information about possible securities violations.
inform the procedures companies should put in place.
The guidance also seeks to clarify the scope of the
corporate offence.
The personal consent of the Director of the Serious
Fraud Office or the Director of Public Prosecutions is
required before proceedings for bribery can be
brought. Their approach to prosecution decisions is set
out in joint guidance (updated October 2012). The
guidance
Liability for corporate acts (continued)
emphasises that a prosecution will only be brought if
there is both sufficient evidence and that prosecution is
in the public interest. The guidance includes nonexhaustive lists of factors both for and against
prosecution, with specific references to facilitation
payments and hospitality and promotional expenditure.
Following the appointment of a new director, David
Green QC, the SFO revised its approach to facilitation
payments, business expenditure (hospitality) and
corporate self-reporting (October 2012). In particular,
whether it will prosecute in respect of a bribe presented
as hospitality or other business expenditure, or in
relation to facilitation payments, will be governed by
18
Directors’ duties
Liability for corporate acts (continued)
the existing tests contained in the joint guidance and
the Code for Crown Prosecutors (and, where relevant,
the Joint Guidance on Corporate Prosecutions).
Assurances given by former director Richard Alderman
that the SFO would not always seek to prosecute,
particularly where companies self-report wrongdoing
and demonstrate their willingness to reform, have not
been restated and references the SFO’s policy of
dealing with overseas corruption, which included
guidance on self-reporting, have been removed from
the joint guidance.
Transparency International has published the following:
-
a report on avoiding corruption risks in the City
(May 2010). This provides an overview of the
Bribery Act 2010 and highlights the types of
business activity which put City businesses at
greatest risk in relation to bribery and prosecution
-
guidance (July 2010) on adequate procedures
-
guidance (May 2012) on anti-bribery due diligence
in mergers, acquisitions and investments
-
a report (July 2012) ranking reporting by listed
companies on matters such as anti-corruption,
organisational transparency and country-by-country
reporting. The report concluded that multinationals
have a long way to go to improve transparency,
especially in the financial sector.
19
Directors’ duties
Liability for corporate acts (continued)
The SFO published “Serious economic crime: a
boardroom guide to prevention and compliance”
(September 2011). The intention is to give board-level
readers in the UK and international businesses informed
commentary on the impact of anti-fraud and anticorruption legislation.
The British Standards Institution published a standard
“BSI 10500 – Specification for an anti-bribery
management system” (December 2011). This is intended
to provide an agreed benchmark against which
organisations can measure that their anti-bribery
systems are adequate.
The British Bankers’ Association published guidance for
the UK banking sector to consider regarding the
implementation of the UK Bribery Act 2010 (December
2011).
The FSA published (March 2012) the findings of its
thematic review of the anti-bribery and corruption
systems of 15 investment banks. While some of the
banks had taken steps to implement effective controls,
most had more work to do. In light of the review, the
Liability for “environmental crimes”
Liability for “environmental violations”
Federal environmental statutes do not define “person”
FSA consulted (March 2012) on updating its regulatory
The EC adopted the Environmental Crime Directive
to expressly include corporate officers or directors in
guidance, “Financial crime: a guide for firms” (December
(November 2008). Under the Directive, Member States
evaluating liability for either civil or criminal violations,
2011).
are required to apply effective criminal sanctions for the
although some laws do include an “individual” within
commission of serious environmental offences when
the meaning of the term. Personal liability for corporate
committed intentionally or with serious negligence. The
officers and directors is therefore very rare under US
criminal penalties to be imposed are left to Member
environmental law, absent certain specific facts such as
Liability for manslaughter
Although only companies can be liable under the
20
Directors’ duties
Liability for corporate acts (continued)
Corporate Manslaughter and Corporate Homicide Act
States’ discretion but should be effective, proportionate
(i) personal participation in an environmental violation;
2007, a director may still be open to prosecution under
and dissuasive.
(ii) authority, and failure, to control wrongful conduct
the general criminal law.
giving rise to the violation (as in the case of a director
responsible for the environment, health and safety); (iii)
Liability for “environmental crimes”
participation in decision making at the facility level that
Most health and safety legislation in the UK already
creates the violation; or (iv) serving as both an officer
allows for secondary individual liability in that a
and a shareholder in a closely held corporation in a
“director, manager, secretary or other similar officer”
case where the US Government pierces the corporate
may also be liable where an offence by the company
veil to impose personal liability.
was committed with such person’s “consent,
connivance, or [was] attributable to his/her neglect”. It
is also possible for civil penalties to be imposed on
businesses as an alternative to prosecution in some
cases.
Disqualification for breach of competition law
The OFT published (June 2010) guidance on director
disqualification orders in competition law cases. The
guidance sets out how and when the OFT will take
action to disqualify directors where they uncover
evidence that a director was responsible for, or ought
to have known of, competition law breaches at a
company.
The guidance makes clear that the OFT will be just as
concerned with directors who ought to have known of
competition law breaches at a company as those who
were personally involved in an infringement. Cases will
21
Directors’ duties
Liability for corporate acts (continued)
be chosen based on the evidence available and the
seriousness of the conduct.
Further guidance on how the OFT will assess the extent
of a director’s responsibility for infringements of
competition law was published (June 2011). This is
intended to provide guidance on the knowledge the
OFT expects directors to have and the steps it believes
are reasonable for directors to take to detect and
prevent infringements of competition law.
Criminal liability in regulatory contexts
The Law Commission published a consultation paper
(August 2010) on issues connected with criminal liability
in regulatory contexts. Among other things, this
considers the basis on which directors can be made
liable for offences committed by their companies. In
general terms, it considers that, where it is appropriate
for directors to be liable for an offence committed by
their company on the basis that they consented or
connived with the company’s commission of the
offence, the provision should not be extended to
include instances where the company’s offence is
attributable to neglect on the part of the directors.
However, it does seek views on whether it might be
appropriate in some circumstances to provide that
directors can be liable for a separate offence of
negligently failing to prevent an offence.
The Law Commission published a summary of
22
Directors’ duties
Liability for corporate acts (continued)
responses received (November 2011).
23
Remuneration
Current regime affecting listed companies
Section 420 CA 06 and Schedule 8 of the Accounts
The EC’s Recommendation on remuneration for
Item 402 of SEC Regulation S-K requires the following
Regulations 2008 require quoted companies (see
directors of listed companies (December 2004) advised
disclosure about the principal executive officer, principal
Glossary) to publish, as part of the annual reporting
that shareholders be kept informed about the
financial officer, the three other highest-paid executive
cycle, a report on directors’ pay on which shareholders
company’s policy on directors’ remuneration as well as
officers and the directors:
will vote at each annual general meeting. The vote of
how much individual directors are earning and in what
shareholders is advisory only. The content requirements
form, and that they should have adequate control over
for the report are set out in the Accounts Regulations
these matters and over share-based remuneration
2008. These overlap with disclosure requirements in the
schemes. It invited Member States to adopt the
Listing Rules and UK Corporate Governance Code.
following measures:
BIS has proposed significant changes to this disclosure
-
-
a compensation discussion and analysis or “CD&A”
addressing the objectives and implementation of
executive compensation programmes and focusing
on the most important factors underlying each
company’s compensation policies and decisions.
an annual statement in relation to remuneration
The CD&A must be filed with the SEC and will form
framework which are intended to take effect in 2013.
policy should be released by all listed companies
part of the disclosure subject to certification by the
For more information, see Proposals affecting listed
containing information about the breakdown of
CEO and CFO
companies below.
remuneration (fixed and variable), performance
criteria and the parameters for bonus schemes
ICSA updated its guidance on the remuneration report
compensation) for each named executive officer
information need not be disclosed
practice guidelines on executive contracts and
over the last three years, accompanied by narrative
directors’ remuneration should be on the agenda at
disclosure and details on the grant of plan-based
these require companies to disclose fully in the
the shareholders’ general meeting and, to increase
awards showing non-equity and equity-based
remuneration report the constituent parts of any
accountability, should be the subject of a vote
awards and other equity compensation
severance payment with a justification of the total value
(either binding or advisory)
and the elements paid and encourage boards to
-
a summary compensation table or “SCT” showing
compensation (including a column reporting total
and/or non-cash benefits. Commercially sensitive
(October 2008). The ABI and NAPF published joint best
severance pay (February 2008). Among other things,
-
a pensions benefit table and a non-qualified
disclosure of the remuneration of individual
deferred compensation table as well as a
directors should include detailed information such
description and quantification of termination and
as remuneration and/or emoluments, shares or
change-of-control payments to named executive
For non-banks, remuneration changes following the
rights to share options, contributions to
officers
2008 financial crisis were limited to the following
supplementary pension schemes and any loans,
clarifications to Section D and Schedule A of the UK
advances or guarantees to each director
consider making directors’ contracts with a shorter
-
-
notice period than 12 months.
Corporate Governance Code:
-
shares and share option schemes for directors
24
-
two additional tables showing outstanding equity
awards at fiscal year-end and amounts realised on
Remuneration
-
performance-related elements of executive
should be subject to prior approval of shareholders
the exercise of stock options and the vesting of
directors’ remuneration should be stretching and
at the annual general meeting.
restricted stock during the last fiscal year
designed to promote the best interests of the
company
-
companies with securities admitted to a regulated
remuneration for NEDs should not include any
market, including non-EU companies with a primary
performance-related elements (options or other
listing.
awards). These can only be granted with
-
a table showing director compensation in the last
fiscal year comparable to the SCT.
The rules do not change the disclosure requirements
for foreign private issuers (see Glossary) whereby such
The EC reported on Member States’ application of the
an issuer is deemed to comply with Item 402 of
Recommendation (July 2007). It found that transparency
Regulation S-K if it provides certain base information
standards were widely followed but was disappointed
with respect to compensation and employee share
executive options should not be offered at a
with the application of the recommendation for
options, unless more detailed information is made
discount, save as permitted by the Listing Rules
shareholders to vote on remuneration policy.
publicly available elsewhere.
Following a recommendation by the European
Issuers that qualify as emerging growth companies (see
Corporate
Glossary) do not have to provide the CD&A disclosure.
shareholder approval and any shares acquired must
be held until at least a year after the NED leaves
-
The Recommendation is expressed to apply to all
Current regime affecting listed companies
(continued)
-
-
payouts or grants under incentive schemes should be
Governance Forum (March 2009), the EC published
SEC guidance has continued to emphasise the
subject to non-financial performance metrics, if
(April 2009) a Recommendation on the remuneration of
importance of clear and concise disclosure and analysis
appropriate (as well as or instead of financial
directors of listed companies to complement the 2004
about executive compensation practices. The SEC also
performance measures), and remuneration incentives
Recommendation. It is not binding, but Member States
issued Compliance and Disclosure Interpretations (May
should be compatible with risk policies and systems
were invited to implement the necessary measures by
2009) providing guidance on the disclosure of tax
31 December 2009 and to notify the EC of the
gross-ups, stock/options grant dates and life insurance
measures taken. Key measures:
premiums.
-
awards of variable components of remuneration
Separate from the listing rules, SEC Regulation S-K
(e.g. bonuses) should be subject to limits and to
requires Exchange Act registrants subject to the proxy
predetermined and measurable performance
rules (i.e. not foreign private issuers (see Glossary), as
criteria, which should promote the “long-term
they are not subject to the proxy rules) to disclose, with
sustainability” of the company. Payment of a major
respect to any compensation consultant whose work
provisions that permit the company to reclaim variable
elements in exceptional circumstances of misstatement
or misconduct should be considered.
The Remuneration Consultants’ Group, a body established
in 2009 and which represents executive remuneration
consultancy firms advising UK listed companies, published
a Code of Conduct (November 2009) in response to the
25
Remuneration
Current regime affecting listed companies
(continued)
recommendation in the Walker Report. It published an
proportion of variable components should be
has raised any conflict of interest, the nature of the
updated version of the Code (December 2011) containing
deferred and the company should be entitled to
conflict and how the conflict is being addressed.
more emphasis on managing conflicts of interest and
reclaim any payment made on the basis of
compliance.
information that is “manifestly misstated”
The ABI publishes guidelines on executive remuneration
involvement. Equity compensation plans, with minor
companies should limit directors’ termination
exemptions, are subject to a shareholder approval
(latest version November 2012). The ABI has not made any
payments so that they are no greater than the
requirement. Accommodations/exemptions are available
major changes in view of the changes proposed by BIS to
equivalent of two years of the fixed component of
to non-US issuers. See Corporate governance codes -
remuneration reports and shareholder votes (see Proposals
a director’s pay
general provisions and guidance below.
termination payments should not be paid if
The CII’s executive compensation policy (updated
termination is due to inadequate performance
October 2012) emphasises compensation for
affecting listed companies below) but highlights the
following messages:
-
the variable element of remuneration should be kept
as simple as possible and limited to an annual bonus
-
NYSE/Nasdaq Rules call for additional shareholder
-
-
three-year vesting period and vesting should be
and one long-term incentive
-
-
subject to predetermined and measurable
shareholders expect the remuneration committee to
performance criteria. After vesting, directors should
protect and promote their interests in setting
hold shares in the company until the end of their
executive remuneration
employment. NEDs should not be remunerated with
share options
performance measures should be linked to the timing
of the implementation of the strategy of the company
-
the remuneration committee should have at least
one person experienced in the field of executive
take undue financial operational risks or adopt an
remuneration policy.
The EC published a report (May 2010) on the
disappointing implementation of its April 2009
employee pay costs on the finances of the company.
Recommendation on the remuneration of directors of
expectations for companies considering early compliance
on benchmarking, executive salaries, disclosure of
annual as well as long-term incentive compensation,
dilution, stock options, perquisites, employment
contracts, retirement arrangements and stock ownership
requirements.
pay proposals if:
-
there is a misalignment between CEO pay and
company performance
companies should consider the impact of total
An appendix to the guidelines sets out the ABI’s general
performance over the long term and provides guidance
ISS will recommend a vote against management say on
and should avoid providing an implicit incentive to
unduly risky capital structure
-
share options should not be exercisable until after a
listed companies. Only 10 Member States had
implemented at least half the Recommendation.
-
the company maintains problematic pay practices
or
-
the board exhibits poor communication and
responsiveness to shareholders.
In its 2013 updates to its proxy voting guidelines
26
Remuneration
Current regime affecting listed companies
(continued)
with BIS new reporting requirements.
NAPF’s Corporate Governance Policy and Voting
Guidelines (latest version November 2012) endorse the UK
Corporate Governance Code, whilst stressing that
companies should tailor policies to their particular
circumstances and structure remuneration to reflect the
The ICGN published its Non-executive Director
(November 2012), ISS announced that it would
Remuneration Guidelines and Policies (March 2010).
recommend a vote “against” or “withhold” from
They are primarily addressed to companies and their
directors (aside from new nominees) if the “board”
non-executive board members and set out key
failed to act on a shareholder proposal that received
remuneration principles which are recommended to be
the support of a majority of votes cast (as opposed to
applied by companies regardless of their domicile.
shares outstanding) during the 2013 proxy season or
subsequent years.
ambitions and risks inherent in the business. There are
also guidelines requiring the remuneration committee to
NYSE Rule 452 prohibits brokers from voting, absent
disclose whether the Remuneration Consultants Group’s
specific instructions from their clients, in relation to the
Code of Conduct (December 2011) has been taken into
election of directors, executive compensation or “any
account when selecting consultants. Companies are
other significant matter”. The NYSE clarified in an
encouraged to submit the recruitment function to periodic
information memo (January 2012) that the following
tender and disclose their policies on it.
proposals the NYSE had previously deemed as “Broker
May Vote” will be treated as “Broker May Not Vote”
The Remuneration Consultants Group published a review
matters:
(December 2012) of the effectiveness of its Code of
Conduct. This set out a number of steps for its members
to take to increase the awareness of the Code of Conduct.
-
de-staggering the board of directors
-
majority voting in the election of directors
-
eliminating supermajority voting requirements
-
providing for the use of consents
-
providing rights to call a special meeting
-
certain types of anti-takeover provision overrides.
The SEC has approved listing rule amendments
proposed by the NYSE (January 2013) and Nasdaq
(January 2013) to require listed companies to comply
27
Remuneration
Current regime affecting listed companies
(continued)
with new compensation committee requirements
mandated by the Dodd-Frank Act. See Remuneration
committees below.
28
Remuneration
Proposals affecting listed companies
The BIS call for evidence “A Long-Term Focus for
In a non-legislative resolution (July 2010), the European
The SEC is expected to propose and adopt further rules
Corporate Britain” (October 2010) highlighted
Parliament called for remuneration policy principles to
in 2013 pursuant to the Dodd-Frank Act that would
considerable increases in executive pay at a time when
be extended to cover all listed companies. This followed
impose the following executive compensation
returns to shareholders and general salaries had been
a European Parliament resolution on questions related
provisions on public companies:
relatively flat.
to companies’ management (May 2010) which urged
Following a discussion paper on executive remuneration
(September 2011) and a consultation on shareholder
voting rights on executive pay (March 2012), BIS
the EC to propose amendments to financial services
-
disclosure of the relationship between executive
compensation and the company’s financial
legislation to ensure consistency between banking and
performance
non-banking institutions in remuneration policy.
-
disclosure of the ratio between median employee
published a consultation (June 2012) on draft
In the Corporate Governance Green Paper (April 2011),
regulations to replace the existing rules on reports on
the EC expressed concerns about the mismatch
directors’ remuneration. The report will be divided into
between performance and executive directors’
two parts:
remuneration. It also suggested that a focus on short-
based compensation during the three-year period
term performance could have a negative influence on
prior to a restatement (which do not require a
long-term sustainability of the company. It sought views
showing of misconduct and apply to current and
on whether the disclosure of remuneration policy, the
former executive officers)
-
a largely forward-looking statement of the
company’s remuneration policy from the date of
the AGM (the policy report)
-
remuneration report and individual remuneration of
a report on the implementation of the company’s
executive and non-executive directors should be
existing policy in the year under review, including
mandatory and whether the remuneration policy and
actual sums paid (the implementation report). This
remuneration report should be put to a vote by
will include a requirement for a single figure for
shareholders.
each director and a chart comparing CEO pay
against company performance. Details of
termination payments must also be included.
compensation and CEO compensation
-
-
mandatory clawback policies to recover incentive-
disclosure of whether employees may hedge the
company’s stock.
It is likely but not certain (until the SEC and/or the
exchanges issue their rules) that non-US issuers will be
exempt from such requirements, as long as they comply
In the Company Law and Corporate Governance Action
with their home jurisdiction requirements and make
Plan (December 2012), the EC indicates that it will
certain disclosures.
propose an amendment to the Shareholder Rights
The regulations are expected to take effect for AGMs
Directive in 2013 to improve the transparency of
held in financial years beginning on or after 1 October
remuneration policies and individual remuneration of
2013.
directors and give shareholders the right to vote on the
Alongside these disclosure changes, BIS published draft
remuneration report.
29
Remuneration
legislation (June 2012) which will amend CA 06 to
require quoted companies (see Glossary) to seek
shareholder approval on the implementation report
every year and on the policy report at least every three
years (or sooner if changes are made to a policy
previously approved or if shareholders voted against
the implementation report the previous year). An
ordinary resolution is required in each case. The vote
on the implementation report is advisory but the vote
on the policy report is binding.
If a payment is promised or made and is not consistent
with the previously approved policy report, it will have
no effect and the director will be required to repay the
Proposals affecting listed companies (continued)
money or other assets, holding them in trust for the
company in the meantime. Any director who
authorises a payment must indemnify the company for
any loss which results from the payment.
The draft legislation is contained in amendments to
the Enterprise and Regulatory Reform Bill. The Bill is
expected to get royal assent in April 2013 and is likely
to take effect in October 2013.
The FRC has indicated (September 2012) that it will
consult on further changes to the UK Corporate
Governance Code once the Government’s legislation
has been finalised. The amendments will relate to
clawback arrangements; the practice of executive
30
Remuneration
Proposals affecting listed companies (continued)
directors sitting on the remuneration committees of
other companies; and whether companies should
engage with shareholders and report to the market in
the event that they fail to obtain at least a substantial
majority in support of a resolution on remuneration.
The Financial Reporting Lab published a report (June
2012) on the practicalities of disclosing a single figure
for remuneration. It launched a second project
(November 2012) on BIS’ proposals to require the
disclosure of (i) scenarios for directors’ pay for
performance above, on and below target and (ii) a
chart comparing company performance and CEO pay.
The Kay Report (July 2012) recommended that
companies should structure directors’ remuneration to
relate incentives to sustainable long-term business
performance. Long-term performance incentives
should be provided only in the form of company
shares to be held at least until the executive has
retired from the business.
The GC 100 has established a working group to
develop best practice guidance on the practical
implications of BIS proposed regulations on directors’
remuneration reports. The working group aims to
publish guidance by the end of June 2013.
The ABI envisages that it will issue revised guidelines
on executive remuneration once the legislation and
regulations on executive remuneration have been
31
Remuneration
Proposals affecting listed companies (continued)
finalised (so after April 2013).
A group of pension investment bodies, including
NAPF, published (February 2013) a discussion
document setting out four remuneration principles for
building and reinforcing long-term business success.
These provide that:
-
management should make a long-term investment
in the success of the businesses they manage
-
pay should be aligned to the long-term success
and desired corporate culture throughout the
organisation
-
pay schemes should be simple, understandable for
both investors and executives and ensure that
rewards reflect long-term returns to shareholders
-
remuneration committees should fully explain and
justify how their decisions operate to deliver longterm business success.
The authors plan to meet with remuneration
committee chairs and shareholder representatives over
the coming months to discuss the principles and refine
the document as a guide to help shareholders assess
companies’ pay practices.
32
Remuneration
Remuneration in financial institutions
The FSA 2010 (effective 8 June 2010):
-
gave power to HM Treasury to make regulations for
certain authorised firms to prepare, approve and
disclose remuneration reports covering their
executive officers, employees and consultants
-
imposed a duty on the FSA to make rules requiring
certain authorised persons to establish, implement
and maintain a remuneration policy which is
consistent with the effective management of risks
and the implementation standards for Principles for
Sound Compensation Practices issued by the FSB
-
gave power to the FSA to provide that provisions of
a service contract contrary to FSA rules on
The Financial Stability Board published Principles for
As mandated by the Dodd-Frank Act, the SEC and six
Sound Compensation Practices which were endorsed by
other US federal regulators jointly approved the
the G20 Leaders (April 2009). The Principles require
issuance of a proposed rule (March 2011) imposing the
financial institutions to ensure that their compensation
following on “covered financial institutions” (i.e. banks,
policies are consistent with their long-term profitability
bank holding companies, broker-dealers and investment
and prudent risk-taking.
advisers with US$1 billion or more in assets, including
The OECD’s report, “Corporate Governance and the
Financial Crisis: Key Findings and Main Messages” (June
FSB’s Principles for Sound Compensation Practices. The
OECD also identifies a number of failings by financial
-
setting out the bands for disclosure of executive
were not taken forward on the grounds that they went
beyond CRD III. However, these are replicated in the
draft regulation within CRD IV (which proposes that
firms disclose the number of individuals being paid €1
million or more per financial year, broken down into
pay bands of €500,000), so may yet be implemented.
The FSA published the Remuneration Code to
implement the powers given to it by FSA 2010 and to
-
-
compensation arrangement that encourages
managers and others had too much influence on
with excessive compensation, or that could lead to
the level and conditions for performance-based
material financial loss
-
a requirement for incentive-based compensation
the link between performance and remuneration
arrangements to be adopted under policies and
was often weak or difficult to establish
procedures developed and maintained by a covered
remuneration schemes were often overcomplicated.
The FSB published Implementation Standards
(September 2009) for its Principles for Sound
Compensation Practices. The Implementation Standards
provide that:
-
prohibitions on maintaining any incentive-based
inappropriate risks by providing covered persons
remuneration
-
disclosure of incentive-based compensation
arrangements to their regulators
institutions in its report:
of assets paid or money transferred.
remuneration, beginning at £500,000. These proposals
-
2009), recommends that financial institutions follow the
remuneration are void and provide for the recovery
HM Treasury published draft regulations (March 2010)
foreign private issuers (see Glossary)):
financial institution and approved by its board.
Under the proposed rule, further restrictions, including
mandatory deferral of at least 50% of executive officers’
incentive-based compensation over a period of at least
three years and board approval of the compensation of
non-executive officers who could expose the financial
significant financial institutions should ensure that
institution to substantial losses, would also be imposed
total variable compensation does not limit their
on covered financial institutions with total consolidated
ability to strengthen their capital base and national
assets of US$50 billion or more.
supervisors should limit variable compensation as a
33
Remuneration
implement CRD III and the Walker Report. The
percentage of total net revenues when it is
The SEC has not indicated when it will adopt the
Remuneration Code amended the FSA’s previous Code
inconsistent with the maintenance of a sound
proposed rule.
of Practice on remuneration (which applied from 1
capital base
January 2010) and reflected the CEBS Guidelines
(December 2010). The Remuneration Code applies from
-
a substantial proportion of compensation for senior
executives and employees whose actions have a
1 January 2011 and:
-
material impact on the risk exposures of the firm
extended the scope of the old Code from 26
financial institutions to all banks, building societies
and investment firms (including asset managers) –
should be variable and performance-based
-
a substantial proportion of such variable
compensation – 40 to 60% – should be payable
approximately 2,700 firms
-
under deferral arrangements over a period of at
recast certain evidential provisions and guidance
least three years. For senior management and the
into rules to reflect the binding nature of CRD III
most highly paid employees, the percentage should
be above 60%
Remuneration in financial institutions (continued)
-
introduced rules that require firms to ensure that total
be awarded in shares or share-linked
strengthen their capital base and that total variable
instruments, subject to an appropriate share
remuneration must be significantly reduced where the
retention policy
performance
introduced a rule to implement the voiding provisions
of FSA 2010. The rule defines instances where
breaches of the Code may render a contract void and
require recovery of payments to be made
-
more than 50% of variable compensation should
variable remuneration does not limit their ability to
firm produces subdued or negative financial
-
-
introduced rules on remuneration structures, covering
the deferral of variable remuneration, ex-post
performance adjustment and guaranteed minimum
-
the remaining proportion of deferred
compensation can be paid in cash, vesting
gradually and subject to clawback.
G20 leaders endorsed the Implementation Standards
at the Pittsburgh summit (September 2009).
The FSB launched (March 2012) a bilateral complaints
handling process to address complaints made by
individual firms to their regulators concerning
inconsistent implementation of the FSB’s principles
34
Remuneration
Remuneration in financial institutions (continued)
bonuses
-
extended the group of employees to which the Code
and standards by firms headquartered in other
jurisdictions.
applies to include senior management and anyone
The FSB published a progress report on
whose professional activities could have a material
implementing the Principles for Sound Compensation
impact on a firm’s risk profile.
Practices and the Implementation Standards (June
The FSA adopted a proportional approach in applying the
changes, as permitted by CRD III. There were originally
four tiers of firms but this was reduced to three in
December 2011 (see below). Firms in tiers three and four
could disapply certain rules.
2012) since its peer review (October 2011). It noted
that almost all member jurisdictions had completed
implementation of the principles and standards and
progress had been made in implementing the Basel
Committee’s Pillar 3 disclosure requirements for
remuneration. However, more needed to be done to
The FSA published Remuneration Disclosure Rules
fully embed them in regulation or supervisory
(December 2010). They form part of the Prudential
guidance across all jurisdictions. Notwithstanding
Sourcebook for Banks, Building Societies and Investment
reported progress, some jurisdictions elected not to
Firms (BIPRU 11.5.18) and implement the disclosure
implement one or more of the standards related to
requirements of CRD III. They also took effect on 1 January
the alignment of compensation with prudent risk
2011 and require firms to disclose on an annual basis both
taking. The findings confirm the conclusion of the
remuneration policy and details in respect of senior
peer review that national authorities must sustain
management and members of staff whose actions have a
their implementation efforts to achieve lasting
material impact on the risk profile of the firm, subject to
improvements in compensation structures and
proportionality.
practices. The FSB will continue to monitor actions
The FSA published guidance and templates relating to the
taken.
Remuneration Code (August 2011). The package includes
The Basel Committee on Banking Supervision
guidance on how to apply to vary a firm’s proportionality
published (January 2010) an assessment
tiers, templates for self-assessment of compliance,
methodology to help supervisors assess individual
guidance on retention periods and guaranteed variable
firms’ compliance with the FSB’s Principles for Sound
remuneration and a set of frequently asked questions on
Compensation Practices and Implementation
the Remuneration Code.
35
Remuneration
Remuneration in financial institutions (continued)
The FSA published two Dear CEO letters (October 2011)
setting out its plans for monitoring implementation of the
Remuneration Code during 2012, guidance on the
definition of “Code staff”, what the FSA expected to see in
a long-term incentive plan that was used to pay part of
variable remuneration and the structure of instruments
used as an alternative to shares in paying variable
remuneration.
The FSA published finalised guidance on buy-out awards
to new staff (October 2011). This confirms that, although
the FSA does not encourage the use of buy-out awards,
such awards may normally be made without contravening
the Remuneration Code if (i) the firm has taken reasonable
steps to ensure that the buy-out is not more generous in
Standards.
The Basel Committee published guidance on aligning
remuneration policies with risk and performance
outcomes (May 2011). It asserts that appropriate
compensation structures are integral to effective risk
management and corporate governance, and requires
banks to fully implement the FSB Principles or
equivalent national standards.
The Basel Committee published Pillar 3 disclosure
requirements for remuneration (July 2011). They take
full account of FSB Principles and Implementation
Standards and aim to promote greater convergence
and consistency of disclosure.
amount or terms than the award from the previous
The EC published a Recommendation on
employer and (ii) the buy-out is subject to appropriate
remuneration policies in the financial services sector
performance adjustment conditions.
(April 2009). It was not binding but Member States
The FSA amended (November 2011) the application of its
rules on voiding and recovery so that they apply to the
largest banks and broker dealers. These took effect on 1
January 2012.
