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Corporate governance: Not telling

Life, as we all know, would be simpler if everyone simply got on with it.
But, particularly in the world of business, this rarely happens. Instead of
doing the logical, simple and common sense thing, we reach for a more formal way
often involving lawyers or the suffocating entanglements of health and safety.

There are two good examples of this which touch upon the reluctance of
finance directors to engage in a clear and straightforward way with the issues
involved. The first is the matter of qualified accounts. The second is auditor
liability.

The Financial Reporting and Review Panel, an offshoot of the Financial
Reporting Council, has a duty to look into company accounts to ensure they have
properly complied with company law and accounting standards. An obvious starting
place in such a quest would be qualified accounts. Once upon a time qualified
reports were hugely publicised blots upon the corporate landscape. These days
they go mostly unreported. The FRRP wanted to create a more orderly way of
identifying them. So last year it suggested that, for example, auditors could
simply, as a matter of course and voluntarily, let them know when one cropped
up.

The auditors immediately said how supportive they were of the FRRP’s work.
But they went on to say it would be more than their job’s worth to let anyone
know what their clients have been up to. They passed the buck and suggested that
directors, who are, after all, responsible for producing the things in the first
place, could pass on the news of qualified accounts. As we all know no director
is going to voluntarily inform anyone, particularly regulators or investors, of
any bad news.

As a result, the FRRP has had to give up on the simple and sensible approach
and has been forced to take another route. It has, as it puts it, “arranged for
other means of notification of qualified audit reports on accounts that fall
within the panel’s remit”. In short, it has hired a data crunching company to
provide details from Companies House records of companies, large and small, that
have had their accounts qualified. That, you might say, is a simple answer which
perhaps should have been seen as the solution at the outset.

But auditors, finance directors and everyone else in sight would have shouted
loudly had the FRRP done so.

They would have suggested that they were being snooped upon and that their
openness was being questioned. And it was. But auditors and directors, when
asked to be open, had simply reached for as much complexity as they could
muster.

The second example of the reluctance to get involved and sort out problems
comes with the question of auditor liability. This again was a relatively simple
issue. For years, auditors have complained, with some justification, that there
was no logic that they alone could be sued for everyone else’s poor behaviour
which led to a company going belly up. What the audit profession wanted was a
system where they could only be sued for anything that they themselves had
specifically got wrong. Proportionality was the principle. This would bring to
an end the practice of directors stepping free from the wreckage while investors
hammered the auditors alone.

After many years of wrangling, the principle was enshrined in the most recent
Companies Act.

And here lies the initial problem. The auditors might have won the
intellectual argument, but the process of implementing it was flawed. It was up
to companies to put a contract to the shareholders’ vote at the annual general
meeting that auditors in future would be liable only for their own and not the
directors, or anyone else’s negligence.

And what have the directors of companies done? Well, for the most part they
have done nothing.

We are back to the “couldn’t it be someone else’s responsibility?” arguments.
Annual general meetings have been notable for the lack of any mention of
limiting auditors’ liability.

And directors have come up with a variety of excuses. No one wants to be the
first to make the move, is one of them. We haven’t got a boilerplate set of
words to use, was another. Red herrings were strewn about. And, in any case,
directors, for the most part, are not interested. It is someone else’s problem.

The FRC promised to come up with a variety of appropriate boilerplate clauses
for directors to use and they have, somewhat belatedly, done so. But now, as a
result of the flawed implementation arrangements and of the dithering of
directors, another problem has arrived from left field, as they would say in the
US.

This is the spectre of the main US regulatory body, the Securities and
Exchange Commission.

The Companies Act says limiting liability can only be done through a
contract. The SEC says that means auditors and directors getting into a huddle
to agree it and as far as they are concerned that means the end of independence
and, in future, they will deem the accounts invalid.

It could, as one observer put it, be “a showstopper”. Finance directors need
to put their heads together for once and sort all this out.

Related reading

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