Corporate governance in the UK is about to undergo its biggest transformation in a generation. Next month, the Government consultation into the powers held by the new Audit Regulation and Governance Authority (ARGA), closes. Some of the proposals are seismic, driven by corporate scandals, and could mean directors of public companies, large AIM-listed and large private companies could be personally liable for financial or audit failings.
The proposals set out the powers and duties the new regulator will have in order to be effective. Some are both necessary and appropriate. Others, however, have a wide and threatening net.
The aim is to ensure investors, users of corporate reporting, and the wider public interest are protected. But the proposals change what will be expected of directors – and their liability. These powers are far-reaching and have the potential to cause real strife for directors of companies which fall foul of the rules.
Directors will have to sign new annual statements explaining capital maintenance and dividend decisions, steps taken to detect fraud, and the adequacy of internal controls. The last of these has been described as “Sarbanes-Oxley Lite”, mirroring similar requirements in the US. Whilst this statement may seem laudable, there is a risk the box-ticking associated with the new rules will be expensive, time-consuming and yet unlikely to drive better judgements or expose wrongdoing.
To give these annual statements teeth, the government plans to foist more duties on directors, alongside a Code of Ethics to govern financial audit matters. This will include the requirement to act with “due skill, care and diligence, and honesty and integrity”.
It is hard to dispute that directors should comply with these duties. But it depends, surely, on what that actually turns out to mean. If annual statements prove inaccurate, directors could be personally investigated. They could, in other works, be fined or even temporarily disqualified for actions taken far below them in the chain of command.
Laying more and more responsibility at directors’ doors is the direction of travel taken by other regulators. Both the Financial Conduct Authority and the Competition and Markets Authority have taken steps to create individual accountability for company directors. They are, increasingly, the bullseye target of regulators.
There may be unintended consequences to this. The White Paper asks whether the regulatory should be able to access legally privileged material shared with auditors. the FRC claims it needs this to assess audit quality. Such a power is an unprecedented step. There is no guarantee the material won’t then be obtained by third parties and used against directors or the company in question. Companies would inevitably be less willing to share privileged information with their auditors, making it harder for them to do their job.
A regulator with super-charged powers and dramatic increases in liability could also prove a pricey move: directors & officers’ insurance rates will likely go up, along with compliance costs.
Directors will need to prepare for the slew of new responsibilities. There is a blueprint to follow, from the FCA’s similar scheme. The best preparation, however, will be making their voices heard before the consultation period comes to an end and they find themselves tangled up in the rules.