The FSA updated its guidance on proportionality
(December 2011). This changed the boundary between
tiers 2 and 3 for banks and building societies. The FSA
amended its proportionality guidance (September 2012) to
replace the four-tier division of Remuneration Code firms
(based on capital resources) with three new levels (based
were invited to implement the suggested measures
by 31 December 2009. Member States were to
ensure that financial institutions had remuneration
policies for risk-taking staff that were consistent with,
and promoted, sound and effective risk management.
The EC published a report (June 2010) noting the
disappointing implementation of its April 2009
Recommendation on remuneration policies in the
financial services sector. According to the report, only
16 Member States had fully implemented the
Recommendation.
36
Remuneration
Remuneration in financial institutions (continued)
on total assets). This approach is intended to allow the
CRD III (effective 1 January 2011) requires EU credit
FSA to focus its resources on the most significant firms
institutions and investment firms to have sound
who pose risks to financial stability.
remuneration policies that do not encourage or
The FSA published (August 2012) a statement on the
implementation of CRD IV. It noted that the plenary vote
reward excessive risk-taking. Key provisions:
-
upfront cash bonuses must be capped at 30% of
in the European Parliament had been delayed and that
the total bonus and at 20% for particularly large
CRD IV would not take effect in January 2013 as originally
bonuses and at least 50% of the total bonus
indicated. No alternative date has been set for
must be paid broadly as shares, ownership
implementation but the FSA indicated that it would keep
interests or, as appropriate, capital instruments
the situation under review.
(which will bear losses first in case of bank
difficulties), in each case subject to retention
Following the publication (July 2012) by the EBA of final
arrangements
guidelines on the data collection exercises regarding high
earners and remuneration benchmarking, the FSA
-
between 40% and 60% of any bonus must be
published guidance (November 2012) on data collection
deferred for at least three years and be
on remuneration practices.
recoverable if investments do not perform as
expected
HM Treasury published a consultation (December 2011)
setting out draft regulations that require large banks
-
operating in the UK (excluding the UK operations of EEA
firms) to publish the pay details of their eight most highly
remunerated individuals by 31 December 2012, covering
the capital and liquidity costs of bonuses
-
February 2011 between the Government and the UK’s five
appropriate, specified capital instruments
-
to all large banks.
The Treasury Select Committee published terms of
harsher rules will apply to banks which received
government support
biggest banks which envisaged that the Government
would be consulting on extending remuneration disclosure
discretionary pension payments must be held in
shares, equivalent ownership interests or, as
the financial year beginning after 1 January 2011.
The consultation follows the Project Merlin agreement in
performance measures for bonuses must reflect
-
supervisors will be given powers to impose
financial and non-financial penalties for noncompliance.
37
Remuneration
Remuneration in financial institutions (continued)
reference for an inquiry into corporate governance and
remuneration in systemically important financial
institutions (April 2012). On remuneration, the terms of
reference include:
-
the role of institutional investors, remuneration
consultants, employees and others with respect to
remuneration
-
-
and practices to help regulators implement CRD III
(December 2010).
The EBA published the results of its survey (March
2012) on the implementation of the CEBS guidelines.
The survey findings indicated that in most countries
the guidelines came into force on 1 January 2011
the case for introducing greater transparency for
and that supervisors had actively assessed
senior executives with respect to remuneration
remuneration policies requiring, where needed,
whether there should be further reform of the
remuneration arrangements of senior executives and
whether this should extend to those highly paid
individuals who sit below executive level
-
CEBS published guidelines on remuneration policies
interventions in the remuneration structures and
payouts of the variable component. While
considerable progress had been reported with
respect to the governance of remuneration, some
areas of concern remained. Further supervisory
the merits and drawbacks of strict liability for bank
guidance was needed in setting up the criteria for
executives or an automatic incentives-based approach,
identifying risk takers as well as in the application of
as suggested by the FSA.
the proportionality principle and of the risk alignment
The Treasury Select Committee published written evidence
practices.
submitted to the inquiry (June 2012).
The EBA published final guidelines (July 2012) on the
The FSA published a consultation (November 2012) on
data collection exercise regarding high earners and
implementation of the AIFMD. This requires the disclosure
on the remuneration benchmarking exercise, as
of the following information on remuneration:
mandated by CRD III. The objective of the guidelines
-
the total amount of remuneration for the financial
year paid by the alternative investment fund manager
to its staff, split into fixed and variable remuneration;
is to streamline the data collection and increase the
consistency and comparability of the information
collected by national competent authorities.
the number of beneficiaries and carried interest paid
The EC published a draft of CRD IV (July 2011). The
by the alternative investment fund
draft regulation forming part of CRD IV includes the
38
Remuneration
Remuneration in financial institutions (continued)
-
the aggregate amount of remuneration broken down
following provisions in relation to remuneration
by senior management and members of staff of the
(which would be directly applicable in Member States
alternative investment fund manager whose actions
without the need for further legislative action):
have a material impact on the risk profile of the
alternative investment fund.
-
national authorities should collect information on
the number of individuals per institution earning
HM Treasury published a consultation (January 2013) on
more than €1 million, to be published by the EBA
the transposition of the AIFMD. Among other things, this
on an aggregate country basis
seeks views on the proportionate implementation of the
AIFMD’s remuneration provisions.
-
significant institutions should publicly disclose
the number of staff whose professional activities
For further information on the governance of
have a material impact on the institution's risk
remuneration, see Remuneration committees below.
profile, who are being paid €1 million or more
per financial year, broken down into pay bands
of €500,000
-
institutions whose capital falls below the capital
buffers set pursuant to CRD IV will be subject to
restrictions on the award of variable
remuneration and discretionary pension benefits,
and will not be able to pay, or create an
obligation to pay, variable remuneration or
discretionary pension benefits if the obligation to
pay was created at a time when the institution
failed to meet the combined buffer requirements.
It has been proposed that CRD IV should include a
cap on variable pay. The Economic and Monetary
Affairs Committee of the European Parliament voted
to cap bankers’ bonuses at 1x fixed pay (May 2012).
Following a compromise (December 2012) with the
39
Remuneration
Remuneration in financial institutions (continued)
Council, the default position remains at 1x salary
unless a supermajority of the firm's shareholders
approve an increase to 2x salary.
The plenary vote of the European Parliament on CRD
IV (including the proposed bonus cap) has been
postponed to April 2013.
ESMA published a consultation (September 2012) on
proposed guidelines on remuneration policies and
practices under MiFID. These aim to foster a
consistent application and improved implementation
of the existing MiFID conflicts of interest and conduct
of business requirements in the area of remuneration
across Member States.
ESMA published final guidelines (February 2013) on
remuneration guidelines on remuneration policies
and practices under the Alternative Investment Fund
Managers Directive. These are similar to the
guidelines which CEBS issued (December 2010) for
firms caught by CRD III, although the requirements
are tailored to asset management firms.
40
Corporate governance codes
General provisions and guidance
The UK Corporate Governance Code sets out standards
In the Company Law Action Plan, the EC rejected the
There is no unitary corporate governance code.
of good practice in relation to directors, remuneration,
creation of a single European code of corporate
Corporate governance is covered by state law, federal
accountability and audit.
governance but proposed that the EU should adopt a
law and regulation and exchange listing requirements.
Listing Rule 9.8.6R(5) requires companies with a
premium listing (wherever incorporated) to report on
how they have applied the Main Principles of the UK
Corporate Governance Code. LR 9.8.6R(6) requires such
companies to confirm that they have complied with its
common approach covering a few essential rules and
ensure adequate co-ordination and convergence of
national corporate governance codes. It established the
NYSE Rules require companies to:
-
ethics (see Corporate social responsibility below)
European Corporate Governance Forum (October 2004),
comprising 15 experts, to take this forward.
adopt and disclose a code of business conduct and
-
adopt and disclose formal corporate governance
Provisions or provide an explanation where they have
The European Corporate Governance Forum published
guidelines that include, inter alia, director
not. This is known as the “comply or explain” principle.
a statement on the comply or explain principle
qualification standards, director responsibilities,
(February 2006) which it believes is a better and more
director access to management and outside
efficient approach than detailed regulation. It
advisers, director compensation and management
encouraged Member States that had not yet adopted a
succession
The FRC published a paper (October 2010) explaining
the UK approach to corporate governance and the
comply or explain principle.
Before 6 April 2010, non-UK companies only had to
disclose whether they complied with the corporate
governance regime of their country of incorporation
and the significant ways in which their corporate
governance practices differed from those set out in the
code to do so.
-
establish an internal audit function
The EC’s Recommendation on independent directors
-
certify annually as to compliance with NYSE
and board committees (February 2005) is generally
similar to, or slightly less onerous than, the UK
Corporate Governance Code.
corporate governance listing standards.
Nasdaq Rules also require the adoption and disclosure
of a code of conduct, which must be applicable to all
Code. This changed (effective for financial years
The Fourth and Seventh Amendment Directive requires
directors, officers and employees and must comply with
commencing on or after 31 December 2009) and non-
EU-incorporated listed companies to include a
the definition of a “code of ethics” under SOX § 406.
UK companies must now include the same information
statement in their annual report which must:
as UK companies (i.e. state how they apply the Main
Principles of the Code and comply or explain relative to
-
the Provisions). More than 300 companies were
non-US issuers listed on NYSE/Nasdaq from corporate
to the company
governance requirements. However, NYSE/Nasdaq Rules
as well as SEC Rules (as amended in September 2008)
affected.
-
describe its corporate governance practices
The FRC published amendments (September 2012) to
-
include a description of the main features of the
the UK Corporate Governance Code. These take effect
Current rules permit the NYSE and Nasdaq to exempt
refer to the corporate governance code applicable
company’s internal control and risk management
41
require annual disclosure of any significant ways in
which a non-US issuer’s corporate governance practices
differ from NYSE/Nasdaq listing standards. Under SEC
Corporate governance codes
for financial years commencing on or after 1 October
2012. The changes include:
-
system in relation to the financial reporting process.
The Fourth and Seventh Amendment Directive also
Rules, such disclosure must be made in a registrant’s
annual report. NYSE/Nasdaq Rules impose the following
additional requirements:
additional guidance has been included on the
requires disclosure by unlisted companies of
meaning of a good explanation of non-compliance.
transactions with related parties and requires all
This involves providing a clear rationale for the
companies to provide information about off-balance
of SOX (see Audit committees - constitution below)
action taken and a description of any action taken
sheet arrangements.
(NYSE/Nasdaq)
to address any additional risk and to maintain
conformity with the relevant principle of the Code.
Where deviation from a particular provision is
intended to be limited in time, the explanation
should indicate when the company expects to
conform with the provision
The European Corporate Governance Forum published
-
-
an audit committee that satisfies the requirements
prompt notification if the company becomes aware
a statement (March 2009) calling for the following new
of any non-compliance (both the NYSE (November
rules so that EU companies should not have to apply
2009) and Nasdaq (May 2010) changed their rules
more than one code:
to require notification of any non-compliance,
-
material or not) with relevant NYSE/Nasdaq
a company incorporated in the EU with shares
corporate
traded on a regulated market should apply a
corporate
General provisions and guidance (continued)
-
governance code from the Member State of its
the annual report and accounts taken as a whole is
registered seat or the Member State of its primary
fair, balanced and understandable and to provide
share listing
respect to the company’s corporate governance
Member States should require no more than that a
practices (primarily with respect to the audit
company which is registered in that Member State
committee) and an Interim Written Affirmation
or the shares of which are admitted to trading in
within five business days each time a change occurs
that Member State explains in what significant ways
to the audit committee or the company determines
the actual corporate practices of that company
it is no longer a foreign private issuer (see Glossary)
deviate from those set out in the Member State’s
(NYSE)
the information necessary for shareholders to
assess the company’s performance, business model
and strategy. There is also a new supporting
principle requiring the board to establish
arrangements to enable it to be in a position to
provide this confirmation
-
governance standards (NYSE/Nasdaq)
a new provision requiring the board to confirm that
companies are required to identify the external
facilitator of the board evaluation, as well as any
external search consultants and remuneration
consultants used, in the annual report. Also,
-
corporate governance code.
-
-
published “Corporate Governance and the Financial
42
disclosure of receipt of a going concern opinion
(Nasdaq)
Following a fact finding study (February 2009) and
feedback from a consultation (March 2009), the OECD
submission of an Annual Written Affirmation with
-
provision of an interim balance sheet and income
statement within six months of the end of the
Corporate governance codes
General provisions and guidance (continued)
companies that use external consultants must
Crisis: Key Findings and Main Messages” (June 2009)
disclose whether they have any other connection
and “Conclusions and emerging good practices”
with the company.
(February 2010). The second paper concluded that the
The guidance on a good explanation follows a paper
(February 2012) on what constitutes a good explanation
under the comply or explain regime.
For other 2012 amendments to the UK Corporate
Governance Code, see Board diversity, Audit
committees - role, Stewardship, Narrative reporting and
Rotation of audit firm/retendering below.
Further guidance on the UK Corporate Governance
Code is given in the FRC Guidance on Audit
Committees, FRC Guidance on Internal Control, the FRC
Guidance on Board Effectiveness (covering the role of
the chairman, directors and the behaviour of boards)
and the FRC Guidance on Going Concern. For further
information, see Audit committees - role, Risk
management and control and Narrative reporting
below.
All UK companies with a premium listing and all UK and
non-UK companies with a standard listing, unless they
are required to comply with equivalent rules in another
challenge was to encourage and support the effective
implementation of agreed standards rather than to
revise the OECD Principles (updated in 2004).
The FEE published a discussion paper on the auditor’s
role in providing assurance on the corporate
governance statement (November 2009).
The EC commissioned a study (December 2008) on the
monitoring and enforcement systems concerning
Member States’ corporate governance codes. The EC’s
final study (September 2009) revealed widespread
support for the comply or explain principle but also
shortcomings in implementation. The level of
meaningful disclosure by companies was low, especially
in risk management and remuneration, and investors
were too inactive.
A resolution of the European Parliament on questions
related to companies’ management called for legislative
action in relation to corporate governance and
remuneration (May 2010).
EEA State, are required to publish a corporate
The EC published a Financial Institutions Green Paper
governance statement in accordance with DTR 7.2 and
on corporate governance in financial institutions and an
make disclosures about board and committee structures
accompanying Staff Working Paper (June 2010). This
and the main features of the company’s internal control
covered similar themes to the Walker Report but some
and risk management systems in relation to the
of the questions posed by the EC suggested a policy
43
second quarter (Nasdaq).
Corporate governance codes
General provisions and guidance (continued)
financial reporting process.
In most cases, the provisions of the UK Corporate
Governance Code are more detailed than DTR 7.2. In
these cases, companies with a premium listing will
response that would go further than Walker’s
recommendations. The EC’s questions include the
following:
-
remain free to choose whether to comply with the
relevant provision of the UK Corporate Governance
Code but, if they choose to explain rather than comply,
may sit be limited?
-
-
directors improve the functioning and efficiency of
(April 2011). This revealed that only 33 of the top 200
boards?
listed companies undertook external board evaluation
ICSA published a note on directors’ induction (July
2012). This includes a checklist of possible topics and
could the inclusion of more women and individuals
with different backgrounds on the board of
ICSA published a board evaluation survey for 2010
in 2010 (compared with 30 in 2009).
should recruitment policies ensure that directors
have adequate skills?
they must at least ensure that they comply with the
minimum requirements in DTR 7.2.
should the number of boards on which a director
-
should a compulsory evaluation of the functioning
of the board, carried out by an external evaluator,
be put in place?
documents to consider covering in an induction
An EC communication sets out financial reform
programme and makes suggestions for programme
proposals needed to implement fully the EC’s G20
design.
commitments (June 2010).
The ABI published a report on board effectiveness
The Corporate Governance Green Paper (April 2011)
(December 2012) following a review of the annual
referred to the possible need to reinforce certain
reports of FTSE 350 companies. The report highlights
requirements at EU level by introducing them in
best practice examples of disclosures on diversity,
legislation rather than recommendations but said it did
succession planning and board evaluation by FTSE 350
not want to change the fundamentals of the comply or
companies. It noted that boards were making progress
explain approach. It also sought comments on whether
on diversity and external evaluation but could do more
monitoring bodies should be authorised to check the
to clarify their approach to succession planning. The
quality of the explanations in corporate governance
report also includes a new section on the role of the
statements.
44
Corporate governance codes
General provisions and guidance (continued)
chairman, drawing together the perspectives of
The mandate of the European Corporate Governance
chairmen of FTSE 350 companies on the skills they
Forum expired in July 2011 and the EC is considering
consider to be most important in creating an effective
how best to involve experts in future developments in
board.
EU corporate governance, in the light of responses to
The FRC published (December 2012) Developments in
the Corporate Governance Green Paper.
Corporate Governance 2012. It notes that over half of
The EC published a summary of the response to the
FTSE 350 companies comply fully with the UK
Corporate Governance Green Paper (November 2011):
Corporate Governance Code and the aggregate
compliance rate among such companies is 97%. In
-
companies who departed from corporate
cases of non-compliance, the FRC found the standard
governance codes to provide better explanations
of explanation to be variable. Companies are generally
better at setting out the background and actions taken
most of the respondents were in favour of requiring
-
75% of respondents did, however, support carving
to mitigate any governance concerns than they are at
out remuneration from the comply or explain
explaining the reasons for their decisions. In the
approach so that certain disclosures would be
absence of improvement in 2013, the FRC will consider
mandatory
what further action is needed to ensure the criteria set
-
most of the respondents to the Green Paper
out in the UK Corporate Governance Code are
opposed use of monitoring bodies to check the
consistently applied.
quality of the explanations in the corporate
The ABI published (December 2012) a report following
governance statements.
a review of the explanations made by 128 companies
The European Parliament passed a resolution (March
that had departed from the UK Corporate Governance
2012) welcoming the Corporate Governance Green
Code. It identifies six criteria (which reflect the guidance
Paper, but regretting that issues such as directors’
in the UK Corporate Governance Code) to assist
responsibility, directors’ independence, conflicts of
companies in preparing their explanations of non-
interest or stakeholder involvement were left out. In
compliance and gives examples of good and bad
particular:
practice. According to the report, only 27% of
companies provided a convincing and understandable
rationale for non-compliance and only 20% provided
-
a more accountable corporate sector should be
created in the EU. The corporate sector should take
45
Corporate governance codes
General provisions and guidance (continued)
any description of mitigating action. 16% of companies
social, ethical and environmental concerns into
met none of the criteria. The ABI found that disclosure
account in its operations and demonstrate its
was better where the chairman provided an
responsibility to employees, shareholders and
introduction to the corporate governance statement
society as a whole
and encourages all chairmen to do this.
-
Member States should be encouraged to set limits
to the number of boards on which a director can
serve
-
the EC should strengthen the regulation of proxy
advisers
-
the comply or explain system is a useful tool in
corporate governance
-
any deviation from national codes should be
explained in a meaningful way and alternative
corporate governance measures should be
identified and explained.
The OECD published “Corporate Governance, Value
Creation and Growth: The Bridge between Finance and
Enterprise” (May 2012). This examined the role of
corporate governance arrangements in providing the
right incentives to contribute the value creation process
within private enterprises and the implications of the
differences in ownership structures on corporate
governance practices and frameworks.
In the Company Law and Corporate Governance Action
Plan (December 2012), the EC indicated that it
proposed to launch an initiative in 2013, possibly by
46
Corporate governance codes
General provisions and guidance (continued)
means of a recommendation, to improve the quality of
explanations by companies that depart from corporate
governance codes.
47
Corporate governance codes
Board diversity
Following the Government’s commitment in the
The EC’s Strategy for equality between women and men
The SEC adopted rules (December 2009) amending its
coalition agreement (May 2010) to improve gender
(September 2010) sets out the EC’s work programme
proxy rules to require, among other things, additional
equality, it appointed Lord Davies to develop a business
on gender equality for the period 2010-2015. Progress
disclosures in a company’s proxy statement regarding
strategy (August 2010), building on the Tyson report
is to be reported annually. So far two reports have
director qualifications, including whether and how the
(June 2003). Lord Davies published a call for evidence
been published (March 2011) and (April 2012).
company uses diversity as a factor in selecting directors.
on women on boards (October 2010).
EC commissioner Viviane Reding called on listed
The Davies report (February 2011) recommended that
companies (March 2011) to pledge 30% of female
all chairmen of FTSE 350 companies should announce
board members by 2015 and 40% by 2020.
by September 2011 the percentage of women they
hoped to have on their boards by 2013 and by 2015.
For FTSE 100 companies, this figure was to be at least
25% in 2015.
The Corporate Governance Green Paper (April 2011)
sought views on whether listed companies should
disclose diversity policy and report on progress.
Diversity is not just a gender issue; the Corporate
As recommended by the Davies report, executive search
Governance Green Paper suggests that there needs to
firms published a code of conduct (July 2011) to
be more international diversity on boards as well.
encourage headhunters to assist boards in ensuring
diversity and maximising effectiveness. BIS published a
press release (July 2012) noting that 34 executive search
firms had signed up to the code of conduct.
BIS also encouraged companies to adopt the voluntary
“Think, Act, Report” approach of gender equality
reporting. This was produced by the Government
Equalities Office and launched by the Home Secretary
(September 2011).
The FRC consulted (May 2011) on ways to implement
the recommendations in the Davies report in relation to
the UK Corporate Governance Code. It published a
feedback statement (October 2011) confirming the
A resolution of the European Parliament called for
legislative measures if voluntary ones do not increase
the proportion of women on boards (July 2011).
Both the directive forming part of CRD IV and the
MiFID Amendment Directive propose that financial
institutions should have a policy promoting gender,
age, geography, educational and professional diversity
when selecting board members. However, neither
proposes quotas as this stage.
The EC published a consultation (May 2012) on possible
action at EU level, including legislative measures such
as quotas, to redress the gender imbalance on boards.
48
The term diversity is not defined, but the SEC has
indicated that the term is meant to be interpreted
broadly to include differences in viewpoint, professional
experience, education, and skill as well as race, gender,
and national origin.
Corporate governance codes
following changes to the UK Corporate Governance
The EC published a draft directive (November 2012)
Code:
that will set an objective for listed companies to achieve
-
the introduction of a new requirement for listed
companies to report annually on their boardroom
diversity policy, including gender, any measurable
objectives that the board has set for implementing
the policy and the progress it has made in
achieving the objectives
-
40% representation for the “under-represented sex”
among NEDs by 2020. Companies that don’t meet the
target must ensure that their recruitment processes are
transparent and unbiased, and give preference to
equally qualified female candidates. If they fail to meet
the target, notwithstanding such processes, they must
provide an explanation. Companies must also set a
the inclusion of a new supporting principle
voluntary target for the number of executive directors.
confirming that diversity, including gender, should
Companies will be required annually to provide to
be addressed in the board effectiveness review,
national competent
alongside the balance of skills, experience,
independence and knowledge of the company on
the board.
Board diversity (continued)
The changes apply to financial years commencing on or
authorities, and publish on their website, information
after 1 October 2012 but the FRC strongly encouraged
about the gender representation of both executive
companies voluntarily to apply and report on the
directors and NEDs and the measures they have taken
changes with immediate effect.
to achieve the relevant targets.
Grant Thornton’s corporate governance review 2012
No sanctions apply if the targets are not met. Sanctions
(December 2012) indicated that 78% of companies in
will only apply if:
the FTSE 350 provided a basic outline of their policy on
diversity in 2012, with 16% providing detailed
-
NEDs fails to put in place the recruitment measures
disclosure.
The ABI published a report on board effectiveness
(December 2012). Whilst noting examples of good
disclosure by FTSE 350 companies, it concluded that
a company which does not meet the target for
required by the draft directive
-
a company fails to publish a target for the number
of executive directors or
49
Corporate governance codes
Board diversity (continued)
most disclosures were boilerplate and recommends
ways they can be improved.
-
a company fails to comply with the reporting
measures required by the draft directive.
Lord Davies published the first annual progress report
It is for each Member State to lay down the sanctions
(March 2012) on the Davies report. It was accompanied
which will apply. These may include fines and/or the
by Cranfield School of Management’s report, “The
appointment of a NED being declared void if the rules
Female FTSE Board Report 2012”. The reports showed
on recruitment process and positive discrimination have
that:
not been complied with.
-
within the FTSE 100, women held 15.6% of all
In the Company Law and Corporate Governance Action
directorships (up from 12.5%) and there were only
Plan (December 2012), the EC indicates that it plans to
11 all-male boards (down from 21)
make a proposal in 2013 to require companies to
-
within the FTSE 250, women held 9.6% of all
directorships (up from 7.8%) and all-male boards
disclose their board diversity policy through an
amendment of the Fourth and Seventh Directives.
were in a minority for the first time (44.8% down
from 52.5%).
The Equality and Human Rights Commission published
a further report by Cranfield School of Management
(May 2012) on the process of recruiting and appointing
women onto the boards of the FTSE 350 listed
companies. The report reveals that executive search
firms had had some success in getting more women on
long lists but when it came to short-listing and
appointing, successful candidates tended to be those
who were perceived as “fitting in” with the values,
norms and behaviours of existing male board members.
A House of Lords EU Committee sub-committee
published an inquiry (June 2012) into gender imbalance
in boardrooms and a report (November 2012). The
50
Corporate governance codes
Board diversity (continued)
report concluded that the EC had not made a
convincing case in support of board quotas and that a
voluntary business-led approach was preferable. The
Government published a response (January 2013)
welcoming the report.
A Commons Select Committee for Business, Innovation
and Skills announced a new inquiry into women in the
workplace (September 2012). This sought comments on:
-
the success of the Davies report
-
the extent to which investors should take into
account the percentage of women on boards when
considering company reporting and appointments
to the board
-
the reasons why there were so few women in
senior positions on boards.
Following two consultations (August 2010 and
September 2011) on ways to improve the quality of
narrative reporting and a response statement (March
2012), BIS consulted (October 2012) on regulations to
amend CA 06 to require quoted companies (see
Glossary) to include, in a strategic report, a breakdown
of the number of persons of each sex who are
directors, managers and employees of the company.
Managers are defined as persons (other than directors)
who are employees and have responsibility for
planning, directing or controlling the activities of the
company. The additional disclosures will apply for
51
Corporate governance codes
Board diversity (continued)
financial years ending on or after 1 October 2013. See
Narrative reporting below.
52
Corporate governance codes
Risk management and control
The FRC Guidance on Internal Control (October 2005)
The European Corporate Governance Forum issued a
There are additional disclosure requirements under SOX
includes a requirement on boards to confirm in the
statement on risk management and internal control
for financial statements of all companies filing or about
annual report where action has been or is being taken
(June 2006). It considered that there was no need to
to file reports with the SEC:
to remedy significant failings or weaknesses identified
impose an EU obligation on boards to certify the
from their review of the effectiveness of internal control
effectiveness of internal controls as required in the US
systems. However, there is no requirement for directors
by SOX.
to make a statement in the annual report and accounts
on the effectiveness of the company’s internal control
systems, similar to SOX § 404. The FRC is expected to
consult on amendments to the FRC Guidance on
Internal Control in 2013.
-
material off-balance sheet arrangements and known
contractual commitments must be disclosed
(SOX § 401(a)) (SEC Rules adopted January 2003)
Weaknesses in risk management were identified by the
OECD in Corporate Governance and the Financial Crisis:
-
management must report on internal controls over
financial reporting, including the effectiveness of
Key Findings and Main Messages (June 2009). The
those controls, and auditors must issue an
OECD’s paper on conclusions and emerging good
attestation report on the effectiveness of internal
practices (February 2010) found that the board’s
controls over financial reporting (SOX § 404) (SEC
The FRC published a guide (December 2004) for UK and
responsibility for defining strategy and risk appetite
Irish companies registered with the SEC on the use of
needed to be extended to establishing and overseeing
the FRC Guidance on Internal Control (then referred to
enterprise-wide risk management systems. The paper
as the “Turnbull Guidance”) to comply with the SEC
argued that it was good practice for the risk
The SEC provided the following relief (December 2006)
requirements to report on internal controls over
management function to report directly to the board.
with respect to compliance with the internal controls
financial reporting under SOX § 404.
The ICGN revised its Global Corporate Governance
Rules adopted June 2003, February 2004 and June
2007).
rules of SOX:
-
newly public companies will not be obliged to
The Walker Report (November 2009) recommended
Principles (November 2009) to include greater
that banks and financial institutions should establish
consideration of the behavioural aspects of governance
provide either management’s assessments or
risk committees comprising NEDs and supported by a
as well as new sections on corporate culture and risk
independent auditors’ attestations until their
chief risk officer. See Risk committees below.
management. The ICGN also published Corporate Risk
second annual report after becoming a public
Oversight Guidelines (October 2010) to help investors
company
Although risk committees are not mandated for listed
companies in general, there is greater emphasis on risk
assess how well a portfolio company’s board is
-
non-US issuers and non-accelerated filers, when
overseeing risk.
providing management’s assessments without
Main Principle on internal control was extended in 2010
The EC’s Financial Institutions Green Paper (June 2010)
independent auditors’ attestations pursuant to SEC
to confirm that the board is responsible for determining
noted the absence of a healthy risk management
Rules, may “furnish” rather than “file” those
the nature and extent of the significant risks it is willing
culture in financial institutions and the failure of
assessments, reducing liability with respect to those
in the UK Corporate Governance Code. In particular, the
53
Corporate governance codes
to take to achieve its strategic objectives. Also, the UK
financial institutions to take a holistic approach to risk
assessments and eliminating mandatory
Corporate Governance Code provides that the annual
management. It included a number of questions on
incorporation by reference to such assessments.
report should explain the company’s business model to
ways to enhance the status of the Chief Risk Officer and
Non-US issuers that are not large accelerated filers
enable investors to understand better the risks and
how to improve the communications between the risk
(generally, large accelerated filers are filers with a
uncertainties that the company faces.
management function and the board. It also asked
market capitalisation of more than US$750 million),
whether executives should be required to approve a
pursuant to a rule adopted by the SEC in August
report on the adequacy of internal control.
2006, are not obliged to provide the independent
The Institute of Risk Management published
(September 2011) guidance for directors and senior
auditor’s attestation until the year after they first
executives on the UK Corporate Governance Code’s
The Corporate Governance Green Paper (April 2011)
disclosure on board responsibility on risk. The guidance
confirmed that boards of listed companies in general
aims to provide practical advice on how to approach
should take responsibility for risk appetite and
the development and implementation of a risk appetite
reporting. It suggests that disclosures in the risk report
The SEC adopted guidance to management on
framework.
should include key societal risks, such as risks relating
compliance with SOX § 404 (June 2007). The guidance
to climate change, the environment, health and safety
is intended to help management make its evaluation
and human rights.
process more efficient and cost-effective.
The FRC met with companies, investors and advisers in
The Basel Committee on Banking Supervision published
The PCAOB adopted (June 2007) an auditing standard
early 2011 to discuss how boards were approaching the
(January 2013) its principles for effective risk data
for the audits of registrants’ internal control over
disclosures on risk in the UK Corporate Governance
aggregation and risk reporting to strengthen banks’ risk
financial reporting under SOX § 404.
Code. In a summary of its discussions (September
management capabilities.
begin complying with the management’s
assessment requirement.
Risk management and control (continued)
2011), the FRC notes that there had been a “step
change” in efforts made by directors to manage risks
although reports on risk did not always get to the
“heart of the matter”.
For more information, see Corporate reporting - recent
In the Company Law and Corporate Governance Action
Plan (December 2012), the EC indicates that it plans to
make a proposal in 2013 to strengthen disclosure
requirements with regard to risk management through
In view of developments in the eurozone, the FRC
an amendment of the Fourth and Seventh Directives.
published a note on reporting on country and currency
Extending reporting to cover non-financial risks is
risk in annual financial reports (January 2012) and in
intended to establish a more comprehensive risk profile
interim financial reports (June 2012). Both notes stress
of the company, improve risk management and
the importance of:
encourage companies to adopt a sustainable and long54
developments below.
Corporate governance codes
-
conveying a balanced and understandable
term strategic approach to their business.
assessment of the company’s position and
prospects
-
explaining the nature and scope of direct and, if
practicable, indirect exposures to country and
currency risks and how they are being mitigated. In
some circumstances it may be helpful to indicate
that certain risks are absent or not significant.
The FRC encourages companies to make disclosures of
country and currency risk in one section of their
financial reports.
Companies are also required to disclose the principal
risks and uncertainties facing them as part of their
business review. The FRC expressed concerns about the
quality of the disclosures in a statement (February 2011)
but noted a significant improvement in the reporting of
risks and of mitigating actions in its annual report
(September 2012). Risk mitigation is a difficult area
because of the tension between the FRRP’s approach
and the SEC’s practice of not allowing companies to
use mitigating language in their risk factor disclosure in
the Form 20-F and other SEC filings.
The FRC’s Developments in Corporate Governance 2012
(December 2012) noted that reporting on internal
control needed to improve. It plans to consult on
amendments to the FRC Guidance on Internal Control
later in the year.
55
Corporate governance committees
Remuneration committees
Provisions of the UK Corporate Governance Code
The EC’s Recommendation on independent directors
The SEC requires the following disclosures with respect
relevant to remuneration committees include:
and board committees (February 2005) recommended
to compensation committees (and further rules have
that listed companies should establish a remuneration
been adopted by the NYSE/Nasdaq) with respect to
committee to ensure that remuneration was set in an
compensation committees and advisers pursuant to the
objective way. An annex to the Recommendation set
Dodd-Frank Act, as discussed below):
-
the board should establish a remuneration
committee of at least three (or, in the case of
smaller companies outside the FTSE 350
throughout the previous reporting year, two)
members who should all be independent NEDs
(D2.1). The chairman may sit on the remuneration
committee if considered independent at the time of
appointment
-
the remuneration committee should recommend
and monitor the level and structure of
remuneration for senior management in addition to
the remuneration committee. These are generally
similar to, or less onerous than, the UK Corporate
-
the authority of the compensation committee
-
the extent to which the compensation committee
may delegate its authority to other persons
Governance Code.
The Recommendation on the remuneration of directors
-
any role of executive officers in determining or
of listed companies (April 2009) recommended that one
recommending the amount or form of executive
person on the remuneration committee should have
and director compensation
experience in the field of executive remuneration.
-
any role of compensation consultants in
the remuneration for all executive directors and the
This has not been implemented in the UK, partly
determining or recommending the amount or form
chairman. “Senior management” should be
because the meaning of experience was not sufficiently
of executive and director compensation
determined by the board but should normally
clear.
include the first layer of management below board
level (D2.2)
-
out criteria for the composition, role and operation of
the remuneration committee should carefully
consider what compensation commitments their
directors’ terms of appointment would entail in the
event of early termination, to avoid rewarding poor
performance. They should also take a robust line on
reducing compensation to reflect the departing
directors’ obligations to mitigate loss (D1.4).
The Walker Report (November 2009) made a number of
recommendations in relation to the remuneration
-
with respect to any such compensation consultant
The EC’s report (May 2010) on implementation of the
whose work has raised any conflict of interest, the
Recommendation notes that only 10 Member States
nature of the conflict and how the conflict is being
had implemented at least half of it.
addressed.
The FSB published implementation standards for its
The SEC has approved listing rule amendments
Principles for Sound Compensation Practices
proposed by the NYSE (January 2013) and Nasdaq
(September 2009). It recommended that significant
(January 2013) to require listed companies to comply
financial institutions should have a remuneration
with new compensation committee requirements
committee as an integral part of their governance
mandated by the Dodd-Frank Act.
structure. The remuneration committee should:
The NYSE and Nasdaq rules differ in a few aspects, but
-
they both impose the following requirements on listed
be constituted in a way that enables it to exercise
56
Corporate governance committees
committees of banks and financial institutions,
competent and independent judgement on
including:
compensation policies and practices and the
-
incentives created for managing risk, capital and
the terms of reference should include responsibility
-
basis
-
remuneration committee report should confirm that
the committee is satisfied with the way
performance objectives and risk adjustments are
-
independent legal counsel and other compensation
advisers (“compensation advisers”) and be directly
with an assessment of the firm’s financial condition
responsible for oversight of their work
and future prospects
-
work closely with the firm’s risk committee in the
evaluation of the incentives created by the
compensation system
reflected in their compensation structures and
explain the principles underlying such
57
the compensation committee must have the sole
authority to engage compensation consultants,
should demonstrate that its decisions are consistent
respect of all high-end employees
in relation to high-end employees, the
be independent, and certain additional factors must
and likelihood remain uncertain. In so doing, it
the terms of reference should be extended to cover
all members of the compensation committee must
be considered in assessing independence
carefully evaluate practices by which compensation
is paid for potential future revenues whose timing
oversight of remuneration policy and outcomes in
-
-
liquidity
for setting the over-arching principles and
parameters of remuneration policy on a firm-wide
companies:
-
listed companies must provide appropriate funding
Corporate governance committees
Remuneration committees (continued)
objectives and adjustments if they differ from those
-
of executive board members
-
-
for payment of reasonable compensation to a
compliance with the FSB Principles for Sound
compensation adviser
Compensation Practices
for FTSE 100-listed banks and comparable unlisted
entities such as the largest building societies, the
ensure that the firm’s compensation policy is in
-
compensation committees must consider six
ensure that an annual compensation review,
independence factors when selecting a
remuneration committee report should disclose
externally commissioned if appropriate, is
compensation adviser, although a compensation
features of high-end employees’ remuneration (in
conducted independently of management and
adviser is not required to be independent.
bands rather than individually)
submitted to the relevant national supervisory
the remuneration committee should seek advice
-
authorities or disclosed publicly.
As with most of the corporate governance requirements
imposed by the exchanges, foreign private issuers (see
from the board risk committee on specific risk
Both CRD III and the directive forming part of CRD IV
Glossary) may follow home country practice instead of
adjustments to be applied to performance
require competent authorities to ensure that significant
the new compensation committee requirements,
objectives; in the event of any difference in view,
credit institutions and investment firms establish a
although Nasdaq specifically requires a foreign private
risk adjustments should be decided by the
remuneration committee. The chair and members must
issuer (see Glossary) to disclose in its annual report the
chairman and NEDs on the board.
be board members that do not perform any executive
reason it does not have a fully independent
function. They must take into account the long-term
compensation committee.
These recommendations have largely been
implemented through amendments to the FSA’s
Remuneration Code and through powers given to the
interests of shareholders, investors and other
stakeholders.
The requirements relating to compensation committee
responsibilities and authority are effective beginning 1
FSA and HM Treasury in FSA 2010.
July 2013. Listed companies will have until the earlier of
their first annual meeting after 15 January 2014 and 31
ICSA updated its terms of reference for remuneration
October 2014, to comply with the compensation
committees (October 2010) to reflect the UK Corporate
committee independence requirements.
Governance Code.
The FRC published (September 2012) amendments to
the UK Corporate Governance Code which take effect
for financial years commencing on or after 1 October
2012. Companies are required to identify any external
remuneration consultants used and disclose whether
they have any other connection with the company.
58
Corporate governance committees
Remuneration committees (continued)
The FRC has indicated (September 2012) that it plans to
consult on further amendments to the UK Corporate
Governance Code in relation to: clawback; the practice
of executive directors sitting on the remuneration
committees of other companies; and whether
companies should engage with shareholders and report
to the market in the event that they fail to obtain at
least a substantial majority in support of a resolution on
remuneration. The consultation will take place once the
Government’s legislation on voting and executive
remuneration has been finalised.
59
Corporate governance committees
Nomination committees
Provisions of the UK Corporate Governance Code
The EC’s Recommendation on independent directors
Although foreign private issuers (see Glossary) are
relevant to nomination committees include:
and board committees (February 2005) recommends
exempt, SEC Rules require US listed companies to
that listed companies should establish a nomination
provide more robust disclosure of nominating
committee to ensure that the process for the
committee processes in their annual proxy statements
appointment and removal of directors is carried out in
to shareholders, including:
-
the nomination committee should consist of a
majority of independent NEDs (B2.1)
-
the chairman should be allowed to chair the
an objective and professional way. An annex to the
nomination committee except when the committee
Recommendation sets out criteria for the composition,
discusses the appointment of a new chairman (B2.1)
role and operation of the nomination committee. These
the nomination committee should evaluate the
are generally similar to, or less onerous than, the UK
balance of skills, experience, independence and
Corporate Governance Code.
knowledge on the board and prepare a description
The Financial Institutions Green Paper (June 2010) on
of the role and capabilities required for a particular
corporate governance in financial institutions did not
evaluating candidates to be nominated as directors
appointment in light of this (B2.2).
mention nomination committees directly but noted that
(including the involvement of third parties and
Also, there is a Supporting Principle that requires the
the failure of directors in financial institutions to identify
minimum qualifications and standards for director
search for board candidates to be conducted and
and manage risk was at the heart of the origins of the
nominees)
appointments made on merit and against objective
financial crisis and that this raised important questions
criteria and with due regard to the benefits of diversity
about the quality of appointment procedures.
on the board, including gender diversity.
The directive forming part of CRD IV proposes that
ICSA updated its terms of reference for nomination
boards of credit institutions and investment firms
forward by large, long-term shareholders or groups
committees (October 2010) to reflect the UK Corporate
should establish a nomination committee, responsible
of shareholders.
Governance Code.
for defining the roles and capabilities required for
-
The FRC published (September 2012) amendments to
the UK Corporate Governance Code which take effect
for financial years commencing on or after 1 October
2012. Companies are required to identify the external
facilitator of the board evaluation, as well as any
external search consultants and remuneration
particular appointments. Directors will also be subject
to an enhanced “fit and proper” test and should receive
appropriate induction and continuous training. The
MiFID Amendment Directive also proposes that
investment firms should establish a nomination
committee, where appropriate and proportionate in
60
-
whether the company has a separate nominating
committee and, if not, why not
-
whether members of the nominating committee
satisfy independence requirements
-
-
the company’s process for identifying and
whether a company considers director nominees
put forward by shareholders and, if so, its process
-
whether the company has rejected candidates put
Corporate governance committees
consultants used, in the annual report. Also, companies
view of the nature, scale and complexity of their
that use external consultants must disclose whether
business.
they have any other connection with the company.
NAPF’s Corporate Governance Policy and Voting
Guidelines (November 2012) state that shareholders
may abstain or oppose the re-election of the chairman
of the nominations committee or the chairman of the
board in the absence of a full explanation of noncompliance with the UK Corporate Governance Code in
relation to board appointments, succession or
evaluation.
61
Corporate governance committees
Nomination committees (continued)
The Kay Report recommended that companies should
consult their shareholders in advance of making major
appointments to the board. This has been added to the
good practice statement for directors (see BIS’ response
(November 2012) to the Kay Report).
62
Corporate governance committees
Audit committees - constitution
Provisions of the Statutory Audit Directive relating to
The EC’s Recommendation on independent directors
Rules promulgated under SOX § 301 prohibit the listing
audit committees were implemented by DTR 7.1. This
and board committees (February 2005) recommended
of companies not meeting the following requirements:
requires UK companies with transferable securities
that listed companies should establish an audit
admitted to trading on a regulated market to have a
committee. An annex to the Recommendation set out
body responsible for carrying out the audit functions
criteria for the committee’s composition. These are
set out in the Statutory Audit Directive. The body
generally similar to, or less onerous than, the UK
should have at least one independent member and a
Corporate Governance Code.
(SEC Rules adopted April 2003 and NYSE/Nasdaq Rules
The Statutory Audit Directive contains a requirement for
approved November 2003.)
all public interest entities (see Glossary) to have an
SEC Rules make significant accommodations for non-US
audit committee. The audit committee should be
issuers:
member who has competence in accounting and/or
auditing. Companies are also required to issue a
statement which identifies the body which carries out
the audit functions and describes how that body is
composed.
composed of non-executive members of the
administrative body and/or members of the supervisory
Provision C3.1 of the UK Corporate Governance Code
body, i.e. NEDs, and/or members appointed by the
states that the board must establish an audit
shareholders in general meeting, with at least one
committee.
independent member with competence in accounting
To deal with the overlap between the DTR and the UK
Member States may exempt from the audit committee
the FSA’s view, compliance with certain provisions of
requirement:
to ensure full compliance with DTR 7.1.1 to 7.1.5.
Under the UK Corporate Governance Code:
-
each company must have an audit committee
-
each member of the audit committee must be
“independent”.
-
-
board of directors exercise certain statutory
responsibilities relating to the appointment and
oversight of audit committees
-
allowing non-management employees to sit on
audit committees in accordance with home country
legal or listing requirements without violating the
unlisted credit institutions and insurance
undertakings
independence criteria
-
clarifying that, solely for the purposes of these
public interest entities (see Glossary) that have a
rules, the term “board of directors” means the
the audit committee should have a minimum of
“body performing equivalent functions to an audit
supervisory, or non-management, board for issuers
three (or, in the case of smaller companies outside
committee, established and functioning according
from jurisdictions with two-tier board structures
the FTSE 350 throughout the previous reporting
to provisions in place in the Member State where
year, two) members, all of whom should be
the entity to be audited is registered”.
independent NEDs (C3.1)
-
clarifying that the rules do not conflict with home
country requirements that shareholders or the full
and/or auditing.
Corporate Governance Code, DTR 7.1.7 confirms that, in
the UK Corporate Governance Code should be enough
-
The European Confederation of Directors’ Associations
63
-
allowing representatives of controlling shareholders
and foreign government shareholders to sit on
audit committees in certain circumstances
Corporate governance committees
-
the chairman of a company outside the FTSE 350
published (September 2011) guidance on the
may be a member of (though may not chair) the
requirements of the Statutory Audit Directive in relation
audit committee, provided he or she was
to audit committees.
considered independent on appointment (C3.1)
-
-
exempting listed foreign governments from the
requirements of these rules
-
allowing alternative structures such as statutory
The EC’s Financial Institutions Green Paper considers
auditors and boards of auditors to oversee audit
the board should satisfy itself that at least one
whether one of more members of the audit committee
firms.
member should have recent and relevant financial
should participate in the risk committee and vice versa
experience (C3.1) (there is no detailed definition
to strengthen the oversight of risk. This is not
equivalent to “audit committee financial expert” in
specifically addressed in CRD IV.
the US).
If non-US issuers avail themselves of one of the
exemptions, they must disclose that choice in their
annual report on Form 20-F. In addition, non-US issuers
The EC published (November 2011) a draft regulation
that rely on any of the exemptions will be required to
The FRC Guidance on Audit Committees (September
on requirements for audits of public interest entities
disclose their assessment as to whether and, if so, how
2012) provides guidance on how to comply with the
(see Glossary) and a draft directive amending the
that reliance
provisions relating to the establishment of the audit
Statutory Audit Directive. Among other things, the draft
committee in the UK Corporate Governance Code.
regulation includes more detailed rules on the
membership of audit
64
Corporate governance committees
Audit committees - constitution (continued)
NAPF’s Corporate Governance Policy and Voting
committees. In particular, at least one member must
would materially adversely affect the ability of their
Guidelines (November 2012) state that shareholders
have competence in auditing and another member in
audit committee to act independently and satisfy the
may choose to vote against the re-election of the
accounting and/or auditing. This goes further than the
other audit committee requirements of SOX.
chairman of the audit committee, or another member
existing provisions which only require one member to
of the audit committee, or, in exceptional
have competence in accounting and/or auditing.
circumstances, the reappointment of the auditor, where
Each audit committee must either designate an “audit
committee financial expert” or explain why such an
expert has not been appointed.
issues relating to auditor and/or non-audit fees are not
To qualify as an “audit committee financial expert”, an
resolved to their satisfaction.
individual must have all of the following attributes:
-
an understanding of GAAP and financial statements
-
an ability to assess the general application of GAAP
in connection with the accounting for estimates,
accruals and reserves
-
experience in preparing, auditing, analysing or
evaluating financial statements that present a
breadth and level of complexity of accounting
issues that are generally comparable to the breadth
and complexity of issues that can reasonably be
expected to be raised by the company’s financial
statements, or experience in actively supervising
one or more persons engaged in such activities
-
an understanding of internal controls and
procedures for financial reporting
-
an understanding of audit committee functions.
A person can acquire such attributes through any one
or more of the following means:
65
Corporate governance committees
Audit committees - constitution (continued)
-
education and experience as a principal financial
officer, principal accounting officer, controller,
public accountant or auditor or experience in one
or more positions that involve the performance of
similar functions
-
experience in actively supervising a principal
financial officer, principal accounting officer,
controller, public accountant, auditor or person
performing similar functions
-
experience in overseeing or assessing the
performance of companies or public accountants
with respect to the preparation, auditing or
evaluation of financial statements or
-
other relevant experience.
Note that, for non-US issuers, the SEC has clarified that
the audit committee financial expert’s understanding
must be of the GAAP used by the non-US issuer in
preparing its primary financial statements filed with the
SEC.
(SOX § 407) (SEC Rules adopted January 2003.)
The NYSE amended its rules (November 2009) to clarify
that if an audit committee member simultaneously
serves on the audit committees of more than three
public companies, then the board must determine that
such service would not impair such member’s ability to
serve on the audit committee and must disclose such
66
Corporate governance committees
Audit committees - constitution (continued)
determination.
67
Corporate governance committees
Audit committees - role
Provision C3.2 of the UK Corporate Governance Code
IOSCO published “Principles of Auditor Independence
SOX specifies certain audit committee responsibilities,
sets out the main role and responsibilities of the audit
and the Role of Corporate Governance in Monitoring an
including (SOX §§ 202, 204 and 301):
committee. The audit committee should, among other
Auditor’s Independence” (October 2002).
things:
-
-
monitor the integrity of the financial statements of
(May 2002) proposed that auditors should consider
the company and any formal announcements
whether the governance structure of the audited entity
relating to the company’s financial performance,
provides safeguards to mitigate threats to
reviewing significant financial reporting judgements
independence. The involvement of the governance
contained in them
body of listed entities in an auditor’s appointment or in
review the company’s internal financial controls
and, unless expressly addressed by a separate risk
committee of independent directors or by the
-
to independence (para. A 4.1.1 and Annex para. 4.1.1).
-
receiving reports of critical accounting policies and
practices as well as alternative accounting
treatments
-
oversight of accounting firms (including payment of
compensation)
-
whistleblowing procedures
-
authority and funding to engage outside advisers.
(SEC Rules adopted January and April 2003.)
and risk management systems
and board committees (February 2005) recommended
Also, pursuant to SOX § 307 and SEC Rules, audit
that listed companies should establish an audit
committees may receive and take action on attorneys’
committee. An annex to the Recommendation set out
reports of “evidence of material violations of securities
criteria for the committee’s role and operation. These
law…”.
monitor and review the effectiveness of the
make recommendations to the board in relation to
are generally similar to, or less onerous than, the UK
the appointment, reappointment and removal of
Corporate Governance Code.
and terms of engagement of the external auditor
review and monitor the external auditor’s
independence and objectivity and the effectiveness
of the audit process, taking into consideration
-
considered in determining the significance of a threat
pre-approval of non-prohibited non-audit services
The EC’s Recommendation on independent directors
the external auditor and approve the remuneration
-
commissioning non-audit services was a factor to be
-
board itself, review the company’s internal control
company’s internal audit function
-
The EC’s Recommendation on Auditor Independence
The Statutory Audit Directive provides that the audit
committee should, inter alia:
-
monitor the financial reporting process
-
monitor the effectiveness of the company’s internal
relevant UK professional and regulatory
control, internal audit and risk management
requirements
systems
develop and implement a policy on the
-
NYSE/Nasdaq Rules require/authorise audit committees,
amongst other things, to:
-
hire and fire independent auditors; approve nonaudit services; review their work; and obtain advice
from outside legal or accounting advisers if
necessary (NYSE and Nasdaq)
-
consider annual/quarterly financial statements and
MD&A; discuss earnings press releases, guidance
monitor the statutory audit of the annual and
68
provided to analysts and rating agencies and risk
Corporate governance committees
engagement of the external auditor to supply nonaudit services, taking into account relevant ethical
guidance, and report to the board, identifying any
matters in which it considers that action or
improvement is needed and making
recommendations as to the steps to be taken
-
report to the board on how it has discharged its
responsibilities.
Other provisions of the UK Corporate Governance Code
relating to the role of audit committees include
provisions that:
-
the audit committee should review arrangements
consolidated accounts
-
management policies; and meet regularly with
management, internal auditors and independent
review and monitor the independence of the
auditors (NYSE)
statutory auditor or audit firm and in particular the
provision of additional services to the audited
entity.
-
review and approve all related party transactions
(Nasdaq).
Also, the appointment of the statutory auditor of a
NYSE/Nasdaq Rules are largely consistent with SOX,
public interest entity (see Glossary) must be based on a
although they allow for the exemption of non-US
recommendation of the audit committee.
issuers where such exemptions would not be contrary
In the Audit Green Paper (October 2010), the EC sought
views on how the dialogue between the external
auditors, internal auditors and the audit committee
could be improved.
by
69
to US securities laws. However, audit committee rules
under SOX § 301 apply to non-US issuers, albeit with
significant accommodations. See Audit committees constitution above.
Corporate governance committees
Audit committees - role (continued)
which staff of the company may, in confidence,
The EC published (November 2011) a draft regulation
The PCAOB adopted Auditing Standard No. 16,
raise concerns about possible improprieties in
on requirements for audits of public interest entities
Communications with Audit Committees (August 2012)
financial reporting or other matters, to ensure that
(see Glossary) and a draft directive amending the
which the SEC approved (December 2012). The new
arrangements are in place for the proportionate
Statutory Audit Directive. The draft regulation provides
standard primarily retains or enhances existing audit
and independent investigation of such matters and
that:
committee communication requirements and is effective
for appropriate follow-up action (C3.5)
-
the audit committee is to be responsible for
if the board does not accept the audit committee’s
conducting an auditor selection procedure based
recommendation on the appointment,
on detailed criteria set out in the draft regulation.
reappointment or removal of the external auditors,
In order to give mid-tier firms more opportunities
it should include in the annual report, and in any
to bid for audit mandates, at least one of the firms
papers recommending appointment or
invited to tender must be a firm that received less
reappointment, a statement from the audit
than 15% of its total audit fees from large public
committee explaining its recommendation and the
interest entities in the Member State the previous
reasons why the board has taken a different
year
position (C3.7)
-
-
-
unless an auditor’s appointment is being renewed
the annual report should explain to shareholders
(this is permitted only once), the recommendation
how, if the auditor provides non-audit services,
of the audit committee to the board must include
auditor objectivity and independence are
at least two possible choices for the audit
safeguarded (C3.8).
engagement and a justified preference for one of
The FRC Guidance on Audit Committees provides
additional guidance on Section C3 of the UK Corporate
Governance Code.
them. The proposal for the appointment of
statutory auditors made by the board to the
general meeting of shareholders must include the
recommendation of the audit committee and, if the
ICSA’s terms of reference for audit committees were
proposal of the board departs from the audit
updated (October 2010) to reflect amendments to the
committee’s recommendation, it must justify the
UK Corporate Governance Code in June 2010. A further
departure.
update will be required to reflect the 2012 amendments
FEE published (June 2012) a discussion paper on the
70
for audits of financial statements with fiscal years
beginning on or after 15 December 2012. The standard
also applies to audits of emerging growth companies
and foreign private issuers (see Glossary). See
Regulation of auditors and accountants below.
Corporate governance committees
Audit committees - role (continued)
to the UK Corporate Governance Code.
The House of Lords Economic Affairs Committee’s
report “Auditors: Market concentration and their role”
(March 2011) recommended that audit committees
should hold discussions with principal shareholders
every five years, that the published report of the audit
committee should detail significant financial reporting
functioning of audit committees following a survey in a
number of EU countries. The discussion paper
recommends various improvements in relation to
establishment, composition, competences and
responsibilities as well as reporting to and from the
audit committee with the overall aim of improving the
quality of financial information provided by companies.
issues raised during the course of the audit and that
they should explain the basis of the decision on audit
tendering and auditor choice.
The FRC published (February 2012) jointly with the
Institute of Chartered Accountants of Scotland and the
Institute of Chartered Accountants in Australia, a report
summarising discussions with audit committee chairmen
in the UK, Australian and other markets. The report
covers issues such as the role and composition of the
audit committee and its relationship with the board,
management and the external auditor.
The AIU includes a section for audit committees in its
2011/12 Annual Report (June 2012). It warns audit
committees to consider carefully the scope of the audit
where significant fee reductions are contemplated,
suggests ways audit committees can encourage auditor
scepticism and recommends that audit committees seek
additional information if auditors do not provide a
good standard of independence reporting in the
context of non-audit services.
71
Corporate governance committees
Audit committees - role (continued)
The FRC published amendments (September 2012) to
the UK Corporate Governance Code and the FRC
Guidance on Audit Committees which take effect for
financial years commencing on or after 1 October 2012
with earlier adoption encouraged. The amendments in
relation to audit committees implement the FRC’s
effective stewardship project and address concerns
about uninformative audit committee reports expressed
in the FRC’s Developments in Corporate Governance
2011 (December 2011) and the FRC’s Developments in
Corporate Governance 2012 (December 2012). Main
changes:
-
the audit committee must include additional
information in its report to shareholders, including
information on the significant issues that it
considered in relation to the financial statements
and how these issues were addressed, details on
how it assessed the effectiveness of the external
audit process, the approach taken to the
appointment or reappointment of the external
auditor and information on the length of tenure of
the current audit firm and when the tender was last
conducted
-
the audit committee must report to the board on
how it has discharged its responsibilities
-
the board must confirm that the annual report and
accounts taken as a whole are fair, balanced and
72
Corporate governance committees
Audit committees - role (continued)
understandable and provide the information
necessary for shareholders to assess the company’s
performance, business model and strategy. The
board should establish arrangements to enable it to
be in a position to provide this confirmation. In this
context, the board may request input from the
audit committee, as appropriate.
In relation to reporting on significant issues, the FRC
Guidance on Audit Committees suggests that this
should include matters that informed the board’s
assessment of whether the company is a going concern.
There is a greater stress in the FRC Guidance on Audit
Committees on formal reporting by the audit
committee to the board.
The FRC also published updated guidance for audit
committees on the use of audit firms from more than
one network (September 2012). Originally published in
2008, the guidance provides audit committees of
growing companies using non-Big Four audit firms with
factors they may wish to consider when their activities
expand geographically beyond the perceived capacity
of their existing firm.
73
Corporate governance committees
Risk committees
The Walker Report (November 2009) recommended
The EC’s Financial Institutions Green Paper on corporate
The Dodd-Frank Act requires the Board of Governors of
that banks and financial institutions should establish
governance in financial institutions and accompanying
the Federal Reserve to issue rules requiring all public
risk committees comprising NEDs and supported by a
Staff Working Paper (June 2010) considers whether
non-bank financial companies supervised by the Federal
chief risk officer.
board risk committees should be compulsory and seeks
Reserve and all public bank holding companies with
comments on ways to enhance the status of the chief
assets exceeding US$10 billion to have risk committees.
risk officer.
The Federal Reserve may also require public bank
The FSA added guidance to the FSA Handbook (the
Senior Management Arrangements, Systems and
Controls (SYSC) Sourcebook) with effect from 1 May
The directive forming part of CRD IV proposes that
2011 to implement Walker’s recommendations on risk.
boards of credit institutions and investment firms
The guidance encourages regulated firms to consider
should set up a separate risk committee, made up of
appointing a chief risk officer and establish a board risk
NEDs. Credit institutions and investment firms should
committee, taking account of their size, nature and
also have an independent risk management function
complexity. The FSA also states in the guidance that it
with sufficient authority and resources and the ability to
considers FTSE 100 banks and insurers to be examples
report directly to the board, when necessary.
of the type of firm that should structure their risk
holding companies with assets of less than US$10
billion to have risk committees if deemed necessary or
appropriate to promote sound risk management. The
risk committees would be responsible for the oversight
of the company’s enterprise-wide risk management
practices and must include at least one risk
management expert with experience in identifying,
assessing and managing risk exposures of large,
complex firms. The Federal Reserve will determine the
control arrangements in this way. The FSA’s reasons for
number of independent committee members that are
introducing the new rules are set out in a Policy
required, based on the nature of the company’s
Statement 10/15 (September 2010).
operations, size of assets and other appropriate criteria.
According to the FRC’s final report (December 2009) of
Otherwise, risk committees are rare in the US and the
its review of the Combined Code (the predecessor to
audit committee generally supervises risk issues.
the UK Corporate Governance Code), few respondents
supported mandatory risk committees for listed
companies in general. A report (October 2009) carried
out by Independent Audit Limited for the ICAEW on
risk governance in 70 non-financial services companies
in the FTSE 350 suggested that there was no case for
major change in the UK’s risk governance rules for nonfinancial companies and that the focus should be on
74
Corporate governance committees
making the existing rules work better, for example by
encouraging the right behaviour and attitudes to risk
management.
Although risk committees are not mandatory for nonfinancial companies, there is more emphasis on risk
management in the UK Corporate Governance Code
(see also Risk management and control above).
ICSA published terms of reference for risk committees
for the first time (October 2010) reflecting the greater
emphasis given to risk in the UK Corporate Governance
Code.
75
Corporate governance committees
Risk committees (continued)
The FRC met with companies, investors and advisers in
early 2011 to discuss how boards were approaching
their responsibilities on risk. In the summary of its
discussions (September 2011), it noted that different
board committee structures were appropriate to
different industries and companies and that the
decision whether to establish a risk committee should
be left to individual boards.
Grant Thornton’s corporate governance review 2012
(December 2012) noted that increasing numbers of
non-financial companies in the FTSE 350 have risk
committees – 40% in 2012 compared to 33% in 2011.
76
Corporate governance committees
Other committees
Disclosure committees
Disclosure committees
UK companies generally do not have US-style
SEC Rules addressing SOX certification requirements
disclosure committees although Listing Principle 2 set
extend to “disclosure controls and procedures”, i.e.
out in 7.2.1R supplemented by 7.2.2G of the Listing
procedures to ensure that required information is
Rules requires a listed company to take reasonable
recorded, processed, summarised and reported on a
steps to establish and maintain adequate procedures,
timely basis. CEOs/CFOs must certify as to their
systems and controls to enable it to comply with its
evaluation of disclosure controls and procedures and
obligations, in particular in relation to the timely and
the inclusion in the filing of their conclusions about the
accurate disclosure of information to the market. In
effectiveness of such controls.
practice, the audit committee may fulfil the role of a
The SEC recommended (August 2002) that SEC-
disclosure committee. Provision C3.2 of the UK
registered companies should have a disclosure
Corporate Governance Code provides that the audit
committee to assist in establishing controls and
committee should monitor the integrity of a company’s
procedures as well as to oversee the preparation of
financial statements and any formal announcements
disclosure. Members might include the general counsel,
relating to financial performance, reviewing significant
heads of major subsidiaries, the head of investor
financial reporting judgements contained in them.
relations and risk management staff.
Provision 3.4 of the UK Corporate Governance Code
Qualified legal compliance committees
also provides that, where requested by the board, the
audit committee should provide advice on whether the
The SEC provides that issuers may establish qualified
annual report and accounts, taken as a whole, is fair,
legal compliance committees (“QLCCs”) as an alternative
balanced and understandable and provides the
means of addressing the “reporting requirements” for
information necessary for shareholders to assess the
attorneys which are mandated by SOX. Attorneys
company’s performance, business model and strategy.
obliged to report evidence of a material violation of US
securities laws or a breach of fiduciary duty or similar
CSR committees
violation by a client, or by any officer, director,
The UK Corporate Governance Code does not refer to
employee or agent of that client, may report to the
CSR committees and they are not a requirement of UK
QLCC. A QLCC would be composed of at least one
company law. However, there is a growing trend for
77
Corporate governance committees
companies to set up such committees, which reflects
member of the audit committee and two or more
growing pressure on companies to promote sustainable
additional independent board members. However,
businesses.
QLCCs have not been widely adopted.
Executive committees
ICSA provided guidance (September 2004) on terms of
reference for an executive committee, intended as a
forum where the chief executive can consider major
operational decisions.
78
Shareholder engagement
Statutory and regulatory framework
Shareholders have the right to appoint and remove
The Shareholder Rights Directive was intended to
The current default standard in most states for the
directors by a resolution passed by a majority of those
facilitate shareholder engagement by establishing
election of directors is plurality voting, under which a
voting. Under the articles of association, the board
requirements for the exercise of certain shareholder
director is elected if s/he receives the most votes, rather
usually has the right to appoint directors to fill
rights that are attached to voting shares of companies
than having to win at least 50% of the votes. Thus, if an
vacancies and appoint additional directors, subject to
with a registered office in a Member State where the
election is uncontested, it would be possible for a
the approval at the annual general meeting of a
shares are admitted to trading on a regulated market.
nominee to win a board seat simply by receiving one
majority of the shareholders who vote. Under the UK
Main provisions:
“for” vote. Because high costs and the judicial rejection
Corporate Governance Code, all directors of FTSE 350
companies are subject to annual election by the
-
meeting. This can be reduced to 14 days for a
shareholders and must step down if they fail to secure
meeting (other than the annual general meeting)
the approval of a majority of the shareholders who
with shareholder consent where the company offers
vote.
CA 06 contains a number of measures designed to
promote shareholder engagement by facilitating
involvement, and increasing confidence, in the voting
-
a registered shareholder in a company traded on a
regulated market has the right to nominate a
person on whose behalf it holds shares to receive
information that is sent to the registered
shareholder (Sections 146 to 153)
-
subject to provisions to that effect in the
company’s articles, a registered shareholder may
nominate another person to exercise or enjoy all or
any of the shareholder’s rights (including voting
rights) to the extent specified by the shareholder
(Section 145)
-
shareholders to nominate their own candidates for the
board, plurality voting has been criticised as a “rubber
stamp” for the corporation’s nominee.
Activists continue to push for corporations to adopt
means
majority voting for the election of directors, but an
the notice of meeting must also be published on
(or 14 days where the notice of meeting is reduced)
-
of the SEC’s proxy access rule make it difficult for
the facility for all shareholders to vote by electronic
the company’s website 21 days before the meeting
process:
-
a company must give 21 days’ notice of a general
each Member State must fix a single record date
attempt to insert a majority voting requirement in the
Dodd-Frank Act was ultimately rejected.
The CII considers plurality voting to be flawed and
endorses majority voting.
for all companies to determine the eligibility of a
The DGCL, the Model Act (the foundation of corporate
shareholder to vote. Share blocking, the practice of
statutes in many states excluding Delaware) and the
preventing shareholders from trading their shares
California Corporations Code were amended in 2006 to
during a certain period before the meeting, is
facilitate majority voting. Under the DGCL, shareholders
prohibited
can propose and adopt changes to bylaws, including
Member States must permit companies to offer
participation in the general meeting by electronic
means. Unjustified obstacles to electronic voting are
prohibited
changes establishing majority voting. Whilst these
changes can be overruled by the board of directors if
the certificate of incorporation permits the board of
directors to amend the bylaws, Section 216 of the DGCL
prohibits repeal by the board through unilateral action
79
Shareholder engagement
-
quoted companies (see Glossary) must disclose on
-
their websites the results of polls at meetings
(Section 341) (Provision E2.2 of the UK Corporate
Governance Code recommends that companies
publish on their website details of proxies lodged
-
of any shareholder-adopted bylaw that addresses the
exercise rights by proxy
requisite vote for election of directors. To accommodate
a company must publish voting results on its
website within 15 days of the meeting.
majority voting proposals which require nominees who
are not elected by a majority to tender their
resignation, Section 141(b) of the DGCL allows a
at any general meeting where votes are taken on a
The EC published a consultation document (April 2007)
resignation of a director to be conditional upon a
show of hands as well as votes for and against a
to assess the need for further measures to facilitate
future event, such as a director failing to receive a
resolution)
shareholder rights and a summary of responses
specified vote for re-election, and further allows such
(September 2007). The responses showed support for
resignations to be irrevocable.
shareholders of quoted companies (see Glossary)
have the right to require independent scrutiny of
any poll (Sections 342 to 351)
-
-
shareholders should have a general right to
registered shareholders may nominate proxy/ies to
provisions on stock lending, giving depositary holders
the right to direct how votes on underlying shares
should be cast and provisions requiring intermediaries
to pass on and execute voting instructions. The EC
originally indicated
80
The DGCL authorises but does not require the adoption
by the company of:
Shareholder engagement
Statutory and regulatory framework (continued)
speak at meetings, demand a poll, and vote on a
that it would publish a recommendation in 2008, but
show of hands or on a poll (Section 324).
has not taken any further action.
-
a bylaw setting forth requirements for shareholder
access to the company’s proxy materials (DGCL
Section 112)
The Shareholder Rights Directive was implemented by
For an analysis of the problems with cross-border
The Companies (Shareholders’ Rights) Regulations 2009
voting, caused by shares being held through chains of
on 3 August 2009. The regulations made the following
intermediaries, see the statement and memorandum
reimbursement of shareholder proxy expenses
amendments to CA 06 and give shareholders a number
(June 2006) by the European Corporate Governance
(DGCL Section 113).
of additional rights to be heard:
Forum.
-
5% (reduced from 10%) of members can requisition
The Company Law Action Plan considered that there
a general meeting (Section 303)
was a medium- to long-term case for introducing a
-
every member has the right to have questions
answered at a general meeting, unless an exception
applies (Section 319A)
-
-
a bylaw setting forth requirements for the
The DGCL also:
-
separate the date by which shareholders must
“one share, one vote” principle in the EU and doing
register in order to be entitled to notice of a
away with the multiplicity of voting rights, voting right
shareholder meeting from the date by which
ceilings, priority (or preference) shares, depositary
shareholders must register in order to be entitled
receipts and non-voting shares. The EC published an
5% of members can require “other matters of
independent research report (June 2007) and the
business” which are not resolutions to be included
European Corporate Governance Forum published a
in the annual general meeting agenda (Section
paper (June 2007). Neither showed conclusive evidence
338A).
of a causal link between one-share-one-vote and the
authorises, but does not require, a board to
to vote at the meeting (DGCL Section 213(a))
-
allows judicial removal of directors under certain
circumstances (DGCL Section 225(c))
-
provides a statutory default rule confirming a
In addition, the regulations required companies to
economic performance of companies. The EC
covered person’s right to indemnification for certain
provide additional information in notices of meetings
announced (October 2007) that it would be taking no
expenses accrued while an indemnification bylaw
and on company websites.
further action on this issue.
was in force where such bylaw is subsequently
ICSA has published the following guidance notes:
The OECD Steering Group on Corporate Governance
amended to limit or eliminate the right (DGCL
agreed (November 2007) a common position on
Section 145(f)).
-
Indirect Investors – Information Rights and Voting
(October 2007). This seeks to explain Sections 145
and Sections 146 to 153 of CA 06 and offers
guidance and best practice recommendations to
indirect and registered shareholders, companies
whether there should be proportionality between
The Model Act permits the adoption of bylaws
ownership and control (also known as one-share-one-
mandating majority voting. Specifically, the Model Act
vote) in listed companies. Among other things, it
provides for election by a plurality vote, but with the
concluded that:
qualification that a nominee who is so elected but fails
-
to receive a majority of the votes cast in the director’s
the cost of regulating proportionality would be
81
Shareholder engagement
Statutory and regulatory framework (continued)
and registrars
-
Implementation of the Shareholder Rights Directive
considerable
-
(July 2009). This summarises and gives guidance to
companies on corporate representatives, proxies
voting on a show of hands, advance voting on a
poll, website requirements for poll results and the
-
election would serve as a director only for a term
strengthening corporate governance frameworks
was a better alternative
-
on which the board otherwise fills the office. The Model
specific problems could be dealt with through
Act also allows corporations to adopt resignation
carefully targeted regulation.
policies tied to the occurrence of a future event, similar
The ICGN published a code of best practice on stock
to the DGCL.
general meetings
lending (September 2007). This was intended to clarify
California law provides that certain California-based
the responsibilities of all parties engaged in stock
corporations that are also listed corporations may
lending, increase transparency and ensure that the
amend their bylaws or charters to require directors to
governance consequences of lending shares (such as a
be elected by “approval of the shareholders” in
possible loss of shareholder votes) were taken into
uncontested elections.
Practical issues relating to shareholder voting at
the notice of meeting, proxy deadline and record
date, the voting period and what should happen
after the proxy deadline has passed.
account. It included a principle that companies should
know who controlled the votes at their general
Section E of the UK Corporate Governance Code deals
meetings. The relevant market authorities were invited
with relations between companies and shareholders.
to consider amending their disclosure regimes to
Among other things:
include the transfer of actual or contingent voting
the chairman should discuss governance and
strategy with major shareholders (Provision E1.1)
-
-
rights executed through the use of securities lending
and derivatives.
Shareholders can require a US public company to
include shareholder proposals on the company proxy
statement under Rule 14a-8 of the Exchange Act. If a
company is able to exclude such proposal under the
various bases provided under Rule 14a-8, the
shareholder would have to undertake the expensive and
difficult project of creating its own proxy materials and
the senior independent director should attend
ESME published a report on the implementation of TOD
conducting its own proxy solicitation, if it wants to
sufficient meetings with a range of major
in the EU (December 2007). Among other things, it
disseminate its proposal. If a shareholder is successful
shareholders to help develop a balanced
flagged the variation in the understanding and the
under Rule 14a-8, the shareholder proposal is included
understanding of their concerns (Provision E1.1)
consequences of securities lending across Member
in the company’s proxy statement along with
States and noted concerns, such as where securities are
management’s proposals. Foreign private issuers (see
borrowed for the purpose of influencing a shareholder
Glossary) are not subject to Rule 14a-8 and the SEC’s
meeting. The report set out what ESME considered to
proxy rules in general.
the chairman should ensure the views of
shareholders are communicated to the board as a
whole (Provision E1.1)
-
which the voting results are determined or (ii) the date
right of shareholders to have questions answered at
company general meetings (April 2012). It covers
-
ending on the earlier of (i) 90 days from the date on
the board should state in the annual report the
be elements of good practice in the lending market.
IOSCO published a report (June 2009) on minority
82
The SEC adopted rules (August 2010) requiring
Shareholder engagement
Statutory and regulatory framework (continued)
steps taken to ensure that members of the board,
shareholders in listed issuers and summarised the
companies to allow a qualifying shareholder (or group
especially NEDs, develop an understanding of the
protections and standards in 18 jurisdictions.
of shareholders) to include its nominee(s) for the board
views of major shareholders e.g. through face-toface contact, analysts’ or brokers’ briefings and
surveys of shareholder opinion (Provision E1.2).
The European Parliament’s Committee on Economic and
Monetary Affairs published a study (December 2009) on
the questionable use of shareholder voting rights, such
Also, new directors should avail themselves of
as where an investor can direct voting without being a
opportunities to meet major shareholders as part of
shareholder (hidden voting) or where a shareholder
their induction (Provision B4.1).
votes without a corresponding financial interest in the
The Bank of England’s Securities Lending and Repo
Committee’s Securities Borrowing and Lending Code of
Guidance (July 2009) applies to securities lending by UK
the company’s remuneration policy every three years
and an advisory vote (ordinary resolution) on the
implementation of its policy in the year under review.
See
Remuneration
-
proposals
affecting
listed
companies above for more information.
The FSA published a consultation “Enhancing the
effectiveness of the Listing Regime” (October 2012). It
proposes new rules principally addressed to premium
listed companies with a controlling shareholder (on the
basis that engagement by institutional shareholders
that it will not appeal the decision. See also Nonexecutive directors of listed companies above.
proxy solicitation and proxy voting. It has issued a
limitation of voting rights to avoid such uses.
concept release (July 2010) for public comment on
statement on empty voting and transparency of
CA 06 to require a binding vote (ordinary resolution) on
of Columbia Circuit (July 2011), and the SEC has stated
voting). The study proposes compulsory disclosure and
stock loans when corporate activities are concerned.
published draft legislation (June 2012) which will amend
struck down by the US Court of Appeals for the District
The SEC is also exploring reform of the mechanics of
The European Corporate Governance Forum adopted a
voting rights on executive pay (March 2012), BIS
rules were stayed (September 2010) and were ultimately
company, e.g. if shares are lent or swapped (empty
participants. It states that shareholders should recall
Following a consultation to give shareholders greater
of directors on the company’s proxy statement, but the
shareholder positions (February 2010). It also
recommended mandatory disclosure of voting rights
held within empty voting arrangements (e.g. through an
certain aspects of the proxy system, including the
accuracy and transparency of the voting process;
communications and shareholder participation; and the
relationship between voting power and economic
interest.
amendment of TOD), the right of lenders to recall
The SEC approved the amendment to NYSE Rule 452
securities at any time and the introduction of a rule
(September 2010) to prohibit broker discretionary
that a company and its subsidiaries should only lend
voting (i.e. voting without instructions by shareholders)
the company’s shares if the lending contract stipulated
in all elections for directors, on executive compensation
that the borrower would not vote the shares.
or on “any significant matter” as determined by the
The EC’s report on TOD (May 2010) concluded that
TOD’s disclosure obligations needed to be adapted to
take account of innovative financial products. In
particular, the insufficient disclosure of stock lending
SEC. Previously, NYSE Rule 452 permitted a broker to
vote on behalf of beneficial owner customers in
uncontested elections of directors if the customers had
not returned their voting instructions.
practices had increased the risk of empty voting and
The NYSE published an information memo (January
lack of disclosure regarding cash-settled derivatives had
2012) clarifying the application of NYSE Rule 452 to
83
Shareholder engagement
Statutory and regulatory framework (continued)
may have little influence on such companies), but some
proposals are expressed to apply to all companies with
a premium listing of shares.
For example:
-
controlling shareholders will have to enter into
relationship agreements with listed companies to
led to increased
problems of hidden ownership.
The TOD Amendment Directive (October 2011) contains
proposals to:
-
from the shareholders
companies with controlling shareholders will need
to have a majority of independent directors and the
shareholders other than the controlling
-
-
majority voting in the election of directors
holding of shares, including cash-settled derivatives
-
eliminating supermajority voting requirements
require the aggregation of holdings of shares with
-
providing for the use of consents
-
providing rights to call a special meeting
-
certain types of anti-takeover provision overrides.
those of financial instruments giving access to
shares (including cash-settled derivatives).
election of independent directors
the UK disclosure provisions in DTR 5 (which are
currently super-equivalent).
into the listing principles for premium listed
ESMA published a call for evidence (September 2011) in
companies
relation to the issues and potential problems relating to
the rules on control of business and independence
LR 9.8.6(5) will be amended to require the company
to disclose in its corporate governance statement
how the chairman has ensured the directors have a
sufficient understanding of the regulatory
requirements applicable to a premium listed
company and the requirements regarding fiduciary
duties that are applicable to directors in the
company’s country of incorporation.
be treated as “Broker May Not Vote” matters, including:
-
These will align the TOD provisions more closely with
a “one share, one vote” principle will be introduced
that it previously ruled as “Broker May Vote” will now
de-staggering the board of directors
shareholders will be given a separate vote on the
from controlling shareholders will be tightened
-
-
The NYSE has determined that certain proxy proposals
-
extend the current disclosure regime to cover all
instruments with a similar economic effect to the
ensure independence of the company’s business
-
certain types of corporate governance proxy proposals.
empty voting. It published a feedback statement (June
2012) which concluded that there was insufficient
evidence to justify any regulatory action at European
level.
ESMA published a discussion paper on proxy advisers
and how to regulate them (March 2012). This considers
the factors influencing the accuracy, independence and
reliability of proxy advice, such as the potential for
conflicts, proxy advisers’ methodology and their
dialogue with issuers, the degree of transparency on
the management of conflicts, the dialogue with issuers,
84
Shareholder engagement
Statutory and regulatory framework (continued)
The consultation also proposes that all disclosures
voting policies and guidelines, voting recommendations
required by the Listing Rules should be placed in a
and procedures for drawing up a voting
separate section of the annual report.
recommendations report. ESMA seeks views on a
number of policy options, ranging from encouraging
the development of improved investor codes and
developing ESMA recommendations to more formal
legislative measures.
85
Shareholder engagement
Stewardship
The drive to ensure that institutional investors engage
The Company Law Action Plan rejected a requirement
Regulations under the Employment Retirement Income
with the companies in which they invest has a long
for institutional investors to exercise voting rights, but
Security Act of 1974 state that the fiduciary
history. The Myners Report, “Institutional Investment in
set out a proposal for the medium term to require
responsibility of managing employee benefit plan assets
the UK: A Review” (March 2001), recommended that
institutional investors to disclose their investment and
consisting of equity securities extends to the exercise of
those responsible for pension scheme investment
voting policies and, at the request of beneficiaries, their
voting rights attaching to those securities.
should adopt on a “comply or explain” basis a series of
voting records in individual cases.
principles codifying best practice for investment
decision making, actively monitor and communicate
with the management of investee companies and
exercise shareholder votes where these would enhance
the value of an investment.
Lord Myners published a review (January 2004) on the
impediments to voting UK shares, followed by three
progress reports (March 2005, November 2005 and July
2007) for the Shareholder Voting Working Group. The
July 2007 report showed that voting levels and
electronic voting were increasing, but that some votes
continued to be lost in the chain of instructions.
Section 1277 CA 06 includes a reserve power for the
Secretary of State and the Treasury to make regulations
requiring institutional investors to disclose how they
have voted the shares in which they have an interest.
investment advisers with authority over client proxies
institutional shareholder responsibilities (July 2007). This
to:
set out the responsibilities of institutional shareholders
both in relation to their role as owners of a company’s
The OECD published “Corporate Governance and the
Financial Crisis: Key Findings and Main Messages” (June
adopt voting policies and procedures designed to
ensure that the adviser votes in the best interest of
clients
-
disclose voting policies and procedures to clients.
2009). This called on companies to do more to support
SEC-registered management investment companies are
constructive engagement with shareholders and on
also required to disclose proxy voting policies and
shareholders to play a more active, informed role.
procedures, as well as voting records (SEC Rules
The EC published a Financial Institutions Green Paper
(June 2010). In relation to shareholder engagement, and
in view of the emergence of new categories of
shareholder with little interest in long-term governance,
it questioned the effectiveness of corporate governance
rules based on the presumption of effective control by
shareholders. It sought views on whether shareholder
published a comply or explain code on voting
control of financial institutions was still realistic and on
disclosure (June 2007) and an updated version of the
ways to improve shareholder engagement in practice.
policy on voting and voting disclosure to be included in
-
equity and in relation to their internal governance.
To pre-empt use of the reserve power, the ISC
“Statement of Principles” (June 2007) to require the
SEC Rules (January 2003) require SEC-registered
The ICGN published a statement of principles on
The EC’s Corporate Governance Green Paper (April
2011) considered how to encourage shareholders to be
86
adopted January 2003). The SEC also proposed rules
(October 2010) pursuant to the Dodd-Frank Act, that
would require institutional investment managers with
investment discretion over at least US$100 million in US
public company equity and certain other securities to
disclose at least once a year how they voted in the now
required “say on pay” votes. The rules have not yet
been adopted.
SEC Rules (November 2003) require enhanced
disclosure regarding shareholder communications with
directors, including whether a company has a process
Shareholder engagement
the terms of engagement between institutional
more active on corporate governance issues and to
for communications by shareholders to directors and, if
investors and their agents. ISC reclassified the
take an interest in sustainable returns and longer-term
not, why not, and disclosure of director attendance at
Statement of Principles as a comply or explain Code
performance. In particular, the EC indicated that it was
annual meetings. Foreign private issuers (see Glossary)
(November 2009).
considering a framework requiring institutional investors
are exempt from these rules.
The principles set out in the Myners Report were
reviewed by NAPF in 2007. NAPF’s recommendations
(including that trustees should adopt or ensure their
investment manager adopted the ISC Code) were
endorsed by HM Treasury (October 2008).
to publish their voting policies and records following
widespread support for this in the responses to the
Financial Institutions Green Paper.
In addition, the EC sought comments on the following:
-
whether EU rules (e.g. on pension fund accounting)
The FRC commissioned a review of shareholder
contributed to inappropriate short-termism among
engagement by the JCA Group. The review was carried
investors
out between January and March 2009 and suggested
actions for companies and shareholders to take to
improve
87
The SEC has adopted rules (January 2008) which
promote the use of electronic shareholder forums by
exempting solicitations in these forums from the proxy
rules in certain circumstances (January 2008).
Shareholder engagement
Stewardship (continued)
engagement.
-
incentive structures for, and performance evaluation
The ISC published a statement (June 2009) on ways to
of, asset managers
improve institutional shareholders’ role in governance.
Among other things, it called on the authorities to
whether there should be greater disclosure of
-
whether there should be rules to prevent conflicts
make it clear that there are no regulatory impediments
of interest arising within asset managers or to
to collective engagement. In response to this:
enhance disclosure and management of conflicts of
-
interest
the FSA confirmed (August 2009) that ad hoc
discussions and understandings between
-
institutional shareholders do not contravene its
rules. In particular, engaging collectively with the
management of an investee company is not market
through reform of EU laws on acting in concert)
-
-
whether other legislative measures were necessary
avoid disclosure of shareholdings could be market
(e.g. restrictions on the ability of proxy advisers to
abuse). Furthermore, ad hoc discussions between
provide consulting services to investee companies)
investors regarding particular issues will not trigger
-
whether there was a need for a European
a requirement to aggregate shareholdings for the
mechanism to help issuers identify their
purposes of determining whether a disclosure
shareholders in order to facilitate dialogue on
threshold has been reached under DTR 5 or
corporate governance issues.
whether there has been a change of control of an
FSA-authorised institution under FSMA
-
the role of proxy advisers and whether this needed
to be made more transparent
abuse (although dealing on the basis of knowledge
of another party’s intentions or working jointly to
ways to facilitate shareholder co-operation (e.g.
In relation to companies with controlling or dominant
shareholders, the EC sought comments on whether
the Takeover Panel published a practice statement
minority shareholders needed more protection against
(September 2009) setting out the circumstances in
related party transactions and referred to the statement
which a mandatory offer may be triggered by
by the European Corporate Governance Forum (March
activist shareholders. It also explains why the
2011). The statement is similar in principle to the
Takeover Code’s acting in concert provisions and
related party provisions that apply to premium listed
mandatory offer requirements should not constrain
88
Shareholder engagement
Stewardship (continued)
normal collective shareholder action.
companies under the UK Listing Rules.
Following the 2008 financial crisis, the Walker Report
To help align the interests of shareholders and
recommended that the FRC should assume
companies in significant corporate transactions, the
responsibility for stewardship from the ISC. The FRC
European Corporate Governance Forum also published
consulted on the form of a code (January 2010) and
a statement (April 2011) recommending that all
published the UK Stewardship Code and a note on
acquisitions or disposals of businesses by a listed
implementation (July 2010). The principles of the UK
company representing 25% or more of assets or profits
Stewardship Code are based on the ISC Code and state
of that listed company should be submitted to
that institutional investors should:
shareholders for their prior approval before becoming
-
publicly disclose their policy on how they will
discharge their stewardship responsibilities
-
have a robust policy on managing conflicts of
interest in relation to stewardship which should be
publicly disclosed
-
monitor their investee companies
-
establish clear guidelines on when and how they
will escalate their activities as a method of
protecting and enhancing shareholder value
-
-
-
effective. Alternatively, listed companies could obtain a
blanket authority from their shareholders, provided this
authority was renewed at least once every 12 months.
The OECD published the following:
-
a report on the role of institutional investors in
promoting good corporate governance. It included
a detailed review of institutional investors in
Australia, Chile and Germany (January 2012)
-
a report (April 2012) on related party transactions
and the protection of minority shareholder rights in
be willing to act collectively with other investors
31 jurisdictions. It also includes a detailed analysis
where appropriate
of the regulatory and legal systems in Belgium,
have a clear policy on voting and disclosure of
France, Italy, Israel and India.
voting activity
IOSCO published a report (June 2012) on the
report periodically on their stewardship and voting
development and regulation of institutional investors in
activities.
emerging markets.
Also, as recommended by the Walker Report, the UK
In the Company Law and Corporate Governance Action
89
Shareholder engagement
Stewardship (continued)
Stewardship Code is applied on a comply or explain
Plan (December 2012), the EC indicates that it will
basis. UK-authorised asset managers are required by
propose an initiative in 2013 to improve the visibility of
Rule 2.2.3 of the FSA’s Conduct of Business sourcebook
shareholdings in Europe as part of its legislative work
(effective from December 2010) to disclose on their
programme in the field of securities law. It also
website, or in other accessible form, the nature of their
proposes to amend the Shareholder Rights Directive to:
commitment to the UK Stewardship Code or, where
they do not commit, to explain their alternative
-
engagement policies and voting records
investment strategy.
Details of all signatories to the UK Stewardship Code,
-
application and monitoring of the UK Stewardship Code
improve shareholder control over related party
transactions
with links to their statements, are available on the FRC
website. Additional information on the background,
require institutional investors to disclose voting and
-
improve the transparency and the conflict of
interest frameworks applicable to proxy advisers.
is also available on the FRC website. By December 2012,
Also, the EC plans to work closely with competent
259 asset managers, owners and service providers had
national authorities and ESMA to develop guidance to
signed up to the UK Stewardship Code.
increase legal certainty as regards the relationship
NAPF published guidance on how investors can apply
between investor co-operation on corporate
the UK Stewardship Code (November 2010). It also
governance issues and the rules on acting in concert.
published a guide (March 2011) to help pension funds
develop and implement a stewardship policy based on
the UK Stewardship Code.
NAPF published its first Stewardship Policy (November
2012) setting out best practice for pension fund
trustees and explaining how pension funds should fulfil
their stewardship responsibilities.
Shareholder engagement has also been considered by
the Takeover Panel following concerns about
institutional shareholders selling shares to short-term
90
Shareholder engagement
Stewardship (continued)
speculative investors during the Kraft bid for Cadbury in
2010. As part of its review of the UK takeovers regime,
the Takeover Panel published a paper (June 2010)
seeking comments on measures to give more say to
long-term shareholders. These included withdrawing
voting rights from offeree shares acquired during an
offer period or giving enhanced voting rights on shares
held for a specified period.
None of these changes were included in the
amendments to the City Code on Takeovers and
Mergers that took effect in September 2011. Instead, to
redress the balance between bidders and target
companies, the Takeover Panel introduced rules that
affect virtual bids (such as requiring potential offerors
to be identified at the start of an offer period and fixing
“put up and shut up” deadlines), prohibit deal
protection measures, increase the quality of disclosure
of certain information and provide greater recognition
of the offeree company employees.
The ICAEW published a report on activist shareholders
(November 2011) and the implications for corporate
governance.
In response to concerns about the short-term focus of
investors and directors, BIS commissioned (June 2011)
Professor John Kay to conduct a review into investment
in the UK equity markets. Following a call for evidence
(September 2011) and an interim report (February
91
Shareholder engagement
Stewardship (continued)
2012), Professor Kay published the Kay Report (July
2012). The Kay Report set out 10 principles for equity
market participants, including institutional investors, and
recommended:
-
the extension of the UK Stewardship Code to cover
strategic issues as well as questions of corporate
governance
-
the adoption by directors, asset managers and
asset holders of good practice statements to
promote stewardship and long-term decision
making. However, no changes were recommended
to directors’ duties under CA 06
-
the establishment of an investors’ forum to
facilitate collective engagement by investors in UK
companies
-
that companies consult their major long-term
investors over key board appointments
-
that the scale and effectiveness of merger activity
of and by UK companies be kept “under careful
review” by BIS and by companies themselves.
However, the report did not recommend any formal
national interest test or additional regulation of
takeovers
-
the application by UK and EU regulatory authorities
of fiduciary standards to all relationships in the
investment chain which involve discretion over the
92
Shareholder engagement
Stewardship (continued)
investments of others, or advice on investment
decisions
-
an investigation by the Law Commission into the
legal concept of fiduciary duty as applied to
investment to address uncertainties and
misunderstandings on the part of trustees and their
advisers
-
full disclosure by asset managers of all costs and
performance fees charged to the fund
-
disclosure of all income from stock lending and the
rebating of such income to investors
-
structuring asset managers’ remuneration to align
the interests of asset managers with the interests
and timescales of their clients. A long-term
performance incentive should be provided in the
form of an interest in the fund (either directly or via
the firm) to be held at least until the manager is no
longer responsible for that fund
-
exploration by the Government of ways individuals
can hold shares directly in CREST.
BIS published its response (November 2012) to the Kay
Report. It endorsed the 10 principles for equity market
participants set out in the Kay Report but recast the
meaning of fiduciary standards to require equity
participants to act in good faith, in the best long-term
interests of their clients or beneficiaries and in line with
93
Shareholder engagement
Stewardship (continued)
generally prevailing standards of decent behaviour. It
has asked the FSA and FRC to consider to what extent
current regulatory rules align with this principle. Also,
BIS has asked the Law Commission to conduct the
investigation (as recommended by the Kay Report) into
the fiduciary and other duties applicable to trustees and
other investment intermediaries.
BIS has added two of the Kay Report recommendations
to the good practice statement for directors to give
them greater emphasis:
-
companies should consult their shareholders in
advance of making major appointments to the
board
-
whilst not detracting from the obligation of
companies to meet their obligations to disclose
regulated information, companies should seek to
disengage from the process of managing shortterm earnings expectations and announcements.
This is intended to help shift the focus of investors
onto the fundamentals of the company and its
long-term strategy.
BIS intends to publish a progress report in summer
2014 setting out whether Professor Kay’s
recommendations have been achieved and what further
action may be necessary.
The Ownership Commission, an independent body
endorsed by the former Labour Government and
94
Shareholder engagement
Stewardship (continued)
supported by the Co-operative Group, published a
report (March 2012) on ways to deliver better longterm “stewardship-orientated” ownership. It made a
number of detailed recommendations, including:
-
giving tax relief to equity finance to even out the
tax advantages given to debt
-
widening directors’ fiduciary duties so that directors
owe a “duty of stewardship”. The fiduciary duties of
institutional investors should also include
stewardship responsibilities
-
greater transparency in the behaviour of
institutional shareholders in an offer period. Also,
directors should be able legally to act with
discretion as to the interests of the company, and
their judgements and recommendations protected
by a safe harbour provision.
Fair Pensions, a charity which campaigns for responsible
investment, published a report on the enlightened
shareholder (March 2012). This called for a clarification
of investors’ duties to the people whose money they
manage in order to overcome narrow interpretations of
the law based on maximising short-term returns and
refocus it on sustainable wealth creation.
The 2020 Investor Stewardship Working Party (a group
of six institutional investors supported by Tomorrow’s
Company, a think tank) published 2020 Stewardship Improving the Quality of Investor Stewardship (March
95
Shareholder engagement
Stewardship (continued)
2012), containing recommendations for improving
engagement practices. This followed a number of
discussions with company chairmen who spoke about
the shortcomings in investor engagement.
In response to a request from the 2020 Investor
Stewardship Working Party, ICSA published a
consultation paper on improving engagement practices
between companies and institutional investors (October
2012). The consultation paper sought views on a list of
practical measures designed to make meetings more
productive, including:
-
whether the nature of the discussion between a
company and its institutional investors needed to
change, with more emphasis on dialogue which
builds and encourages a long-term relationship
with the company
-
the improvements that could be made to the
process of conducting engagement meetings
-
whether companies and institutional investors
should seek feedback on the quality of
engagement meetings and how that might
achieved.
The FRC published (September 2012) amendments to
the UK Stewardship Code. The amendments:
-
clarify the meaning of stewardship and the
respective responsibilities of asset owners and asset
96
Shareholder engagement
Stewardship (continued)
managers
-
require signatories to review their policy statements
annually, update them as necessary and indicate
the date of their last review
-
encourage more informative disclosure on conflicts
of interest
-
remove the inference that institutions should not
become insiders by stating that institutional
investors “may or may not want to be made
insiders”. Institutional investors that wish to become
insiders should indicate their willingness to do this
and the mechanism by which this could be done in
their stewardship statement
-
encourage more informative disclosure about when
an investor might participate in collective
engagement
-
require institutional investors to disclose the use
they make of proxy voting or other voting advisory
services, describing the scope of such activities and
identifying the providers. They should also disclose
the extent to which they use, rely on and follow the
recommendations of proxy advisers
-
require signatories to disclose their stock lending
policy and whether they recall lent stock for voting
purposes
-
require asset managers to obtain an assurance
97
Shareholder engagement
Stewardship (continued)
report.
The FRC’s Developments in Corporate Governance 2012
(December 2012) confirms that the FRC will monitor the
impact of changes to the UK Stewardship Code on the
quality of engagement. It identifies four factors that
could lead to improvements in stewardship:
-
a more pro-active approach by asset holders in
setting investment mandates
-
more involvement from overseas long-term holders
of UK shares e.g. by means of an investor forum
-
the development of investors’ engagement skills
-
increasing the reliability of the voting chain.
In relation to the latter, the FRC plans to meet with
market participants in the first quarter of 2013 to
debate voting by investors in pooled funds and will
consider whether to address the issue in a future
edition of the UK Stewardship Code. The FRC also
hopes action by the EC to improve visibility of
shareholdings of listed companies and revisit
shareholder identification more generally will improve
the operation of the voting chain.
98
Corporate reporting
Recent developments
The DTR require UK-incorporated issuers of shares (and
TOD requires issuers with securities traded on a
The Dodd-Frank Act exempts issuers with a market
other issuers where the UK is the “home state”) to
regulated market to publish annual and half-yearly
capitalisation of less than US$75 million from the
publish annual and half-yearly reports and an interim
reports and an interim management statement within
internal control reporting requirements of SOX § 404.
management statement within each half-year period.
each half-year period.
Pursuant to the Dodd-Frank Act, the SEC also issued a
The Companies and Limited Liability Partnerships
ESMA published (April 2012) Frequently Asked
(Accounts and Audit Exemptions and Change of
Questions on TOD. They confirm that additional
Accounting Framework) Regulations 2012 exempt a
information in annual and half-yearly financial reports
subsidiary from statutory audit if its parent company
(beyond the minimum requirements) is permitted and
guarantees its debt and the shareholders unanimously
discuss the requirement to make regulated information
declare each year to dispense with the audit. The
public.
subsidiary must be unlisted and may not be in the
banking or insurance sectors and the parent company
must be incorporated in the EU. The subsidiary must
still be included in the consolidated accounts of the
parent company. The exemption takes effect for
accounting years ending on or after 1 October 2012.
CESR published a consultation on pan-European access
to financial information (July 2010). This addresses the
requirements of SOX § 404, see Risk management and
control above.
Glossary) to present just two years (rather than three) of
information as mandated by TOD.
audited financial statements and just two years (rather
same date if the same conditions are met.
particularly annual reports (February 2010). The
principles also cover the timeliness of disclosures,
disclosure criteria and the storage of information.
(July 2012) recommended that:
Following a review of TOD, the EC published:
-
-
a report (December 2008) on the measures being
process of managing short-term earnings
adopted by Member States that are more stringent
expectations and announcements
than TOD (a minimum harmonisation directive)
interim management statements should be
SOX § 404(b) requirements for such companies.
mechanisms for the central storage of regulated
periodic disclosure by listed entities in periodic reports,
-
million, which recommends maintaining the existing
The JOBS Act allows an emerging growth company (see
the requirement to file accounts with effect from the
companies should seek to disengage from the
market capitalisation is between US$75 and US$250
development of the network of officially appointed
IOSCO published a final report on the principles for
focusing on short-term information, the Kay Report
of complying with SOX § 404(b) for companies whose
For further information on the internal control reporting
The Regulations also exempt dormant companies from
As part of the effort to stop companies and investors
study (April 2011) regarding how to reduce the burden
-
an external study on the application of TOD
99
than five) of selected financial information in its IPO
registration statement and exempts such companies
from the SOX § 404(b) auditor attestation report
requirement for up to five years after IPO.
Corporate reporting
abolished.
Under BIS’ narrative reporting proposals (October 2012),
(December 2009)
-
a consultation and report on the operation of TOD
the strategic report will replace the summary financial
together with a staff working document on issues
statement that companies may provide to shareholders
emerging from the review (May 2010).
under certain conditions instead of the annual report
and accounts. See Narrative reporting below.
The FRRP’s annual report (September 2012) notes that
the issues raised in half-yearly reports were not of such
In the TOD Amendment Directive (October 2011) the EC
proposes:
-
reduce the administrative burden of publishing
substance to justify an approach to the companies
quarterly information, especially for smaller listed
concerned. It does, however, recommend a number of
companies
actions for companies to consider in their next halfyearly
to abolish interim management statements to
-
additional disclosure requirements for listed
100
Corporate reporting
Recent developments (continued)
reports, given prevailing economic uncertainty:
-
undertakings active in the extractive and logging of
primary forest industries (and, if amended as
boards should review assets and liabilities for
proposed by the European Parliament’s Legal
indications of significant impairment since the end
Affairs Committee, the banking, telecoms and
of the previous financial year. One possible trigger
construction industries) - see Corporate social
is a reduction in the company’s market
responsibility below
capitalisation to a level significantly below the
amounts at which its assets and liabilities are stated
-
in its accounts
-
including standard forms or templates in relation to
management reports, to reduce the administrative
companies for whom funding is a challenge should
burden and to ensure the comparability of
reconsider the disclosures provided in their year-
information
end accounts and update them where appropriate
to reflect the current position at the half-year stage
-
to require ESMA to issue non-binding guidelines,
-
to take powers to specify minimum standards for
the dissemination of regulated information, access
boards should refer to the FRC’s Update for
to regulated information at EU level and central
Directors, Country and Currency Risk – Interim
storage mechanisms (since the network of national
Reports (June 2012) for points to consider in
storage mechanisms mandated by TOD does not
respect of heightened country and currency risk.
allow easy access to information).
The EC published the Accounting Directive (October
2011). The main purpose of the Accounting Directive is
to simplify the preparation of financial statements for
smaller companies but it also proposes:
-
additional disclosure requirements for large unlisted
undertakings active in the extractive or logging of
primary forest industries (and, if amended as
proposed by the European Parliament’s Legal
Affairs Committee, the banking, telecoms and
construction industries) - see Corporate social
101
Corporate reporting
Recent developments (continued)
responsibility below
-
measures to make the rules on financial statements
clearer for all companies (e.g. by merging the
Fourth and Seventh Directives, updating the
language and removing the overlap between the
two Directives).
The Council of the European Union agreed (July 2012)
the general approach of the Accounting Directive.
Under the Company Law and Corporate Governance
Action Plan, the EC plans to publish proposals in 2013
to require companies to disclose additional nonfinancial information.
102
Corporate reporting
Narrative reporting
Section 417 CA 06 requires companies to include a
The Modernisation Directive requires large and
Registration statements and annual reports (Form 20-F
business review in the directors’ report. This is a
medium-sized companies to provide an analysis of the
for most non-US companies) are required to include a
requirement of the Modernisation Directive. The
development and performance of their business in
“Management’s Discussion and Analysis of Financial
business review must, to the extent necessary for an
their annual reports, describing the principal risks and
Condition and Results of Operations” (“MD&A”) or
understanding of the development, performance or
uncertainties they face and providing financial and
“Operating and Financial Review and Prospects” (“OFR”).
position of the business of the company, include an
non-financial performance indicators such as
Management discusses the company’s “financial
analysis using financial and, where appropriate, other
environmental and employee information. Member
condition, changes in financial condition and results of
key performance indicators, including information
States may exempt medium-sized companies from
operations” for the historical period covered by the
relating to environmental and employee matters, with
certain non-financial requirements.
financial statements and gives its assessment of factors,
the depth of analysis required being proportionate to
the size and complexity of the business.
IOSCO published a report (February 2003), “General
Principles Regarding Disclosure of Management’s
trends and uncertainties which are anticipated to have a
material effect.
BIS published guidance (December 2005) on the
Discussion and Analysis of Financial Condition and
Additional disclosure regarding liquidity and capital
requirements for the directors’ report. This endorses
Results of Operations”.
resources and critical accounting policies and estimates
guidance on non-financial matters, including:
-
-
-
CESR published (October 2005) a recommendation on
is typically included (SEC Rules proposed May 2002 and
interpretive guidance issued December 2003).
the report of the Accounting for People Task Force
the best way to use and present alternative
on measuring and evaluating the workforce
performance measures, i.e. financial data which is not
Rules promulgated under SOX require disclosure of non-
(October 2003)
extracted or cannot be derived from the statutory
GAAP financial information (SEC Rules adopted January
audited financial statements.
2003) and off-balance sheet arrangements (SOX § 401)
Environmental Reporting Guidelines – Key
(SEC Rules adopted January 2003).
Performance Indicators published by DEFRA and
The ICGN published guidance on non-financial
Trucost (January 2006) but currently being updated.
business reporting (December 2008). This sets out
The SEC adopted rules (July 2006) requiring companies
See DEFRA’s consultation (July 2012)
disclosure criteria that will assist companies in meeting
to provide a narrative explanation of the objectives and
the expectations of investors. It also aims to generate
implementation of an issuer’s executive compensation
substantive dialogue between investors and company
programme. See Regulation S-K under Remuneration -
boards about the content and timing of non-financial
current regime affecting listed companies above.
the ASB’s Reporting Statement setting out best
practice for a voluntary operating and financial
review (January 2006).
Section 417(5) of CA 06 contains an additional
requirement for directors of quoted companies (see
business reporting.
The SEC proposed amendments (September 2010) (not
The Climate Disclosure Standards Board published a
yet adopted) to require SEC-registered companies,
framework on how companies can report climate
including non-US companies, to make more extensive
103
Corporate reporting
Glossary) to include an “enhanced” business review in
the directors’ report. They must disclose, to the extent
necessary for an understanding of the development,
performance or position of the company’s business,
information covering:
change in their annual reports (September 2010).
The IASB published (December 2010) a practice
statement setting out a broad, non-binding framework
for the presentation of narrative reporting to
accompany financial statements prepared in
disclosures regarding their short-term borrowings in
order to provide investors with a more accurate picture
of their financing activities. The SEC’s current MD&A
rules already require companies to disclose their use of
short-term borrowing arrangements and their exposure
to related risks and uncertainties, but do not specifically
-
future developments
accordance with IFRS.
-
environmental, employee and social policies
Following its questionnaire on country-by-country
to disclose information about intra-period short-term
reporting by multinational enterprises (October 2010),
borrowings. The proposed amendments would require
the EC published (October 2011) the TOD Amendment
To prevent defensive disclosures and encourage useful
disclosure of, among other things, the maximum daily
Directive and the Accounting Directive. These contain
narrative reporting, CA 06 introduced a new regime
amount of each specified category of short-term
proposals to require listed and large unlisted
borrowings during the reporting period (financial
undertakings active in the extractive or logging of
companies only) or the maximum month-
-
essential contractual arrangements.
require companies other than bank holding companies
primary forest
104
Corporate reporting
Narrative reporting (continued)
defining the extent of liability for financial reporting
industries (and, if amended as proposed by the
end amount of each specified category of short-term
disclosures, including the “enhanced” business review.
European Parliament’s Legal Affairs Committee, the
borrowings during the reporting period (all other
See Liability for reports and other statements below.
banking, telecoms and construction industries) to report
companies). At the same time, the SEC also issued
annually on all material payments to governments on a
interpretive guidance intended to make clear that
country-by-country basis and by project - see
companies may not use financing structures to mask
Corporate social responsibility below.
their financial condition.
2012), BIS published (October 2012) draft regulations to
The TOD Amendment Directive (October 2011) also
Pursuant to the Dodd-Frank Act, the SEC has adopted
amend CA 06 to require companies to prepare a
contains proposals to require ESMA to issue non-
rules that would require SEC-reporting companies to
strategic report instead of a business review.
binding guidelines, including standard forms or
make certain disclosures relating to the use of certain
templates in relation to management reports to reduce
minerals financing conflict in the Democratic Republic
the administrative burden for listed SMEs and ensure
of the Congo and adjoining countries (August 2012),
the comparability of information.
mine safety (December 2011) and payments made by
Following two consultations (August 2010 and
September 2011) on ways to improve the quality of
narrative reporting and a response statement (March
The requirements applicable to the strategic report
largely replicate the business review except that quoted
companies (see Glossary) will also have to include, to
the extent necessary for an understanding of the
The EC published a questionnaire (November 2010)
development, performance or position of their business:
seeking comments on whether changes were needed to
-
information about human rights alongside social
and community issues
-
a breakdown of the number of persons of each sex
who are directors, managers and employees of the
company. Managers are defined as persons (other
than directors) who are employees and have
responsibility for planning, directing or controlling
the activities of the company.
There is also a requirement for quoted companies (see
Glossary) to describe their business model and strategy.
This makes mandatory the UK Corporate Governance
Code provision that applies to premium listed
resource extraction issuers to governments (August
2012). See Corporate social responsibility below.
the EU’s rules on companies’ disclosure of non-financial
The SEC has also issued guidance (October 2011) on
information. It published a summary of the responses
disclosure obligations relating to cybersecurity risks and
(April 2011).
incidents. The purpose of the guidance is to assist
The Corporate Governance Green Paper (April 2011)
sought views on whether the board should be required
to report the company’s risk appetite “meaningfully” for
shareholders. It also asked whether risk disclosure
should extend to “societal risks”, meaning risks that
affect society as a whole.
registrants in assessing what disclosures, if any, they
should provide about cybersecurity matters in light of
each issuer’s specific facts and circumstances. According
to the guidance, although no existing disclosure
requirement explicitly refers to cybersecurity risks and
cyber incidents, a number of disclosure requirements
(including the risk factors, MD&A, description of
Disclosure of non-financial information is part of the
business, legal proceedings, financial statements and
EC’s agenda for a renewed CSR strategy as set out in its
disclosure controls and procedures sections) may
Communication on CSR (October 2011). See Corporate
impose an obligation on registrants to disclose such
105
Corporate reporting
Narrative reporting (continued)
companies on a comply or explain basis.
social responsibility below.
risks and incidents.
The strategic report will replace the summary financial
The Company Law and Corporate Governance Action
The SEC has also issued guidance (January 2012)
statement that companies may provide to shareholders
Plan (December 2012) states that the EC will make a
regarding disclosure relating to registrants’ exposures
under certain conditions instead of the annual report
proposal in 2013 to strengthen disclosure requirements
to European sovereign debt. The guidance states that
and accounts.
in relation to risk management, diversity and other non-
registrants should consider the following in drafting
financial information by means of an amendment to the
their disclosure:
To offset the additional disclosures in the strategic
report, the requirement for quoted companies (see
Glossary) to report on their essential contractual
arrangements in the strategic report and for companies
to include information in relation to asset values,
charitable donations, creditor payment policies and
information on purchases by private companies of own
Fourth and Seventh Directives. The disclosure
requirements in relation to non-financial information
-
counterparty, categories of financial instruments
are expected to cover similar ground to the BIS
proposals for the strategic report (environment,
-
-
-
The following proposals contained in BIS’ earlier
-
requiring companies to publish an annual directors’
other risk management disclosure – how
management is monitoring and/or mitigating
statement in a prescribed format
exposures, impact of current developments in
splitting information on remuneration between the
identified countries
strategic report and annual directors’ statement. BIS
-
effects of credit default protection to arrive at net
exposure – by counterparty and country
consultation (September 2011) have been dropped:
-
total gross exposure (funded and unfunded) – by
counterparty and country
shares in the directors’ report, will be removed.
-
unfunded exposure – by counterparty and country,
key terms
employees, human rights) but with additional
disclosures on anti-bribery procedures.
gross funded exposure – by country, type of
has now decided to keep the remuneration report
-
as a separate document because of its shareholder
In determining which countries are covered by this
voting proposals (see Remuneration – proposals
guidance, registrants should focus on those
affecting listed companies above)
experiencing significant economic, fiscal and/or political
the auditors’ confirmation that nothing had come
strains such that the likelihood of default would be
to their attention that was inconsistent with the
higher than would be anticipated when such factors do
report. Instead, the strategic report will be reviewed
not exist. The guidance states that disclosures should
106
post-reporting date events.
Corporate reporting
Narrative reporting (continued)
-
-
by auditors for consistency in the same way that
be provided separately by country, segregated between
the directors’ report is reviewed for consistency
sovereign and non-sovereign exposures, and by
with financial statements
financial statement category, to arrive at gross funded
exposure, as appropriate.
the introduction of a statutory standard or
independent assurance on narrative information.
The JOBS Act allows an emerging growth company (see
Instead, BIS has asked the FRC to provide guidance
Glossary) to present just two years (rather than three) of
on the strategic report to replace the ASB reporting
audited financial statements and just two years (rather
statement on the operating and financial review
than five) of selected financial information in its IPO
(January 2006)
registration statement. The MD&A only needs to cover
the audited financial statements presented.
the proposal for the strategic report to be signed
by each individual director.
President Obama signed into law the Iran Threat
Reduction and Syria Human Rights Act of 2012 (August
BIS proposes to bring the changes into force for
2012). Among other things, this makes US firms liable
financial years ending on or after 1 October 2013.
for their foreign subsidiaries’ involvement in
DEFRA published a consultation (July 2012) on draft
sanctionable activity in Iran and subjects corporate
regulations to require quoted companies (see Glossary)
officers to liability as well. It also imposes requirements
to report on greenhouse gas emissions. These are
for the reporting of certain Iran-related dealings on
expected to take effect for financial years ending on or
companies that filed periodic reports under Section
after 1 October 2013 in line with BIS’ proposals. See
13(a) of the Exchange Act, including with respect to the
Corporate social responsibility below for more detail.
Iran-related dealings of US parents’ foreign subsidiaries.
The FRC has also been considering how companies can
improve the way they report to shareholders. It
launched a project (July 2010) to examine the lessons
to be learned from the credit crisis and other market
developments as they affect corporate reporting,
accounting and auditing of non-financial services
companies. This was followed by its effective company
stewardship project (January 2011) to improve
107
Corporate reporting
Narrative reporting (continued)
corporate reporting and audit, its cutting clutter
initiative, Lord Sharman’s inquiry into going concern
assessments (March 2011) and the launch of the
Financial Reporting Lab (October 2011).
In light of findings from the effective company
stewardship project (January 2011), the FRC published
changes to the UK Corporate Governance Code and its
Guidance for Audit Committees (September 2012). The
changes include a new provision requiring the board to
confirm that the annual report and accounts taken as a
whole is fair, balanced and understandable and provide
the information necessary for shareholders to assess the
company’s performance, business model and strategy.
There is also a new supporting principle requiring the
board to establish arrangements to enable it to be in a
position to provide this confirmation.
Other changes to the UK Corporate Governance Code
are discussed in Corporate governance codes - general
provisions and guidance and in Audit committees – role
above and in Audit quality below.
In relation to cutting clutter, the FRC published
(October 2011) a discussion paper, “Thinking about
disclosures in a broader context: a road map for a
disclosure framework”. This aims to improve the quality
of information disclosed in annual reports as a whole,
not just in financial statements, and to curtail a
piecemeal approach to reporting. Among other things,
108
Corporate reporting
Narrative reporting (continued)
the FRC seeks views on common themes for the
information users may need and principles for good
communication and calls for the development of
placement criteria and guidance on materiality to
reduce duplication and cut clutter.
In relation to going concern assessments, Lord
Sharman’s panel of inquiry published a final report
(June 2012) recommending that the FRC should:
-
review the FRC Guidance on Going Concern
(October 2009) to ensure that the going concern
assessment is integrated within directors’ business
planning and risk management processes
-
ensure that the directors’ discussion of strategy and
principal risks always includes the directors’ going
concern statement
-
work with international standard setters to
harmonise the different descriptions of going
concern in international accounting and auditing
standards and to agree a common international
understanding of the purposes of the going
concern assessment
-
liaise with the UKLA to ensure consistency between
the going concern disclosures in the UK Corporate
Governance Code and the Listing Rules
-
take a more systematic approach to learning
lessons when significant companies fail or suffer
109
Corporate reporting
Narrative reporting (continued)
significant financial or economic distress but
nonetheless survive.
The FRC published a consultation paper (January 2013)
proposing new guidance for directors on going concern
assessments to implement Lord Sharman’s
recommendations. According to the guidance:
-
the directors’ going concern assessment should be
integrated into the company’s processes for setting
strategy, risk management and business planning
-
the directors should cover not just liquidity and
solvency over the next 12 months but also the
sustainability of the business model over both the
economic cycle and the company’s own business
cycle
-
the directors should confirm in the annual report
that they undertook a robust going concern
assessment and should refer to the significant
solvency and liquidity risks that they considered
and indicate how they are being addressed. This
should form part of the discussion of the
company’s principal risks in the business review.
In addition to these revisions, the FRC proposes to
issue supplementary guidance to address going
concern risks for banks and amendments to audit
standards to provide for an enhanced role for the
auditor in relation to going concern assessments.
110
Corporate reporting
Narrative reporting (continued)
For more information in relation to audit standards, see
Audit quality below.
These amendments are expected to take effect for
financial years commencing on or after 1 October 2012.
For other developments in relation to the reporting of
risk, including the FRC’s recommendations in relation to
the reporting of country and currency risk, see Risk
management and control above.
111
Corporate reporting
Liability for reports and other statements
DTR 4.1 and 4.2 implement TOD and require the annual
TOD requires issuers to publish annual reports, half-
Under US law, directors can be held liable to purchasers
and half-yearly financial report to contain responsibility
yearly reports and interim management statements with
of securities based on allegations of material
statements by persons responsible within the issuer.
the objective of allowing investors to make an informed
misstatements in, or material omissions from,
assessment of an issuer’s position and to increase
information provided to investors (including, but not
investor protection in the EU. Such reports and
limited to, a prospectus).
Concerns that responsibility statements and the
implementation of TOD would overturn existing
principles of English law and make directors liable not
just to shareholders but also to investors led to the
inclusion of a new liability regime for financial reporting
disclosures in CA 06 and FSMA:
statements must be made generally available
throughout the EU and a statement of responsibility
must be given by persons responsible in the annual and
half-yearly reports. Member States must impose liability
on at least the issuer or the directors but they may
Section 463 CA 06 provides that directors are liable, but
determine the extent of the liability. TOD has been
only to their company, in respect of an untrue or
implemented in the UK by CA 06, FSMA and the DTR.
misleading statement in, or omission from, the annual
directors’ report if they knew or were reckless as to
whether the statement was misleading or knew the
omission to be a dishonest concealment of a material
fact.
An issuer of securities is strictly liable for material
misstatements or omissions in a registration statement
(which includes the prospectus) declared effective by
the SEC. In such filings, directors can assert a “due
diligence” defence based on the directors’ reasonable
investigation and care with respect to the relevant
statements. In a leading case on the availability of the
The Fourth and Seventh Amendment Directive confirms
due diligence defence, the court held that, although
the collective duty and liability of board members
directors are not required to conduct an independent
towards the company for the financial and other key
audit, they must read the registration statement and
information that they publish in their annual report and
make an independent investigation of the material facts
accounts. It also requires Member States to have
contained in it.
Section 90A and Schedule 10A FSMA (as amended
appropriate sanctions and liability rules for failure to
following a review and report by Professor Paul Davies
comply with accounting rules. The Directive applies to
(March and June 2007, respectively) and a consultation
all types of companies incorporated in the EU, not just
by HM Treasury (July 2008)) impose statutory liability
listed ones.
Projections and other forward-looking information that
are within a securities law “safe harbour” will not
subject a director to liability if a prediction of financial
results or future conditions fails to materialise, so long
on listed issuers to compensate buyers, sellers or
as the projections are accompanied by meaningful
holders of their securities who suffer loss as a result of
cautionary language.
(i) misleading statements or dishonest omissions in
information published via a Regulatory Information
Service or (ii) dishonest delay in publishing such
information. However, issuers are only liable for
misleading statements or omissions if a director knew
112
Corporate reporting
Narrative reporting (continued)
or was reckless as to whether the statement was untrue
or misleading or knew the omission to be a dishonest
concealment of a material fact. The regime exempts
issuers and their directors from any other liability
relating to such information (but without prejudice to
the regulatory powers of the FSA or any criminal
sanctions which may be imposed).
The liability regime is designed to protect directors and
issuers from liability unless the directors are reckless or
fraudulent, in order to ensure that directors are not
necessarily deterred by fears of liability from making
useful and, in particular, forward-looking disclosures. In
its consultation on narrative reporting (September
2011),
113
Corporate reporting
Liability for reports and other statements (continued)
BIS noted the reluctance of directors to make forwardlooking statements and sought views on what could be
done to encourage fuller and more meaningful
disclosure and on how best to promote understanding
of the protection provided by the UK’s liability regime.
The requirements of the Fourth and Seventh
Amendment Directive in relation to the collective
responsibility of the directors for reports and accounts
are reflected in CA 06.
The UK Corporate Governance Code contains a new
provision requiring the board to confirm that the
annual report and accounts taken as a whole are fair,
balanced and understandable and provide the
information necessary for shareholders to assess the
company’s performance, business model and strategy.
There is also a new supporting principle requiring the
board to establish arrangements to enable it to be in a
position to provide this confirmation.
The LR and DTR already require issuers to take
reasonable care to ensure that information notified to a
Regulatory Information Service is not misleading and
omits nothing that would affect the import of the
information. As such, the board’s confirmation arguably
does not place additional obligations on boards, but
boards may wish to review their processes for reviewing
and approving the annual report and accounts.
114
Corporate reporting
Liability for reports and other statements (continued)
Confirmation as to adequacy of accounting systems
For financial years commencing on or after 21 July
2009, Section 93 and Schedule 46 of the Finance Act
2009 require “senior accounting officers” of “qualifying
companies” to take reasonable steps to establish and
monitor accounting systems that are adequate for the
purposes of accurate tax reporting. The senior
accounting officer must also certify this annually to
HMRC or alternatively specify any inadequacies in the
system. The “senior accounting officer” is the director or
officer of the company who has overall responsibility
for the company’s financial accounting arrangements,
and a “qualifying company” means a UK company that
individually or when its results are aggregated with UK
companies in the same group had a turnover of more
than £200 million or a balance sheet total of £2 billion
in the previous financial year. In the event of failure to
take reasonable steps or to provide a certificate, the
senior accounting officer is liable to a penalty of £5,000.
The company is also liable to a penalty of £5,000 if it
fails to notify HMRC of the identity of the senior
accounting officer.
HMRC updated its guidance in relation to the new
duties of senior accounting officers (June 2012).
115
Corporate social responsibility
Corporate social responsibility
CA 06 introduced CSR into the statutory framework:
-
directors are required to have regard to factors
such as employees, suppliers, customers and the
impact of the company’s operations on the
community and the environment (Section 172 CA
06)
-
The EC Communication (July 2002) sets out key
Both the NYSE Rules and the Nasdaq Rules require
principles and a strategy for the promotion of CSR in
companies to adopt codes of business conduct and
the EU. The EC launched the European Multi-
ethics. The NYSE amended its rules (January 2010) to
stakeholder Forum on CSR in October 2002 to bring
require a listed company to disclose any waiver of its
together companies and other stakeholders to
business code of ethics granted to executive officers or
exchange good practice and assess the appropriateness
directors within four business days. Nasdaq amended
of establishing common guiding principles. The EC
its rules (July 2010) to permit the disclosure of waivers
business reviews of quoted companies (see
hosts plenary meetings of the European Multi-
of a company’s code of conduct to be made on or
Glossary) must include details of policies on
stakeholder Forum on CSR periodically. The last
through a listed company’s website or, in certain
employees, the environment and social and
meeting was in November 2010.
circumstances, through a press release.
The Modernisation Directive (June 2003) requires large
The SEC published an interpretive release (February
community issues and report on their effectiveness
(Section 417(5) CA 06)
and medium-sized companies to provide an analysis of
2010) which, while not amending existing disclosure
the stated purpose of the business review (for all
the development and performance of their business in
rules, is clearly intended to encourage greater climate
companies) is to help members assess how the
their annual reports, describing the principal risks and
change-related disclosure. The guidance describes four
directors have performed their duty under Section
uncertainties they face and providing financial and non-
topics as examples of climate change-related issues that
172 of CA 06 (Section 417(5) CA 06).
financial performance indicators, such as environmental
an issuer, including a foreign private issuer (see
These requirements provide the directors with an
and employee information. Member States may exempt
Glossary), may need to consider under existing SEC
annual opportunity to demonstrate that they are
medium-sized companies from certain non-financial
disclosure rules:
performing their duties. Whilst the review may be
requirements.
scrutinised by non-governmental organisations, activist
The EC’s Communication (March 2006) announced the
shareholders and others with an interest in looking for
launch of a “European Alliance” to encourage the
failings in directors’ strategy or policies and, potentially,
European business community to increase its
evidence to make a derivative claim, no derivative
commitment to CSR. The European Alliance published a
claims based on CSR issues have been made to date.
toolbox for a competitive and responsible Europe
Instead, activist shareholders have sought to highlight
(December 2008).
-
concerns by tabling resolutions at general meetings and
have referred two listed companies to the FRRP for the
-
the impact of legislation and regulation
-
international accords
-
indirect consequences of regulation or business
trends
-
the physical impacts of climate change.
Recently, public companies have also seen a
In the Europe 2020 Strategy (adopted March 2010), the
significantly higher number of activist shareholder
EC made a commitment to “renew the EU strategy to
resolutions seeking greater disclosure regarding
116
Corporate social responsibility
environmental disclosures in their business reviews.
promote CSR as a key element in ensuring long-term
companies’ financial exposure and response strategies
Both cases have now been concluded.
employee and consumer trust”.
to climate-related business trends.
The Corporate Responsibility Coalition, a group of more
The EC’s communication, “Towards a Single Market Act.
Pursuant to the Dodd-Frank Act, the SEC has adopted
than 130 civil rights charities and campaigning
For a highly competitive social market economy”
rules that require SEC-reporting companies to make
organisations, published a campaigner’s guide to CA 06
(October 2010), also stresses the importance of building
certain disclosures relating to the use of certain
(September 2007) and guidance for directors on CA 06
consumer trust and confidence and achieving a
minerals financing conflict in the Democratic Republic
(October 2007).
competitive social market economy with sustainable
of the Congo and adjoining countries (August 2012),
economic growth. Improved disclosure, particularly in
mine safety (December 2011) and payments made by
the areas of the environment, human rights and
resource extraction issuers to governments (August
sustainable development, has a role to play in achieving
2012).
BIS published a corporate responsibility report
(February 2009). This considers developments since
2004 and highlights relevant activity across government
departments.
A note was added to Rule 25.2 of the Takeover Code
(September 2011) to clarify that board of an offeree
company is not required to consider the offer price as
the
these aims.
The first reporting period for the conflicts minerals rules
The Corporate Governance Green Paper (April 2011)
covers 1 January 2013 to 31 December 2013. The first
sought views on whether to require directors to
report must be filed on or before 31 May 2014. The
disclose societal risks, meaning risks that affect society
mine safety regulations took effect on 27 January 2012.
as a whole,
The
117
Corporate social responsibility
Corporate social responsibility (continued)
determining factor when recommending or opining on
such as risks relating to climate change, environment,
resource extraction rules take effect for fiscal years
an offer and is not precluded from taking into account
health and safety and human rights.
ending after 30 September 2013, with a partial report
any other factors which it considers relevant.
G8 governments at the Deauville summit (May 2011)
permitted if the company’s fiscal year began before 30
September 2013.
Following two consultations (August 2010 and
pledged “to setting in place transparency laws and
September 2011) on ways to improve the quality of
regulations or to promoting voluntary standards that
The disclosure requirements relating to mine safety and
narrative reporting and a response statement (March
require or encourage oil, gas, and mining companies to
payments by resource extraction issuers are limited,
2012), BIS published (October 2012) draft regulations to
disclose the payments they make to governments”.
respectively, to companies that operate or have
amend CA 06 to require companies to prepare a
strategic report instead of a business review. The
requirements applicable to the strategic report are
largely the same as the business review except that
Following its questionnaire on country-by-country
reporting by multinational enterprises (October 2010)
and in light of the Deauville pledge, the EC published
subsidiaries that operate coal or other mines, and to
companies engaged in the commercial development of
oil, natural gas, or minerals.
(October 2011) the TOD Amendment Directive and the
The disclosure rules relating to conflict minerals,
Accounting Directive. These contain proposals to
however, have potentially far wider effect, as the
require listed and large unlisted undertakings active in
conflict minerals at issue are used in many common
the extractive or logging of primary forest industries to
products, such as mobile telephones, computers, digital
report annually on all material payments to
cameras, jewellery, jet engine components and a
governments on a country-by-country basis and by
number of electronic components, and the proposed
Disclosure requirements have also been imposed on
project (to the extent payments are allocated to specific
conflict minerals rules do not contain any materiality
investors. The Occupational Pension Schemes
projects). The intention is to capture payments
threshold. The rule requires any SEC-reporting issuer for
(Investment) Regulations 2005 require trustees of
comparable to those disclosed in an undertaking
whom conflict minerals are necessary to the
pension schemes to disclose in their Statement of
participating in the Extractive Industries Transparency
functionality or production of a product manufactured
Investment Principles the extent to which they take
Initiative and to improve accountability and governance
or contracted to be manufactured by the issuer to
social, ethical or environmental issues into account in
in resource-rich countries. The EC’s proposals are similar
conduct a reasonable country of origin inquiry and
their investment decisions.
to those contained in the Dodd-Frank Act except that
make certain disclosures regarding the conflict minerals.
(i) they also apply to large unlisted companies and to
If the conflict minerals originated in the Democratic
companies in the forestry sector and (ii) there are no
Republic of the Congo or an adjoining country, then
requirements to disclose conflict minerals.
the issuer must conduct due diligence in accordance
quoted companies (see Glossary) will also be required
to include information on human rights, to the extent
necessary for an understanding of the development,
performance or position of their business. See Narrative
reporting above for details of BIS’ proposals.
The NAPF’s Responsible Investment Guide (March 2009)
is designed to assist investors, especially pension funds,
in developing policies. It recommends that funds should
give careful consideration to the extent to which they
The Legal Affairs Committee of the European
118
with a nationally or internationally recognised due
Corporate social responsibility
Corporate social responsibility (continued)
wish managers to take responsible investment issues
Parliament voted (September 2012) to extend these
diligence framework (such as the OECD’s due diligence
into account when implementing their investment
reporting requirements to the banking, telecoms and
guidance for responsible supply chains of minerals from
policies and reporting on them.
construction sectors.
conflict-affected and high-risk areas) and submit an
Companies have published CSR reports on a voluntary
The EC also published a study on sustainability
basis for a number of years, encouraged by guidelines
reporting in the EU (January 2011). The study looked at
such as:
how companies report the challenges they face,
Lawsuits have been filed to overturn the conflict
whether their reporting met investors’ needs and what
minerals and resource extraction payments disclosure
public policy instruments are available to stimulate
rules, but no substantive rulings have been made in the
reporting.
cases yet, and the SEC has rejected a motion to delay
-
Business in the Community’s “Indicators that count”,
a report on indicators found useful and measurable
as a starting point for measuring and reporting
-
-
social and environmental impact (July 2003) and a
The EC published a Call for Proposals (spring 2011) to
Guidance Note on Corporate Responsibility
build the capacity of investors to integrate
Reporting (updated May 2009)
environmental, social and governance information in
Environmental Reporting Guidelines – Key
Performance Indicators published by DEFRA and
The EC published a Communication on CSR (October
Trucost (January 2006). These are currently being
2011) which sets out the EC’s agenda for the period
updated - see DEFRA’s consultation (July 2012)
2011-2014. In particular, the EC intends to:
PIRC (an independent consultant to institutional
-
monitor the commitments made by large European
investors) includes guidelines on sustainability and
enterprises (with over 1,000 employees) to take
non-financial reporting in its annual Shareowner
account of internationally recognised guidelines.
Voting Guidelines. Disclosure of environmental and
This is part of the EC’s plan to improve the
social performance is a key element of PIRC’s
alignment of European and global approaches to
voting recommendations and PIRC expects up-to-
CSR
date environmental, social and governance
disclosure for all FTSE 350 companies
-
their valuation of enterprises.
-
introduce a legislative proposal to improve
company disclosure of social and environmental
the ABI’s Guidelines on Responsible Investment
information following its questionnaire on non-
Disclosure (January 2007). The guidelines call on
financial reporting (November 2010).
boards to confirm they have reviewed and are
119
audited report to the SEC describing, among other
things, the due diligence measures taken.
the effective date of the resource extraction payments
disclosure rule.
Corporate social responsibility
Corporate social responsibility (continued)
managing risks and opportunities and encourage
The Communication on CSR marks a more assertive
boards to take a more integrated approach to risks
approach to CSR by the EC. It includes a new, clearer,
and opportunities and to move away from an
definition, defining CSR as “the responsibility of
emphasis on purely social, environmental and
enterprises for their impacts on society”. The previous
ethical issues.
definition referred to CSR as “a concept whereby
Various guidelines and reports have been published to
encourage companies to report on their greenhouse
gas emissions, e.g.:
companies integrate social and environmental concerns
in their business operations and in their interaction with
their stakeholders on a voluntary basis”.
The Communication on CSR suggests that European
-
DEFRA and the Department of Energy and Climate
policy to promote CSR should be consistent with the
Change published guidance (September 2009) on
following internationally recognised guidelines:
how UK organisations should measure and report
their greenhouse gas emissions
-
-
the OECD Guidelines for Multinational Enterprises
(revised May 2011). These provide voluntary
the ICAEW and the Environment Agency published
principles and standards for responsible business
guidance on environmental issues and annual
conduct in areas such as employment and industrial
financial reporting (September 2009) to help
relations, human rights, the environment,
preparers, users and auditors of annual financial
information disclosure and the combating of
statements to identify environmental issues of
bribery
sufficient relevance to warrant disclosure.
-
the 10 principles of the UN Global Compact
The Climate Change Act 2008 required the Secretary of
(launched July 2000), covering areas such as human
State to make regulations requiring the disclosure of
rights, labour, the environment and anti-corruption
greenhouse gas emissions or lay a report before
Parliament explaining why no such regulations were
required. DEFRA published a consultation (July 2012) on
the form of regulations requiring quoted companies
(see Glossary) to report on greenhouse gas emissions
from the operations worldwide which their group
controls, using the IFRS 10 control test. Emissions for
-
the UN Guiding Principles on Business and Human
Rights (endorsed by the UN Human Rights Council
June 2011). The Guiding Principles, developed by
UN Special Representative Professor John Ruggie,
stress the need for businesses to conduct due
diligence to identify, prevent and mitigate their
120
Corporate social responsibility
Corporate social responsibility (continued)
these purposes covers emissions created directly by the
impact on human rights and for businesses that
group and emissions associated with power brought in
pose a risk of severe human rights impacts to
by the group. The regulations are expected to take
report formally how they address such impacts. The
effect for financial years ending on or after 1 October
Guiding Principles implement the Protect, Respect
2013. Guidance on the new requirements is currently
and Remedy Framework (also developed by
being drafted.
Professor Ruggie) (June 2008)
The Department of Energy and Climate Change
-
the ISO Guidance Standard on Social Responsibility,
published a consultation (March 2012) on a
ISO 26000 (November 2010). This contains
simplification of the CRC Energy Efficiency Scheme. The
voluntary guidance for reporting on social
Department published a response (December 2012) and
responsibility and is intended for use by
confirmed its intention to implement most of the
organisations of all types, in both the public and
proposals as set out in the consultation. An order will
private sectors
be laid before Parliament and is expected to come into
effect on 1 June 2013.
-
the ILO Tripartite Declaration of Principles
Concerning Multinational Enterprises and Social
Anti-corruption campaigner, Transparency International,
Policy (adopted March 2006). This sets out
published a report (July 2012) which ranks 105 of the
guidelines to multinational enterprises,
biggest publicly traded companies worldwide based on
governments, and employers’ and workers’
their public commitment to transparency. It considers
organisations in such areas as employment,
public reporting on matters such as anti-corruption,
training, conditions of work and life, and industrial
organisational transparency and country-by-country
relations.
reporting. The report concluded that multinationals
have a long way to go to improve transparency,
especially in the financial sector.
Other guidelines not specifically mentioned in the
Communication on CSR include:
-
the Equator Principles, a set of voluntary guidelines
for lenders for assessing the economic and social
impact of projects (July 2006). A process to update
the guidelines was launched in July 2011
-
IFC’s Sustainability Framework (updated January
121
Corporate social responsibility
Corporate social responsibility (continued)
2012) consisting of a policy on environmental and
social sustainability, performance standards and
access to information
-
the Climate Disclosure Standards Board’s Reporting
Framework (October 2012). The Framework
provides guidance on the climate change data that
should be included in mainstream reports
-
the Sustainability Reporting Guidelines developed
by the Global Reporting Initiative, a network-based
organisation that is a collaborating centre of the
United Nations Environment Programme. The
Guidelines are for voluntary use by organisations
reporting on the economic, environmental and
social dimensions of their activities, products and
services. The Guidelines were updated in March
2011 to include expanded guidance for reporting
on human rights, local community impacts and
gender
-
the UN Principles for Responsible Investment.
Investors who adopt the principles commit, among
other things, to incorporate environmental, social
and corporate governance issues into their
investment analysis and decision-making processes
and to seek appropriate disclosure of such issues
by the companies in which they invest
-
guidance notes published by the Human Rights
Working Group of the UN Global Compact
122
Corporate social responsibility
Corporate social responsibility (continued)
-
the public exposure draft of the CEO Water
Mandate’s Corporate Water Disclosure Guidelines
(August 2012). The guidelines seek to advance a
common approach to corporate water disclosure
that addresses the complexity of water resources in
a comprehensive yet concise manner. The
guidelines are expected to be finalised in 2013.
The Global Reporting Initiative and the Prince of Wales’
Accounting for Sustainability Project announced (August
2010) the formation of the International Integrated
Reporting Committee. Its remit is to create a globally
accepted framework for accounting for sustainability
which brings together financial, environmental, social
and governance information in a clear, concise,
consistent and comparable format. Its members include
representatives from a number of FTSE 100 companies,
the Big Four firms of accountants and the IASB and
FASB. The Committee invited (July 2011) companies and
investors to participate in a pilot project to test the
principles of integrated reporting. The pilot project
began in October 2011. The Committee also published
a discussion paper (September 2011) which considers
the rationale for integrated reporting and the
development of an international integrated reporting
framework.
The Committee published a draft outline of an
integrated reporting framework (July 2012), followed by
a prototype framework for integrated reporting
123
Corporate social responsibility
Corporate social responsibility (continued)
(October 2012). It intends to publish a consultation
draft of the framework in April 2013 and a final version
in December 2013.
The OECD Due Diligence Guidance for Responsible
Supply Chains of Minerals from Conflict-Affected and
High-Risk Areas (May 2012) provides step-by-step
management recommendations endorsed by
governments for global responsible supply chains of
minerals in order to encourage companies to respect
human rights and avoid contributing to conflict through
their mineral or metal purchasing decisions and
practices. A supplement on gold was published in July
2012.
The EC announced (February 2012) that human rights
guidance will be developed for the sectors of
employment and recruitment agencies, information and
communication technology, and oil and gas. The
guidance will be based on the UN Guiding Principles on
Business and Human Rights and is expected to be
completed by April 2013. Further information about this
process is available on the website of the Institute for
Human Rights and Business.
The EC published a guide to human rights for SMEs
(December 2012), based on the UN Guiding Principles
on Business and Human Rights. This may be of interest
to all companies, as it identifies a number of business
situations that may have a negative impact on human
124
Corporate social responsibility
Corporate social responsibility (continued)
rights.
Following on from its resolution on CSR (March 2007),
the European Parliament adopted two further
resolutions (February 2013) urging the EC to take a
wide range of actions to promote corporate social
responsibility in business.
125
Accounting standards
IFRS
The IAS Regulation (July 2002) requires UK publicly
The IAS Regulation (July 2002) requires “publicly traded
Domestic public companies must prepare their accounts
traded companies to prepare consolidated accounts on
companies” (i.e. companies governed by the law of a
on the basis of US GAAP, while non-US public
the basis of IFRS adopted by the EU for financial years
Member State whose securities are admitted to trading
companies may prepare their financial statements in
commencing on or after 1 January 2005.
on an EU-regulated market) to prepare their
accordance with US GAAP, IFRS as adopted by the IASB
consolidated accounts on the basis of IFRS adopted by
or local GAAP with a reconciliation to US GAAP.
CA 06 implements certain options in the IAS Regulation
and permits (i) UK publicly traded companies to use
IFRS in their individual accounts and (ii) other UK
the EU for financial years commencing on or after 1
January 2005.
Since 2002, the FASB and the IASB have undertaken a
formal process to converge US GAAP and IFRS. A joint
companies and limited liability partnerships to use IFRS
To apply for the purposes of the IAS Regulation,
memorandum of understanding (September 2002)
in their individual and consolidated accounts.
individual standards must be endorsed by the
announced the FASB’s and IASB’s intention to
Accounting Regulatory Committee and adopted by the
collaborate on the development of common, high-
EC. A consolidated text of IFRS adopted and applicable
quality standards with the ultimate goal of a single set
BIS updated (June 2008) its guidance on CA 06 and the
IAS Regulation.
in the EU (December 2008) is set out in Regulation
of high-quality global accounting standards. This was
The ICAEW published a report for the EC on the first
1126/2008. Details of IFRS adopted since that date or
followed by an updated MOU (February 2006) and a
year of implementation across the EU of IFRS (October
which are in the process of adoption are set out on the
progress report (September 2008).
2007) and an assessment for the United Nations of the
EC website.
UK’s experience in implementing IFRS (November 2008).
The SEC adopted rules (December 2007) that allow
The EC and the Accounting Regulatory Committee
foreign private issuers (see Glossary) to make filings
Financial statements prepared in accordance with IFRS
approved (November 2005) standard wording for
with the SEC using financial statements prepared in
must achieve a “fair presentation” rather than give a
compliance with IFRS to be used in notes to the
accordance with IFRS, as issued by the IASB, and
true and fair view. However, the true and fair view is
accounts and in the audit report: “in accordance with
without reconciliation to US GAAP.
still considered central to the preparation of financial
International Financial Reporting Standards as adopted
statements in the UK, whether prepared under IFRS or
by the EU” or “in accordance with IFRSs as adopted by
UK GAAP, and the requirement to present fairly is not a
the EU”.
different requirement from that of showing a true and
fair view but is a different articulation of the same
concept. See the opinion of Martin Moore QC (April
2008), commissioned by the FRC.
Section 393 CA 06 prohibits directors from approving
Following calls from the leaders of the G20, the FASB
and IASB committed (November 2009) to meet a June
2011 target date for convergence. However, this target
Of the standards adopted to date, only IAS 39
was not met. Since then, the IASB and FASB have
“Financial Instruments: Recognition and Measurement”
published (April 2012) a joint progress report describing
has not been adopted in full, because the EC declined
the progress made on outstanding projects, e.g. in
to adopt certain provisions relating to hedge
relation to financial instruments, impairment and hedge
accounting. This means that there is a small difference
accounting.
126
Accounting standards
accounts (including accounts prepared in accordance
between IAS 39 as issued by the IASB and the version
Following a concept release (2007), the SEC published a
with IFRS) unless they are satisfied that they give a true
which publicly traded companies are required by the
roadmap (November 2008) setting a target date of
and fair view of the assets, liabilities, financial position
IAS Regulation to use in their consolidated accounts.
2011 for the SEC to decide whether to require US
and profit or loss of the company.
The EC issued a statement (November 2005) clarifying
The FRC published a statement confirming that the true
that any IFRS adopted and published in the Official
and fair view remains of fundamental importance in
Journal by the date the accounts are signed (rather
both UK GAAP and IFRS (July 2011). This follows
than the end of the financial year) can be used in the
concerns raised in evidence to the House of Lords
preparation of the accounts for that financial year (as
Economic Affairs Committee enquiry into audit market
long as the standard does not prohibit early adoption).
concentration that IFRS leads auditors to place
conformity with IFRS before reliance on the true and
fair view. The FRC statement confirms that:
Third country (non-EU) issuers of securities admitted to
trading on an EU-regulated market are exempted from
preparing their financial statements, and from including
historical financial information in prospectuses, in
accordance with IFRS if the third country GAAP used is
127
issuers to adopt IFRS. However, in a statement
(February 2010), the SEC stepped back from a
commitment to make IFRS mandatory. Instead it stated
that its decision would be about “incorporating IFRS
into the financial reporting system for US issuers”. It
also stated that the earliest date that US issuers would
report under any new system would be 2015 or 2016.
The SEC issued (August 2010) two releases for public
comment on topics related to its consideration of
Accounting standards
IFRS (continued)
-
the introduction of IFRS did not change the
requirement for accounts to show a true and fair
view
-
Regulation (EC) No 1569/2007 as amended by
Commission Delegated Regulation EU 310/2012
incorporating IFRS into the financial reporting system
for US issuers. The first release focused on matters
concerning issuers and the second release considered
the preparedness of investors.
prudence continues to underlie the preparation of
established a mechanism for the determination of
accounts under both UK GAAP and IFRS even
equivalence. Among other things, the EC must consult
The SEC hosted a roundtable (July 2011) involving
though the IFRS conceptual framework replaced
ESMA (formerly CESR) before making a determination.
investors, smaller public companies and regulators.
prudence with neutrality
-
considered by the EC to be equivalent to IFRS.
ESMA provided advice to the EC on the equivalence of
the true and fair override still applies where
US, Japanese and Chinese GAAP (March 2008),
directors and auditors do not believe that following
Canadian and South Korean GAAP (May 2008) and
a particular accounting policy will give a true and
Indian GAAP (November 2008). It also published two
fair view. In such circumstances, the directors are
supplementary reports on the programmes of Canada,
legally required to adopt a more appropriate policy,
India and South Korea to converge with or adopt IFRS,
even if this requires a departure from the standard.
on the level of application of Chinese accounting
The FRC updated its bulletin on auditors’ reports
(October 2012) containing updated examples of
auditors’ reports for audits of financial statements,
including for companies that prepare accounts in
accordance with IFRS. The wording reflects the
formulation for IFRS compliance approved by the EC
and the Accounting Regulatory Committee.
The Companies and Limited Liability Partnerships
(Accounts and Audit Exemptions and Change of
Accounting Framework) Regulations 2012 permit
companies that prepare their individual accounts under
EU-adopted IFRS to change their accounting framework
to UK GAAP. Companies are permitted to make the
change once every five years. The Regulations apply for
standards by Chinese issuers and on the use of third
Some criticised the change to IFRS as too costly,
particularly with regard to smaller companies. It was
also suggested that implementation of IFRS, which,
unlike US GAAP, favours broad principles over detailed
rules, could possibly be too confusing and difficult for
US accountants, who previously have had detailed
interpretive guidance regarding the enactment of new
rules.
country GAAP on EU markets (June 2009 and
The SEC’s Office of the Chief Accountant published (July
November 2010). ESMA’s advice and reports are
2012) its final staff report on the work plan related to
available from the Equivalence/IFRS and GAAP section
global accounting standards. This did not make any
of its website (under the Co-operation and
recommendations to the SEC regarding the
Convergence tab).
incorporation of IFRS into the US financial reporting
The EC adopted a Decision (December 2008) which
determined that the GAAPs of the US and Japan were
equivalent to IFRS. It also accepted financial statements
using the GAAPs of China, Canada, South Korea and
India on a transitional basis. The EC adopted a further
Decision (April 2012) declaring the GAAPs of China,
Canada and South Korea as equivalent and prolonging
the transitional period during which Indian issuers may
128
system or how this could be done but merely
summarised the work plan so far. Former SEC Chairman
Mary Schapiro also stated (July 2012) that the SEC did
not have a timeline for deciding whether to require US
issuers to adopt IFRS.
Accounting standards
IFRS (continued)
accounting years ending on or after 1 October 2012.
The FRC, the European Financial Reporting Advisory
Group and the Autorité des Normes Comptables
continue to prepare their financial statements and
provide historical financial information in third country
GAAP to 31 December 2014.
published a discussion paper (July 2012) on the key
The IASB published an IFRS designed for use by SMEs
principles for a disclosure framework for notes to
(July 2009). Many of the principles in full IFRS have
financial statements. These include objectives-based
been simplified, topics not relevant to SMEs have been
requirements that require greater judgement and
omitted, and the number of required disclosures has
consideration of an entity’s circumstances rather than
been significantly reduced. Revisions to the IFRS for
lengthy boilerplate disclosures and strengthening the
SMEs will be limited to once every three years. The IFRS
application of materiality. The discussion paper is
for SMEs is separate from full IFRS and available for any
intended to support the work of the IASB in developing
jurisdiction to adopt, whether or not it has adopted full
a disclosure framework. It follows concerns that the
IFRS. It is also for each jurisdiction to determine which
ever-increasing length of notes to the financial
entities should use the standard.
statements mean that they no longer serve their
purpose of helping investors and creditors understand
the numbers in the financial statements.
The FRC published a discussion paper, “Thinking about
disclosures in a broader context: a road map for a
disclosure framework” (October 2012). This aims to
improve the quality of information disclosed in annual
reports as a whole, not just in the financial statements,
and to curtail a piecemeal approach to reporting.
Among other things, the FRC seeks views on common
Question and answer guidance on IFRS for SMEs (June
2011) is available from the IFRS for SMEs page on the
IASB website.
The EC indicated (October 2011) that it will not require
the use of IFRS for SMEs at EU level. However, Member
States may still adopt IFRS for SMEs for some or all of
their unlisted companies, provided that they comply
with European legal requirements and modify IFRS for
SMEs where it departs from those requirements.
themes for the information users may need and
The IASB published a consultation (July 2011) on its
principles for good communication and calls for the
work plan for the next three years, followed by a
development of placement criteria and guidance on
feedback statement (December 2012). There was almost
materiality to reduce duplication and cut clutter.
unanimous support for the IASB to prioritise work on
the conceptual framework underlying the preparation
129
Accounting standards
IFRS (continued)
The Financial Reporting Lab is considering a project on
and presentation of IFRS-compliant reports. A
accounting policy disclosure, integrating accounting
discussion paper is expected in the second quarter of
policies with the notes to which they relate.
2013.
The ICAEW published (January 2013) a report on the
The ICGN published (2010) a position paper setting out
future of IFRS. This summarises the benefits of a global
what investors want from financial reporting.
set of standards, assesses what has been achieved to
date and seeks to encourage a debate on the steps
required to safeguard the success of international
accounting standards.
The FRC, along with EFRAG and the national standard
setters of France, Germany and Italy, published
(February 2013) a strategy on the IASB’s revision of its
conceptual framework. The collaboration between
standard setters is intended to ensure that the revised
conceptual framework is conducive to robust and
effective accounting standards in Europe. The document
illustrates some of the major issues that may arise, such
as whether adequate emphasis is given to prudence
and reliability, explains the strategy for engaging with
the IASB and encourages others within Europe to
engage with the development of the new framework.
The Institute of Chartered Accountants in Scotland and
the New Zealand Institute of Chartered Accountants
published (July 2011) recommendations to reduce
disclosures in financial statements following a study
commissioned by IASB.
ESMA published a consultation (November 2011) on
the application of materiality in financial reports
produced using IFRS, followed by a summary of
responses (August 2012) and a feedback statement
(February 2013). ESMA intends to provide the IASB and
IAASB with the outcome of the consultation and
encourage them to address aspects of materiality that
are seen to be problematic in practice, e.g. the diverse
application of the concept of materiality and the length
of disclosures.
The IFRS Foundation published proposals (November
2012) to create an advisory group to the IASB
consisting of national accounting standard setters and
regional bodies. The aim is to create a more effective
dialogue between the IASB and standard setters now
that more than 100 countries permit or require the use
of IFRS.
130
Accounting standards
Domestic accounting standards
Companies not required to prepare their accounts on
Domestic public companies must prepare their accounts
the basis of IFRS, or which choose not to do so (see
on the basis of US GAAP, while non-US public
IFRS above), continue for now to prepare their accounts
companies may prepare their financial statements in US
in accordance with UK GAAP.
GAAP, IFRS as adopted by the IASB or local GAAP with
a reconciliation to US GAAP.
The Statutory Auditors (Amendment of Companies Act
2006 and Delegation of Functions etc) Order 2012
The process for incorporating IFRS into the US financial
prescribes the FRC as the body responsible for issuing
reporting system appears to have stalled. The target
accounting standards for the purposes of Section 464
date for the SEC to decide whether to require US
of CA 06 with effect from 2 July 2012. The FRC took
issuers to adopt IFRS (as set out in the SEC’s roadmap
over the role from the ASB, following the restructuring
(November 2008)) was not met and the SEC does not
of the FRC.
currently have a timeline for making the decision. See
IFRS above.
The FRC is in the process of finalising proposals for the
replacement of UK GAAP. It published (November 2012)
FRS 100 and 101 and is expected to publish FRS 102 in
early 2013. The standards will apply from 1 January
2015, with earlier adoption permitted.
FRS 100 sets out the overall financial reporting
framework and FRS 101 sets out reduced disclosures for
subsidiaries and other qualifying entities, allowing them
to apply the measurement and recognition
requirements of EU-adopted IFRS, without complying
with the full disclosure framework.
FRS 102 is expected to set out substantive rules based
on the IFRS for SMEs, but with certain accounting
treatments currently permitted under UK accounting
standards being retained.
131
Accounting standards
Companies that are not eligible to apply the Financial
Reporting Statement for Smaller Entities (FRSSE) (or that
are eligible but choose not to apply it) may prepare
their accounts using FRS 102, EU-adopted IFRS or, if
they are a subsidiary or other qualifying entity, the
reduced disclosure framework set out in FRS 101.
The newly published FRSs have been developed from
the exposure drafts (FREDs 46, 47 and 48) on which the
FRC consulted in January 2012.
The Accounting Standards (Prescribed Bodies) (United
States of America and Japan) Regulations 2012 permit
132
Accounting standards
Domestic accounting standards (continued)
companies listed on stock exchanges in the US and
Japan but not in an EU Member State to continue using
their local GAAP for a transitional period if they relocate
to the UK. This applies until 31 December 2015.
133
Accounting standards
Enforcement
CA 06 provides for a system of administrative
CESR issued Standard No. 1 on Financial Information,
Federal securities laws authorise the SEC to investigate
enforcement where the Secretary of State can apply to
“Enforcement of standards on financial information in
any person or entity suspected of violating federal
the court for a declaration that the report and accounts
Europe” (March 2003). It is based on general principles
securities laws or SEC Rules. In addition, the federal
do not comply with statutory requirements or for an
with a view to harmonising institutional oversight
securities laws grant express private rights of action for
order requiring directors to produce revised accounts.
systems in Europe. It issued Standard No. 2 on Financial
some specific types of violations. The SEC has authority
The Secretary of State has power to authorise others to
Information, “Co-ordination of enforcement activities”
to issue cease-and-desist orders and to seek injunctive
apply to the court.
(April 2004), setting out key principles for a co-
orders in a federal district court against persons for
ordination mechanism for enforcement, followed by
violations of the securities laws, including violations of
implementation guidance (October 2004). These
the fraud provisions. In addition, the SEC may seek
documents are available from the IFRS Enforcement
monetary penalties in federal district court from
section of the ESMA website (under the Investment and
persons who have violated a cease-and-desist order or
Reporting tab).
federal securities laws. The court decides the penalty
The Prescribed Body Order 2012 authorises the
Conduct Committee of the FRC for these purposes. The
Conduct Committee assumed this role from the FRRP
(July 2012), following the restructuring of the FRC.
C(AICE)A enables the Secretary of State to make an
order appointing a body to keep under review periodic
accounts and reports that are produced by issuers of
listed securities and inform the FSA of any conclusions.
The Prescribed Body Order 2012 appoints the Conduct
Committee for these purposes in relation to annual and
As proposed in Standard No. 2 (April 2004), ESMA has
developed a database of enforcement decisions. In
Under SOX, the SEC has the power to enforce the
response to public comment on the standard, ESMA
following:
publishes extracts of the database from time to time on
the IFRS Enforcement section of its website.
half-yearly reports published under DTR 4. The Conduct
IOSCO announced (October 2005) that it was
Committee’s jurisdiction under the Order extends to
establishing arrangements for regulators to share
companies that are not UK-incorporated if the UK is
decisions on the application of IFRS. IOSCO catalogues
their “home state” for the purposes of TOD.
the decisions on a database in order to maximise co-
The FRC published the FRRP’s 2012 annual report
based on the facts and circumstances of each case.
ordination and convergence.
(September 2012). The FRRP noted a significant
The Fourth and Seventh Amendment Directive confirms
improvement in the reporting of principal risks and
the collective responsibility of board members towards
uncertainties and considered that the reporting of
the company for the financial and other key information
mitigating actions had been done well. See Risk
that they publish in their annual report and accounts.
management and control above. It also welcomed signs
The Directive applies to all EU-incorporated companies.
134
-
periodic reports, including financial statements, for
SEC-reporting companies every three years (SOX §
408)
-
SEC enforcement initiatives for the five years
preceding SOX (SOX § 704)
-
the requirement for CEOs and CFOs to certify that
the financial information included in periodic
reports fairly presents in all material respects the
financial condition and results of operations of the
company. There are two overlapping certification
requirements with civil and criminal penalties (SOX
Accounting standards
of a greater focus on key messages and material
TOD requires directors of issuers of securities traded on
disclosures, with some companies eliminating
an EU-regulated market to give a responsibility
unnecessary content and making changes to the order
statement for information contained in the annual and
of content of the annual reports.
half-yearly reports they publish in the EU.
Following the restructuring of the FRC, the Conduct
For both the Fourth and Seventh Amendment Directive
Committee published (July 2012) operating procedures
and TOD, Member States are required to apply their
setting out its policy on reviewing reports and accounts.
liability regimes to the givers of such statements.
These are substantially similar to those of the FRRP and
include the following changes made by the FRRP in
April 2012:
-
§§ 302 and 906) (SEC Rules adopted August 2002)
-
public company and tampering with records
(SOX §§ 802, 807 and 1102)
-
breach of EU financial services rules, the TOD
to allow the FRC to make an announcement where
Amendment Directive also seeks to ensure that
a company makes a significant change to its
competent authorities have uniformly tough sanctioning
corporate
powers, providing for
135
the prohibition on officers and directors taking any
action that improperly or fraudulently influences or
misleads auditors (SOX § 303) (SEC Rules adopted
Consistent with the EC’s Communication (December
2010), which called for more dissuasive sanctions for
criminal sanctions for securities fraud involving a
May 2003)
-
the requirement for CEOs and CFOs to forfeit
equity-based compensation and trading profits if
their company has had to restate financial
statements as a
Accounting standards
Enforcement (continued)
reporting following an FRC intervention
-
to allow the FRC to release an announcement
where the existence of an FRC enquiry has become
public other than as a result of an FRC press notice
(e.g. where a complainant has published an
approach made to the FRC).
There is currently no formal regulatory monitoring of
the quality of the explanations companies provide when
explaining departures from the UK Corporate
Governance Code and the FRC believes that it is for
shareholders to judge whether corporate governance in
a particular company is satisfactory.
sanctions of up to 10% of consolidated annual turnover
result of misconduct (SOX § 304). In several cases,
for companies and up to €5 million for individuals for
the SEC has successfully pursued compensation
breach of the periodic reporting and certain other
clawbacks under § 304 despite the lack of any
obligations of TOD. Competent authorities will be
allegation of wrongdoing on the part of the CFO or
required to publish the sanctions that are applied. A
CEO. The SEC has indicated that it believes that
similar sanctions framework is proposed in CRD IV and
misconduct by anyone at the company resulting in
the MiFID Amendment Directive.
a restatement is a sufficient basis to pursue
regulatory framework applicable to auditors and
The SEC issued (January 2006) a statement concerning
enforcement matters. It included common criteria for
financial penalties in which it articulated the points it
public oversight systems, proposed a model of co-
considers in assessing penalties against issuers:
operation between Member States and established
procedures for the exchange of information between
The FRC announced (January 2013) that its monitoring
oversight bodies of Member States in investigations. It
activity in 2013/14 will focus on the support services,
also allowed for reciprocal co-operation with third
retail, natural resources/extractive industries and
countries.
construction sectors.
clawbacks from the CEO and CFO under § 304.
The Statutory Audit Directive sought to strengthen the
-
the presence or absence of a benefit to the
corporation
-
the degree to which the penalty will recompense or
harm the shareholders.
Article 63 of the directive forming part of CRD IV (July
Other factors include deterrence, level of injury to
2011) proposes a duty for the statutory auditor to
innocent parties, pervasiveness of the violation, the
report to the competent authorities any fact or decision
level of intent and the difficulty of detection.
which is liable to constitute a material breach of law,
Although the Dodd-Frank Act (July 2010) did little to
regulation or administrative provision relating to the
affect private rights of action, it does expand SEC
authorisation of a financial institution it audits or which
enforcement authority in several areas, including the
could affect the continuous functioning of the
liability of control persons (e.g. whereby a “controlling”
institution or lead to a refusal to certify the accounts or
director or officer could be held liable for the acts of
to the expression of a reservation.
the “controlled” company) and aiding and abetting
ESMA published (June 2012) an activity report on IFRS
liability. The SEC will be provided with increasingly
enforcement in the European Economic Area in 2011.
larger budgets over the next few years and is
136
Accounting standards
Enforcement (continued)
Whilst the quality of IFRS financial statements is
improving, more needs to be done by some issuers in
areas such as disclosures related to fair value, the
hierarchy of financial instruments, disclosures of
assumptions used as part of impairment tests,
presentation of risk factors and uncertainties with an
impact on going concern assumptions and issues
related to consolidation.
ESMA published a list of enforcement priorities
(November 2012) to be used by EU national competent
authorities in their assessment of listed companies’
2012 financial statements. These relate to financial
assets, impairment of financial assets, defined benefit
obligations and provisions, contingent liabilities and
contingent assets.
137
expanding its enforcement resources.
Auditors
Regulation of auditors and accountants
The powers of the Secretary of State in Part 42 of CA 06
IOSCO published “Principles for Auditor Oversight”
As mandated by SOX, the PCAOB was established by
to oversee the regulation of statutory auditors by
(October 2002), setting out principles of oversight for
the SEC (April 2003) to register, inspect, investigate and
professional accountancy bodies were delegated to the
auditors of listed companies. It published a survey on
discipline public accounting firms that prepare audit
FRC by the Statutory Auditors (Amendment of
the regulation and oversight of auditors in 59
reports for companies. The PCAOB is responsible for
Companies Act 2006 and Delegation of Functions etc)
jurisdictions (April 2005).
establishing audit, quality control and ethics standards
Order 2012 (SI 2012/1741). Before the restructuring of
the FRC in July 2012, the powers of the Secretary of
State were exercised by the POB. The Order provides
The Statutory Audit Directive:
-
systems at Member State level
that directions issued by the POB remain in force as if
issued by the FRC.
established common criteria for public oversight
-
established an audit regulatory committee of
The professional accountancy bodies have the primary
Member State representatives at EU level to
direct responsibility for the supervision of their
implement the detailed measures of the Directive
members acting in their professional capacity. However,
and allow for continuous monitoring
Part 42 of CA 06 requires the audits of major public
-
created a co-operative model between regulatory
for registered accounting firms (SOX §§ 101 et seq.).
Only accounting firms that are registered with the
PCAOB can participate in audits of, or issue audit
reports on, companies (whether US or non-US
companies) that are registered with the SEC.
The PCAOB has promulgated a number of standards,
including:
-
Auditing Standard No. 3 Audit Documentation
-
Auditing Standard No. 4 Reporting on Whether a
interest entities (see Glossary) and the disciplining of
authorities of Member States on the basis of “home
statutory auditors in relation to major public interest
country control” (i.e. audit firms are principally
Previously Reported Material Weakness Continues
cases to be carried out independently. The FRC’s Audit
regulated by authorities in the Member State where
to Exist
Quality Team carries out the monitoring role (see Audit
they are established). This model of co-operation
quality below) and the Conduct Committee of the FRC
was also extended to third countries on the basis of
carries out the disciplinary role.
reciprocity
The FRC published a consultation (June 2012) proposing
-
required audit firms that audit public interest
entities (see Glossary) to publish annual
The aim was to enable the FRC to make its own rules
transparency reports on their websites within three
for disciplinary arrangements in relation to accountants,
months of financial year-end
professional accountancy bodies. The proposals were
finalised and the Accountancy Scheme became effective
-
Auditing Standard No. 5 An Audit of Internal
Control Over Financial Reporting that is Integrated
with an Audit of Financial Statements
changes to the disciplinary schemes for accountants.
without needing to obtain the agreement of the
-
contained rules on the registration and oversight of
auditors and audit firms from non-EU countries who
issue audit reports in relation to the accounts of
138
-
Rules 3501, 3502, and 3520 to 3524: Ethics and
Independence Rules.
The Dodd-Frank Act allowed the PCAOB to share
information with foreign auditors’ oversight authorities.
This removed an obstacle to the exchange of audit
working papers between EU and US competent
Auditors
(October 2012).
Amendments to CA 06 took effect on 2 July 2012 and
require supervisory bodies to participate in
on the adequacy of US supervisory authorities
auditors”). There is an exemption if the country
(September 2010).
equivalent systems of registration and oversight
failing to comply with the relevant supervisory body’s
procedure to implement these changes.
regulated market in the EU (“third country
the audit firms from third countries are subject to
against audit firms and/or independent auditors for
consultation (December 2012) on the sanctions
authorities and enabled the EC to publish its decision
concerned offers reciprocity to EU auditors and if
arrangements enabling the FRC to determine sanctions
rules relevant to statutory audit. The FRC published a
non-EU companies whose securities are traded on a
-
The PCAOB has published (October 2011) proposed
changes to its standards which would require the name
of the engagement partner to be disclosed in the audit
permitted the use of ISAs as adopted by the EC for
report. It would also require disclosure of other
EU statutory audits.
accounting firms and other persons not employed by
The EC established (December 2005) the European
the auditor that took part in the audit.
The POB’s last annual report to the Secretary of State
Group of Auditors’ Oversight Bodies to ensure the
The PCAOB adopted Auditing Standard No. 16,
(June 2012) related to the year to 31 March 2012. It
efficient co-ordination of new public oversight systems
Communications with Audit Committees (August 2012),
suggested that some aspects of the monitoring process
of statutory
which the SEC approved (December 2012). The new
secure improvements in audit quality. Following the
auditors and audit firms within the EU. The Group also
standard primarily retains or enhances existing audit
restructuring of the FRC, next year’s report will be
provides technical input into the preparation of
committee communication requirements and is effective
issued by the FRC’s Conduct Committee.
measures to implement the Statutory Audit Directive,
for audits of financial statements with fiscal years
such as endorsement of ISAs or assessment of third
beginning on or after 15 December 2012. The standard
countries’ public oversight systems.
also applies to audits of emerging growth companies
by professional accountancy bodies should be modified
to
Regulation of auditors and accountants
(continued)
The Statutory Auditors and Third Country Auditors
Regulations 2007 amended Part 42 of CA 06 to put in
and foreign private issuers (see Glossary).
place, as required by the Statutory Audit Directive, a
The EC published a consultation (January 2007) on
system of registration and regulation of third country
measures to implement the provisions of the Statutory
Auditing Standard No. 16 requires the communications
auditors of non-EU companies listed in the UK.
Audit Directive regarding the regulation and oversight
with the audit committee to occur before the issuance
of third country auditors.
of the audit report. The standard requires auditors to
The powers of the Secretary of State to regulate third
country auditors have been delegated to the FRC by
The EC adopted a decision (January 2011) declaring the
The Statutory Auditors (Amendment of Companies Act
audit oversight regimes of 10 non-EU countries
139
communicate, among other matters, the following to
audit committees:
Auditors
Regulation of auditors and accountants
(continued)
2006 and Delegation of Functions etc) Order 2012 (SI
equivalent to those of the EU. This allows EU national
2012/1741) (effective July 2012). Before that time, the
audit oversight bodies to rely on the inspections of third
management in connection with the appointment or
powers were exercised by the POB.
country auditors carried out in Australia, Canada, China,
retention of the auditor, including significant
Croatia, Japan, Singapore, South Africa, South Korea,
discussions regarding the application of accounting
Switzerland and the US. In addition, auditors from 20
principles and auditing standards
The POB published (November 2008) detailed
arrangements implementing the requirements of the
Statutory Audit Directive in relation to regulation of
third country auditors in the UK.
other non-EU jurisdictions were granted transitional
relief for financial years commencing in the period from
-
-
any significant issues that the auditor discussed with
certain matters regarding the company’s accounting
policies, practices and estimates (consistent with
2 July 2010 to 31 July 2012. During this period, auditors
Rule 2-07 of Regulation S-X)
POB published a consultation (March 2012) Monitoring
of those jurisdictions are allowed to perform audit
the work of third country auditors in which it sought
activities in the EU without EU oversight and without
views on the system of external monitoring that should
registering with EU competent authorities, provided that
apply to third country auditors. The aim was to carry
they comply with minimum information requirements
out reviews of third country audits and audit firms in a
necessary for maintaining adequate investor protection
way that was effective but did not impose
transactions, including the business rationale for
levels in Europe.
such transactions
-
the auditor’s evaluation of the quality of the
company’s financial reporting
-
disproportionate costs and regulatory burdens. The POB
-
information related to significant unusual
an overview of the overall audit strategy, including
concluded that this was difficult to achieve under
The Statutory Audit Directive only allows third countries
current EU requirements and called for a simplification
access to EU auditors’ working papers if the competent
timing of the audit, significant risks the auditor
of the relevant provisions.
authorities in those countries meet requirements which
identified, and significant changes to the planned
the EC has declared adequate and there is a reciprocal
audit strategy or identified risks
The EC decisions (February 2010 and September 2010)
which permit the transfer of audit working papers to
agreement in place regarding the exchange of papers.
-
information about the nature and extent of
certain countries outside the EU were implemented by
The EC adopted (February 2010) a decision recognising
specialised skill or knowledge needed in the audit,
The Companies Act 2006 (Transfer of Audit Working
the adequacy of the auditor supervisory authorities in
the extent of the planned use of internal auditors,
Papers to Third Countries) Regulations 2010.
Canada, Japan and Switzerland. The EC adopted a
company personnel or other third parties, and other
further decision (September 2010) recognising the
independent public accounting firms, or other
adequacy of the auditor supervisory authorities of
persons not employed by the auditor that are
Australia and the US. This will enable the exchange of
involved in the audit
The Statutory Audit Directive requires, that in certain
circumstances, Member States should apply their system
for the external monitoring of audit work to third
country auditors and the relevant audit engagements.
audit working papers between the Member States’
140
-
difficult or contentious matters for which the
Auditors
Regulation of auditors and accountants
(continued)
This requirement applies for the most part where there
oversight authorities and their counterparts in the
is no equivalent system of audit regulation and external
jurisdictions covered by the decisions.
monitoring in the third country, and no plans to
introduce such a system.
The EC published an independent study on the
ownership rules that apply to audit firms and their
auditor consulted outside the engagement team
-
the auditor’s evaluation of going concern
-
expected departures from the auditor’s standard
report
The EC decision (January 2011) on the equivalence of
consequences on audit market concentration (October
the audit oversight regimes of 10 non-EU countries has
2007). The study noted that restrictions on access to
been implemented by The Statutory Auditors and Third
capital were one of the barriers into the market for
significant to the oversight of the company’s
Country Auditors (Amendment) Regulations 2011. This
large audits and suggested that a relaxation of
financial reporting process, including complaints or
allows the POB to disapply the requirement to monitor
ownership restrictions in the audit profession could help
concerns regarding accounting or auditing matters
the audits of issuers in equivalent countries on the basis
reduce market concentration. The EC published a
that have come to the auditor’s attention during the
of reciprocity.
consultation on ownership structures in audit firms
audit.
The AIU agreed a statement of protocol with the PCAOB
(January 2011). This was intended to facilitate effective
co-operation between the two organisations and pave
the way for joint work on inspections, including
exchanges of information and interviewing firm
personnel. However, in its consultation on the
monitoring of third country auditors (March 2012), the
POB noted that reciprocity had not yet fully been met in
relation to the US.
The FRC published (jointly with BIS) a study and a
discussion paper on choice in the UK audit market (April
and May 2006, respectively). It appointed a market
(November 2008) and a summary report of the
responses (July 2009). Lack of harmonisation of
regulatory requirements, especially independence rules
for auditors, professional qualification requirements and
the impossibility of providing cross-border services
without multiple registrations, were also seen as
important barriers. There was a need for action at EU
level but this would also need to take into account the
position outside the EU.
IOSCO published consultation papers (September 2009)
on:
-
the transparency of firms that audit public
participants’ group (October 2006) to provide advice
companies. This explores the potential effects of the
and identify and assess possible actions to mitigate the
enhanced transparency of audit firms and whether
risks arising from the concentrated nature of the UK
this will improve audit quality and the availability
141
-
other matters arising from the audit that are
Auditors
Regulation of auditors and accountants
(continued)
audit market. The group published a final report in
October 2007.
and delivery of audit services
-
the content of auditors’ reports. This outlines the
In response to the recommendations of the Market
history and shortcomings of auditors’ reports and
Participants’ Group:
suggests possible solutions
-
-
-
the Joint Audit Committee of the Institute of
-
non-professional ownership structures for audit
Chartered Accountants published new audit
firms. This examines the impact of audit firm
regulations and guidance on mechanisms to allow
ownership restrictions on the concentration in the
incoming auditors access to information held by
market for auditing large issuers and explores the
outgoing auditors (March 2008)
pros and cons of authorising other audit firm
ownership and governance models.
the Consultative Committee of Accountancy Bodies
published a voluntary code of practice on disclosure
The European Group of Auditors’ Oversight Bodies
of audit profitability which applies to audit periods
published a guidance paper (December 2009) setting
beginning on or after 6 April 2009 (March 2009)
out a common approach for co-operation between the
an ICAEW working group published an audit firm
governance code (January 2010) aimed at the eight
firms which audit more than 20 UK companies listed
competent authorities of Member States with respect to
audit firm and auditor oversight within the EU, as
required by the Statutory Audit Directive.
on the main market of the London Stock Exchange.
The Financial Institutions Green Paper on corporate
Firms are expected to state in their transparency
governance in financial institutions (June 2010)
reports how they apply the Code’s provisions and
considered the role of auditors of financial institutions
include a comply or explain statement.
and sought comments on the following questions:
On its website, the FRC notes that all but one of the
-
Market Participants’ Group’s recommendations had
been implemented by 2010 without any discernible
change to levels of market concentration. It concluded
that audit regulators did not have sufficient tools to
effect changes to market structure, and so welcomed
should co-operation between external auditors and
supervisory authorities be deepened?
-
should auditors be required to alert the board of
directors and the supervisory authorities of any
substantial risks they discover in the performance of
142
Auditors
Regulation of auditors and accountants
(continued)
the OFT’s decision to refer the audit market to the
Competition Commission. In the meantime, it is working
with the major audit firms to develop contingency plans
their duties?
-
financial information?
which can be activated in the event of a firm finding
itself in serious difficulty.
should auditors’ control be extended to risk-related
-
should auditors validate a greater range of
information which is relevant to shareholders than
The House of Lords Economic Affairs Committee
they do at present?
published a report, “Auditors: Market concentration and
their role” (March 2011), following an inquiry. This made
Following the Audit Green Paper (October 2010), the EC
a number of recommendations in relation to the
published (November 2011) a draft regulation on
regulation of auditors:
requirements for audits of public interest entities (see
-
the regulation of accounting and auditing should be
rationalised and reformed
-
the Government and regulators should promote the
introduction of living wills by auditors
-
Glossary) and a draft directive amending the Statutory
Audit Directive. Proposals affecting the regulation of
auditors include:
-
the elimination of the rule that requires the majority
of the capital of audit firms to be held by auditors
the Government should encourage the emergence
to encourage more entrants to join the audit
of a competitor to the Big Four if the Audit
market. However, the majority of members of the
Commission is abolished and make greater efforts
administrative or management body must be audit
to enable non-Big Four Firms to win public sector
firms or statutory auditors
work
-
the OFT should investigate the audit market
-
the OFT should conduct a market study of
restrictive bank covenants.
The OFT announced (October 2011) that it had formed
the view that competition might not be working well in
the market for statutory audit services to large
-
a requirement for competent authorities responsible
for the supervision of auditors to be independent of
audit firms
-
the assumption by ESMA of the supervisory
functions of the European Group of Auditor
Oversight Bodies. However, national auditor
supervision by competent authorities will continue
143
Auditors
Regulation of auditors and accountants
(continued)
companies in the UK and had referred the matter to the
-
the creation of a single market for statutory audits
Competition Commission for further investigation. This
by introducing a European passport for the audit
followed a round of public consultation, including
profession. This would allow an audit firm approved
meetings with interested parties to determine, among
in one Member State to provide services across the
other things, the potential overlap with parallel work
EU
ongoing at EU level. Although there is potential overlap
with parallel work going on at EU level, the OFT decided
-
recognising the aptitude of an audit firm to perform
to proceed with a referral because the nature, content
high-quality audits of listed companies
and timing of EU legislation was not settled and
because it believed that the Competition Commission
the introduction of a European certificate
-
mandating the use of ISAs.
could provide important inputs during the legislative
process and could address UK-specific competition
concerns that may not be within the scope of the EC’s
work.
The Competition Commission published a statement
(October 2011) inviting initial submissions by 11
November 2011. It published an issues statement and a
timetable (December 2011). The issues statement set
out some initial theories of what might be adversely
affecting competition in the market and what might be
adverse outcomes. Since that time, it has published a
framework for assessment and revised theories of harm
and a number of working papers to invite comments
and assist the inquiry group in developing its thinking
on key areas. Among these published working papers
was a paper (September 2012) on auditor clauses in
loan agreements (requiring borrowers to have their
144
Auditors
Regulation of auditors and accountants
(continued)
accounts audited by one of the Big Four).
The Competition Commission is required to report by
October 2013 and is expected to produce provisional
findings in February 2013 according to its revised
administrative timetable (January 2013).
145
Auditors
Audit quality
CA 06 contains a number of measures to improve the
The Statutory Audit Directive requires Member States to
Section 104 of SOX requires the PCAOB to conduct a
quality of audits:
ensure that statutory auditors and audit firms are
continuing programme of inspections of registered
subject to a system of quality assurance that is
public accounting firms. In those inspections, the PCAOB
independent from the statutory auditors and audit firms.
assesses compliance with SOX, the rules of the PCAOB,
The EC published (May 2008) a recommendation
the rules of the SEC and professional standards in
providing guidance on establishing an independent
connection with the firm’s performance of audits,
system as mandated by the Directive.
issuance of audit reports and related matters involving
-
the Secretary of State has the power to publish
regulations requiring publication of auditors’
engagement letters (Section 494)
-
the senior statutory partner on an audit is required
to sign the audit report (Section 504)
-
auditors of quoted companies (see Glossary) are
required to make a statement when they leave
office explaining the circumstances surrounding
their departure (Section 519)
-
The Statutory Audit Directive permitted the use of ISAs
as adopted by the EC for EU statutory audits.
The EC published a consultation on the adoption of
ISAs and a study on the potential costs and benefits
(June 2009). It published a summary of the results of the
shareholders of quoted companies (see Glossary)
consultation (March 2010). The overwhelming majority
may require website publication of matters relating
of respondents were in favour of the adoption of ISAs.
to the audit or in connection with an auditor
issuers. SOX requires the PCAOB to conduct inspections
annually for firms that provide audit reports for more
than 100 issuers, and at least triennially for firms that
provide audit reports for fewer issuers.
SOX requires the PCAOB to prepare a written report
concerning each inspection. Pursuant to SOX and the
rules of the PCAOB, the PCAOB provides a copy of each
report, in appropriate detail, to the SEC and to certain
IOSCO published a consultation paper (September 2009)
state regulatory authorities. The PCAOB also makes
on the content of auditors’ reports. This outlines the
The FRC’s Audit Quality Review team monitors the
portions of those reports available to the public, subject
history and shortcomings of auditors’ reports and
quality of the audits of listed and other major public
to restrictions in SOX that prohibit, or require a delay in,
suggests possible solutions.
the public disclosure of certain information.
The IAASB published a discussion paper, “The Evolving
In July 2009, the PCAOB issued a concept release to
Nature of Financial Reporting: Disclosure and Its Audit
consider the effects of a potential requirement for the
Implications” (January 2011). This highlights trends in
engagement partner (in addition to the audit firm) to
financial reports, and explores issues and practical
sign the audit report.
ceasing to hold office (Section 527).
interest entities (see Glossary) pursuant to powers set
out in Schedule 10 of CA 06. Before the restructuring of
the FRC (July 2012), the role was carried out by the POB.
A list of such entities is published annually and is
available on the FRC website.
The POB published the Audit Quality Framework
(February 2008), to assist audit committees, companies
and auditors to recognise the critical elements of highquality audits.
challenges in preparing, auditing and using them.
The PCAOB issued a concept release (June 2011)
The IAASB published a consultation paper, “Enhancing
detailing alternatives for changing the auditor’s
the Value of Auditor Reporting: Exploring Options for
reporting model. The alternatives include:
Change” (May 2011). It seeks views on the usefulness of
146
Auditors
The POB published (April 2008) the Statutory Auditors
auditor reporting, describes issues such as the gap
(Transparency) Instrument 2008, requiring auditors of
between what an audit is and what users expect it to be
public interest entities (see Glossary) to publish on their
and sets out possible changes to the way auditors
websites annual transparency reports. Among other
report on financial statements.
things, auditors of such entities must provide
information about themselves, their quality control
systems and their independence procedures and
practices.
In its report to the Secretary of State for the year to
March 2012 (June 2012), POB states that the quality of
transparency reports produced by the largest audit firms
has continued to improve. Those of the smaller audit
-
an auditor’s discussion and analysis
-
required and expanded use of emphasis paragraphs
-
auditor assurance on other information outside the
financial statements
Following the Audit Green Paper (October 2010), the EC
published (November 2011) a draft regulation on
requirements for audits of public interest entities (see
-
clarification of language in the standard auditor's
report.
Glossary) and a draft directive amending the Statutory
The concept release also seeks comments on
Audit Directive.
alternatives for amendments to, or the development of
Key proposals:
new, auditing standards that would supersede the
-
mandatory tendering of audit mandates for public
firms generally meet the statutory requirements but
tend to
147
PCAOB’s current standards on the auditors’ report.
Auditors
Audit quality (continued)
provide boilerplate disclosures.
In its 2011/12 annual report (June 2012), the AIU
reported a further reduction in the proportion of audits
requiring significant improvements. However, it noted
The PCAOB issued a practice alert (December 2012) on
tier firms more opportunities to bid for audit
maintaining and applying professional scepticism in
mandates, at least one of the firms invited to tender
audits to remind auditors of the importance of
must be a firm that received less than 15% of its
professional scepticism.
total audit fees from large public interest entities in
pressure on firms to increase audit efficiency and
the Member State the previous year
recommended that audit firms establish safeguards to
ensure audit quality, especially where significant fee
interest entities (see Glossary). In order to give mid-
-
the draft regulation sets out detailed procedures
reductions have been agreed. Also, it considered that
and selection criteria to be used in the tendering
the effect of changes in behaviour promoted by firms to
process
reinforce professional scepticism in their audit work had
yet to be reflected.
-
any contractual clause entered into between a
public interest entity (see Glossary) and a third party
The APB issued new ISAs to replace the versions issued
restricting the choice of auditor (e.g. to a Big Four
in 2004 and a paper summarising the main changes
firm) will be void
(October 2009). The new standards incorporate the
clarified ISAs issued by the IAASB, where necessary
-
to provide more information to all stakeholders,
augmented to address specific UK legal and regulatory
including more detail on going concern. Auditors
requirements. Compliance with the standards issued by
will also be required to provide a more detailed
the APB nevertheless enables the auditor to assert full
report on the audit to the audit committee and
compliance with the ISAs issued by the IAASB. The new
management
standards became effective for audits of financial
statements for periods ending on or after 15 December
2010.
the content of the audit report should be expanded
-
the rule that the majority of capital of audit firms
must be held by auditors is to be eliminated to
encourage more entrants to join the audit market.
The ICAEW Financial Services Faculty published a report,
However, the majority of members of the
“Audit of banks: lessons from the crisis” (June 2010)
administrative or management body must be audit
following a six-month research project. Among other
firms or statutory auditors.
things, it concluded that the audit report had become
too standardised and considered that more work
FEE published a policy statement (July 2012) on
148
Auditors
Audit quality (continued)
needed to be done to explain how auditing improves
improvements to audit reports. It called for ISAs to be
the quality of reported financial information. It
amended to require more information to be included in
recommended that:
the audit report on the auditor’s view on the use of the
-
auditors should have more involvement in reporting
on the front sections of the annual report, e.g. in
reporting on whether there are any material
omissions in the information provided there
-
the ICAEW should produce guidance for bank
auditors on good practice for reporting to audit
committees
-
going concern assumption by management and on the
entity’s audit approach used in relation to the audited
entity’s significant audit risks.
The IAASB published a consultation paper (January
2013) on an audit quality framework. Among other
things, it sought comments on the key factors that
contribute to audit quality.
banks should develop summary risk statements to
explain the big picture on risk and auditors should
develop assurance reports to accompany such
statements.
The FSA and the FRC published a discussion paper (June
2010) which considered ways of enhancing auditors’
contributions to prudential regulation. This followed a
review by the FSA into how effective auditors had been
in providing the FSA with comfort that the firms they
audited had complied with the FSA’s client assets
regime. This found certain weaknesses in some of the
client assets auditor reports received by the FSA and a
lack of understanding by some auditors of the relevant
FSA rules.
The FSA and FRC published a feedback statement
(March 2011) summarising the responses to their joint
discussion paper (June 2010) on enhancing the auditor’s
149
Auditors
Audit quality (continued)
contribution to prudential regulation. The feedback
statement notes recent actions, including:
-
the development by the FSA of a code of practice
providing guidance on the relationship between
auditors and supervisors of regulated firms. It
recognised that timely, relevant information sharing
was an essential part of an effective working
relationship, and it indicated a minimum level of
bilateral and trilateral meetings that should take
place for high impact firms. A final version of the
code of practice was published (May 2011)
-
increased dialogue between the FSA and auditors,
individually and collectively, to discuss key financial
reporting issues
-
increased use by the FSA of its powers to
commission reports from skilled persons under
Section 166 of FSMA
-
publication of a memorandum of understanding
relating to information sharing between the AIU and
the FSA (January 2011), which included a
commitment to meet at least four times a year.
The FSA confirmed in the feedback statement that it
would not be seeking enforcement powers, as originally
suggested, in light of improved co-ordination between
the AIU and FSA.
The FSA also published (March 2011) a policy statement
150
Auditors
Audit quality (continued)
setting out new requirements for firms holding client
assets and their auditors. This follows a consultation
paper (September 2010). The new rules:
-
confirm and clarify the standards required for
auditors’ client assets reports in order to provide
clear focus of accountability
-
increase the quality and consistency of information
provided in the report so the FSA can better use it
to undertake both firm and thematic reviews
-
improve firms’ governance oversight of their
auditors and their compliance with the client assets
rules.
The APB published (October 2011) guidance for auditors
providing client asset reports, in light of the FSA’s new
rules.
The APB published (August 2010) a discussion paper on
auditor scepticism and a feedback statement (March
2011). Responses suggested a wide range of views
about what the initial mindset should be.
The APB published a further paper (March 2012),
“Professional Scepticism: Establishing a common
understanding and reaffirming its central role in
delivering audit quality”. This concluded that the
immediate emphasis should be on encouraging auditors
and others to deliver a step change in behaviours that
will achieve consistency in the manner in which
151
Auditors
Audit quality (continued)
professional scepticism is exercised in the conduct of
their audits. The APB also intends to seek to influence
the IAASB to enhance the relevant international auditing
standards.
The Companies and Limited Liability Partnerships
(Accounts and Audit Exemptions and Change of
Accounting Framework) Regulations 2012 exempt
unlisted subsidiary companies outside the banking and
insurance sectors from mandatory audit if they fulfil
certain conditions with effect for accounting years
ending on or after 1 October 2012. The Regulations also
align mandatory audit thresholds for small companies
with the accounting thresholds for small companies with
effect from the same date.
The FRC published revisions to ISAs (September 2012)
to give effect to its effective company stewardship
project and to support changes (September 2012) to
the UK Corporate Governance Code and the FRC
Guidance on Audit Committees.
The FRC consulted (January 2013) on further revisions to
ISAs to implement Lord Sharman’s recommendations on
going concern assessments. It also consulted (February
2013) on revisions to the standard on audit reports (ISA
700) to make such reports more informative and less of
a binary pass/fail opinion.
The combined effect of these revisions is to require the
auditor to:
152
Auditors
Audit quality (continued)
-
communicate to the audit committee information
that the auditor believes the audit committee will
need to understand the significant professional
judgements made in the audit
-
report, by exception, if the board’s statement that
the annual report is fair, balanced and
understandable is inconsistent with the knowledge
acquired by the auditor in the course of performing
the audit, or if the matters disclosed in the report
from the audit committee do not appropriately
address matters communicated by the auditor to
the committee
-
consider the directors’ going concern statement and
the related disclosures by the audit committee
about the directors’ going concern assessment and
state in the audit report whether or not there is
anything it should add or draw attention to
-
describe in the audit report the risks of material
misstatement that the auditor identified and which
had the greatest effect on audit strategy and the
allocation of resources in the audit
-
explain how the auditor applied the concept of
materiality in planning and performing the audit
-
provide a summary of the audit scope, including an
explanation of how the scope was adapted to take
account of the risks of material misstatement, and
the auditor’s application of the concept of
153
Auditors
Audit quality (continued)
materiality.
The revisions will be effective for audits of financial
statements for periods commencing on or after 1
October 2012.
The FRC and the Institute of Chartered Accountants of
Scotland announced (November 2012) that they have
commissioned a project to investigate the competencies
and professional skills of auditors. This will explore the
mix of attributes, competencies, professional skills and
qualities that need to be combined in an audit team
and consider whether there is a need to reconsider the
staffing model for the audit of complex businesses. A
report is to be delivered by 30 September 2013.
154
Auditors
Non-audit services
The UK Corporate Governance Code contains a
The EC Recommendation on Auditor Independence
Pursuant to SOX § 201, eight specified types of non-
Provision (C3.8) that the annual report should explain to
(May 2002) adopted a principles-based approach
audit services are completely prohibited:
shareholders how, if the auditor provides non-audit
(whereby auditors cannot provide non-audit services
services, auditor objectivity and independence are
that would compromise their independence or be
safeguarded. Further guidance is given in the FRC
involved in management decisions) and set out specific
Guidance on Audit Committees.
instances where provision of non-audit services caused
Auditors’ ethical guidance in relation to non-audit
services is set out in ES/5, one of five Ethical Standards
for auditors published by the Audit and Assurance team
too high a risk to an auditor’s independence. It also
recommended full disclosure, at least annually, of fees
for audit and non-audit services.
within the Codes and Standards Division of the FRC
The Statutory Audit Directive followed the basic
(which assumed the functions of the APB following the
principles laid down in the EC Recommendation but set
restructuring of the FRC). It is based on a threats and
out additional measures, such as requiring the auditor
safeguards approach and provides guidance on non-
to document in the audit working papers significant
audit services which may create threats to an auditor’s
threats to its independence and safeguards to mitigate
objectivity or perceived loss of independence. The non-
those threats.
audit services covered include internal audit, IT services,
valuation, tax, litigation support, remuneration and
recruitment and corporate finance services. ES/5 also
sets out a number of situations where safeguards are
insufficient and where audit firms should not provide
non-audit services.
Following the Audit Green Paper (October 2010), the EC
published (November 2011) a draft regulation on
requirements for audits of public interest entities (see
-
bookkeeping
-
financial information systems design and
implementation
-
appraisal or valuation services or fairness opinions
-
actuarial services
-
internal audit outsourcing services
-
management functions or human resources
-
broker, dealer, investment adviser, or investment
banking services
-
legal and expert services unrelated to the audit
Non-audit services that are not prohibited must be preapproved by the audit committee pursuant to SOX §
301.
Glossary) and a draft directive amending the Statutory
The above rules have been implemented by SEC Rules
Audit Directive. The draft regulation includes a ban on
adopted January 2003.
large audit firms (essentially, the Big Four) providing
The ICAEW has adopted the Ethical Standards and
non-audit services and a requirement for them to
cross-refers to them in its Code of Ethics (updated
separate their audit activities into pure audit firms
January 2011). The latest update also reflects
(which must be outside a network which provides non-
amendments to the IESBA Code of Ethics for
audit services within the EU), in order to avoid conflicts
Professional Accountants.
of interest.
The APB published an Ethical Standard for Reporting
IOSCO published a statement, “Principles of Auditor
155
Auditors
Accountants (October 2006).
Many of the requirements of the Statutory Audit
Directive in relation to ethics, independence and audit
fees were substantially covered by the Ethical Standards
and audit regulations issued by Recognised Supervisory
Bodies, but required statutory underpinning. This was
Independence and the Role of Corporate Governance in
Monitoring an Auditor’s Independence” (October 2002),
recommending that the audit committee should
oversee policies governing circumstances in which
contracts for non-audit services could be entered into
with the company’s external auditors.
achieved by The Statutory Auditors and Third Country
IOSCO published a study of the regulation of non-audit
Auditors Regulations 2007 which amended Schedule 10
services in 40 countries (March 2007).
of CA 06.
The IESBA Code of Ethics for Professional Accountants
The APB published (December 2011) two amendments
(2012 edition) requires accountants to comply with a
to its Ethical Standards. These involve:
number of fundamental principles, including integrity,
-
amending the appendix in ES/1 to provide a
objectivity, professional competence and due care,
simplified illustrative template for communicating
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Auditors
Non-audit services (continued)
-
information on audit and non-audit services to
confidentiality and professional behaviour. It analyses
those charged with governance which reflects
potential threats to the principles under five headings:
amended UK regulations on auditor remuneration
self-interest, self-review, advocacy, familiarity and
disclosures
intimidation and requires auditors to apply safeguards
amending ES/5 to extend until 31 December 2014
the transitional arrangement for tax services
provided on a contingency fee basis where
contracts were entered into prior to 31 December
2010.
where a threat has been identified. For listed and
certain other public interest entities (meaning those
defined by regulation or legislation as such or for which
the audit is required by regulation or legislation to be
conducted in compliance with the same independence
requirements that apply to the audit of listed entities)
NAPF’s update of its Corporate Governance Policy and
there are new prohibitions on firms providing non-audit
Voting Guidelines (November 2012) states that non-
services, e.g. certain internal audit services, valuation
audit fees should be capped at 100% of audit fees.
services, tax calculations, design or implementation of
The House of Commons Treasury Committee Ninth
certain IT systems and recruiting services.
Report, Banking Crisis: reforming corporate governance
FEE published a policy statement (July 2012) on the
and pay in the City (May 2009) called for a ban on
provision of non-audit services to audit clients. It argues
auditors providing non-audit services to enhance
that non-audit services are not a monolithic bloc which
investor confidence and trust.
endanger auditor independence and have to be
In response to this, ES/5 and the FRC Guidance on
prohibited as a whole. It considers that further
Audit Committees were reviewed. The call for a ban on
harmonisation at EU level could be achieved with the
non-audit services was rejected but additional guidance
application of the principles and requirements of the
was provided. ES/5 as updated (December 2010):
IESBA Code of Ethics for Professional Accountants.
-
provides additional guidance in relation to conflicts
of interest and requires auditors to consider the
consequential implications for their independence
-
provides that outsourcing substantially all of the
internal audit activity to an audit firm is
Certain services should generally be prohibited as
provided in the Code but others should generally be
permitted with an overall requirement to address
specific threats to independence.
FEE published a comparison (January 2013) of auditor
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Auditors
Non-audit services (continued)
-
unacceptable where the work undertaken is
independence provisions in the Statutory Audit
significant to the audited entity
Directive and the EC Recommendation on Auditor
prohibits the provision of restructuring services in
certain circumstances.
Independence and the IESBA Code of Ethics for
Professional Accountants. Although they use essentially
the same conceptual approach, it notes that the IESBA
In addition, the FRC Guidance on Audit Committees
Code of Ethics for Professional Accountants contains
was amended to clarify how the audit committee
stricter provisions for those non-audit services that are
should approve non-audit services. This:
incompatible with audit services.
-
requires the audit committee to consider whether
the audit firm is the most suitable supplier of the
non-audit service and the fees incurred for nonaudit services, both for individual services and in
aggregate relative to the audit fee
-
requires the audit committee to establish a list of
non-audit services for which specific audit
committee approval is required before they are
contracted
-
provides additional guidance on the explanation to
be provided in the annual report as to how auditor
objectivity and independence is safeguarded where
an auditor provides non-audit services.
In its 2011/12 Annual Report (June 2012), the AIU noted
that any threat to auditor independence from the
provision of non-audit services should be reported to
audit committees while there was still time to mitigate
the risk. Sufficient detail should be provided to enable
an informed assessment as to whether auditor
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Auditors
Non-audit services (continued)
independence had been maintained. It considers that
auditors are sometimes too ready to underestimate the
threats and argue without proper consideration that
current arrangements are sufficient safeguards against
the threats. Audit committees are entitled to expect a
good standard of independence on reporting from
auditors and should seek additional information if not
initially provided.
The Companies (Disclosure of Auditor Remuneration
and Liability Limitation Agreements) (Amendment)
Regulations 2011 came into force on 1 October 2011
and replaced the previous classification of audit and
non-audit services, which large companies and groups
must use to disclose the fees they have paid their
auditor or associates of their auditor. The new
classification is intended to link more clearly to the
Fourth and Seventh Directives and the APB’s Ethical
Standards.
The House of Lords Economic Affairs Committee’s
report “Auditors: Market concentration and their role”
(March 2011) recommended that external auditors
should be banned from providing internal audit
services, tax advisory services and advice to the risk
committee for the audit client. It also recommended
that the OFT examine whether any other services
should be banned from being carried out by a firm's
external auditors.
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Auditors
Non-audit services (continued)
In its response to the House of Lords Economic Affairs
Committee’s report (May 2011), the Government
asserted that the APB’s Ethical Standard 5, as updated
in December 2010, was sufficient to ensure the
independence of the auditor.
The POB published (June 2012) “Key Facts and Trends
in the Accountancy Profession”. It noted that, since
2006, the income of the Big Four from non-audit work
for non-audit clients had increased whilst the fee
income from non-audit services from audit clients had
decreased.
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Auditors
Rotation of audit firm/retendering
The House of Lords Economic Affairs Committee’s report
The Statutory Audit Directive does not require the
A study of mandatory audit firm rotation was required
“Auditors: Market concentration and their role” (March
rotation of an audit firm, only the key audit partner
by SOX § 207. In its report (November 2003), the
2011) recommended that FTSE 350 companies should
(see Rotation of audit partner below). However, Recital
General Accounting Office concluded that the most
carry out a mandatory tender of their audit contract
26 allows Member States to require the change of
prudent course of action was for the SEC and the
every five years and that audit committees should hold
audit firm if appropriate to attain the objectives of the
PCAOB to monitor and evaluate the effectiveness of
discussions with principal shareholders every five years.
Directive.
SOX’s requirements for enhancing auditor
The FRC published (September 2012) amendments to
The EC published (November 2011) a draft regulation
the UK Corporate Governance Code. Among other
which provides for mandatory rotation of audit firms
The NYSE has asked audit committees to consider,
things, a separate section of the audit report should
of public interest entities (see Glossary) after six years
where appropriate, audit firm rotation.
describe the work of the audit committee and include an
with a cooling-off period of four years before the audit
explanation of how it assessed the effectiveness of the
firm can be engaged again by the same client. The six-
audit process and the approach taken to the
year period can be extended to eight years in
appointment or reappointment of the external auditor,
exceptional circumstances but these are not defined.
together with information on the length of tenure of the
Although the EC has not mandated joint audits (i.e.
current audit firm and when the tender was last
audits to be carried out by more than one firm) as
conducted. There is also a new provision requiring FTSE
originally rumoured, it is seeking to encourage them
350 companies to put the external audit contract out to
by extending the period for mandatory rotation from
tender at least every 10 years. Transitional arrangements
six to nine years where joint audits are conducted
have been posted on the FRC website (see under “Audit
(extendible to 12 years in exceptional circumstances).
tendering”) to avoid all companies putting their audit
contracts out to tender at the same time.
For details on the tendering procedures set out in the
draft regulation, see Audit quality above.
In its Developments in Corporate Governance 2012
(December 2012), the FRC states that it is holding
meetings with market participants on the conduct of
audit tenders, focusing on how to assess the quality of
current/prospective auditors. This may result in guidance
to assist companies on future tender processes.
161
independence and audit quality.
The PCAOB published a concept release (August 2011)
seeking views on how to enhance auditor
independence, objectivity and professional scepticism. It
also discussed mandatory audit firm rotation.
Auditors
Rotation of audit partner
The APB’s Ethical Standard 3 on long-term association
The EC Recommendation on Auditor Independence
Mandatory audit partner rotation applies to auditors of
with the audit engagement provides that, in the case of
(May 2002) states that “key audit partners” (broadly
SEC-registered companies every five fiscal years (lead
listed companies:
those responsible for reporting on significant matters)
and concurring audit partners) or seven years (other key
should rotate within seven years.
audit partners) (SOX § 203) (SEC Rules adopted January
-
no one should act as an audit engagement partner
for more than five years
-
anyone who has acted as the audit engagement
partner for a particular audited entity for a period of
five years should not subsequently participate in the
audit engagement until a further period of five years
has elapsed.
Ethical Standard 3 permits the extension of the rotation
period for the audit engagement partner of a listed
company from five to seven years if the audit committee
of the audited entity and the audit firm decide that a
The Statutory Audit Directive requires key audit
partner(s) to rotate within a maximum period of seven
years. Key audit partner(s) should not participate in the
audit again for at least another two years. The EC’s
(November 2011) draft regulation extends this twoyear period to three years.
In relation to the audit of listed entities, the IESBA
Code of Ethics for Professional Accountants (2012
edition) provides that:
-
key audit partners should be rotated after serving
degree of flexibility over the timing of the rotation is
for a pre-defined period, normally no more than
necessary to safeguard the quality of the audit.
seven years
According to Ethical Standard 3, the audit committee
and audit firm may decide a degree of flexibility is
necessary where a substantial change has recently been
made or will soon be made to the nature or structure of
the audited entity’s business or where there are
-
such individuals rotating after a pre-defined period
should not participate in the audit engagement
until a further period of time, normally two years,
has elapsed.
unexpected changes in the senior management of the
The definition of “key audit partners” was extended in
audited entity. Any extension and the reasons for it must
2009 to cover not just the engagement partner and
be disclosed to the audited entity’s shareholders as soon
the individual responsible for the engagement quality
as practicable.
control review, but also audit partners on the
The FRC updated the FRC Guidance for Audit
Committees (December 2010) to reflect the extension of
engagement team who make key decisions (e.g. where
they are responsible for substantial subsidiaries or
162
2003).
Auditors
the rotation period as set out in Ethical Standard 3.
divisions).
The Government implemented the rotation requirements
in the Statutory Audit Directive by giving statutory
underpinning to the existing Ethical Standards. This was
achieved by The Statutory Auditors and Third Country
Auditors Regulations 2007 which amended Schedule 10
of CA 06.
163
Auditors
Liability of auditors
Section 507 of CA 06 provides that it is a criminal
The EC established (November 2005) a forum of 20
Current Exchange Act rules regarding independence of
offence (punishable by a fine) for an auditor knowingly
market experts from various professional backgrounds
accounting firms that audit and review financial
or recklessly to cause a misleading, false or deceptive
to look at issues surrounding the liability of auditors
statements and prepare attestation reports filed with the
audit report to be made or omit a statement required
and consider market-led solutions to mitigate litigation
SEC do not explicitly address how auditors may manage
under CA 06.
risks.
their liability to their clients and their clients’
Sections 534 to 538 CA 06 allow shareholders to agree
The EC also published a consultation (January 2007) on
a limit on the liability of auditors in respect of any
whether there was a need to reform rules on auditors’
negligence, default, breach of duty or breach of trust,
liability for negligence in the EU. It invited views on four
occurring in the course of an audit, by means of a
options: a single cap; a cap linked to the firm’s size; a
limitation liability agreement or “LLA”. The limit cannot
cap linked to audit fees; or proportionate liability. It also
reduce the auditors’ liability to less than is fair and
published an overview and an update of the civil liability
reasonable, and must be subject to shareholder
of statutory auditors in Member States (January 2007).
approval, to be given on an annual basis before or after
shareholders in respect of their work. Rather, the SEC
has provided guidance (see Codification of Financial
Reporting Policies, Section 602.02.f.i) which provides
that “[w]hen an accountant and his client, directly or
through an affiliate, have entered into an agreement of
indemnity which seeks to assure to the accountant
immunity from liability for his own negligent acts,
whether of omission or commission….the accountant
The EC published a summary report on the responses
cannot be recognized as independent.” Further, the
(June 2007). The audit profession and respondents from
SEC’s Office of the Chief Accountant stated (December
An LLA must be disclosed in the annual accounts or
countries where a limitation already existed supported
2004) that including clauses in engagement letters
directors’ report pursuant to The Companies (Disclosure
an EC initiative but the majority of the respondents
whereby a company indemnifies or holds the auditor
of Auditor Remuneration and Liability Limitation
from countries without a limitation rejected any EC
harmless from liabilities arising from knowing
Agreements) (Amendment) Regulations 2011.
action. Generally, the audit profession preferred a
misrepresentations by management would also impair
limitation based on capping, whereas the other
the auditor’s independence (see question 4 under
respondents preferred a solution based on
“Other Matters”).
the company enters into the LLA.
The Government took a reserve power (Section 535(2)
of CA 06) to make regulations about the kinds of
provisions that LLAs should (or should not) contain,
proportionate liability.
Numerous committees, such as the Advisory Committee
particularly with a view to preventing adverse effects on
The EC published a recommendation inviting Member
on the Auditing Profession, formed by the US Treasury
competition. This is a reserve power and the
States to limit auditor liability (June 2008) by one or
Secretary in May 2007, as well as the Committee on
Government stated that it had no plans to use it (see
more of the following three methods:
Capital Markets Regulation, formed in 2006,
-
establishing a maximum financial amount (or a
recommended that Congress explore protecting audit
formula for the calculation of such an amount)
firms against catastrophic loss through the provision of
paragraph 2.7 of BIS’ consultation paper on
implementation of CA 06 (February 2007)).
caps or safe harbours, provided that any use of such
An FRC working group published guidance on LLAs
164
Auditors
(June 2008). The guidance:
-
-
explains what is and what is not permitted under
CA 06
-
sets out factors for directors to consider when
assessing the case for an LLA
-
-
-
establishing a set of principles to prevent auditors
protection was balanced by stiff action against those
being liable beyond the actual contribution to the
responsible for misconduct. A report by the Mayor of
loss suffered (so that the auditors are not jointly
New York and Senator Schumer similarly recommended
and severally liable with other wrongdoers)
capping auditor liability. However, no action has been
allowing the company and auditor to determine
taken by Congress or the SEC.
liability by agreement. Any agreement must be
The Advisory Committee published its final report
provides specimen clauses providing for
subject to judicial review, the limitation must be
(October 2008), but was unable to reach a consensus as
proportionate liability, liability based on a fair and
decided by the administrative body of the company
to whether limits on auditor liability would be beneficial
reasonable test and a monetary cap
(i.e. the board in the case of a UK company) and
or harmful to the capital markets and to investors or, for
explains the process for obtaining shareholder
must be subject to shareholder approval. The
that matter, whether such limits were necessary to
approval for public and private companies and sets
limitation and any modification to it must be
sustain the auditing profession.
out specimen resolutions.
published in the notes to the accounts of the
company.
165
Auditors
Liability of auditors (continued)
The ISC published a statement on LLAs (June 2008) to
Member States were asked to inform the EC of any
coincide with the FRC guidance. The statement explains
measures taken by 5 June 2010.
what institutional investors will expect from companies
seeking shareholder approval for LLAs and provides
guidance on the disclosures that institutional investors
will require. Fixed caps are not acceptable and a key
concern is audit quality.
NAPF supports proportionate liability and also opposes
a cap. Its Corporate Governance Policy and Voting
Guidelines (November 2012) state that investors should
consider voting against resolutions which propose any
form of liability limitation other than proportionate
liability unless there are compelling reasons why that is
not appropriate.
The GC100 has published a note on LLAs (July 2009).
This sets out the main issues for boards to take into
account when deciding whether or not to enter into an
LLA and gives guidance on what is meant by
proportionate liability and how to explain the impact of
proportionate liability to shareholders.
In practice, in part because of the SEC’s views for USregistered companies, LLA provisions have not been
entered into by listed companies.
The House of Lords Economic Affairs Committee’s
report “Auditors: Market concentration and their role”
(March 2011) recommended that auditors’ unlimited
liability be investigated by the OFT to determine
166
Auditors
Liability of auditors (continued)
whether it deterred non-Big Four auditors from taking
on large listed clients.
In its response to the House of Lords Economic Affairs
Committee (June 2011), the Government indicated that
it has no current plans to further limit liability for
auditors.
167
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