Further changes to the world of corporate governance, particularly for directors

Pinsent Masons

After the high-profile collapse of a number of large businesses, the government has launched a consultation about maintaining the credibility of reporting by companies, writes Tom Proverbs-Garbett of Pinsent Masons. 

The Department of Business, Energy and Industrial Strategy (BEIS) has published its consultation, 'Restoring Trust in Audit and Corporate Governance', which aims to "strengthen the UK’s audit and corporate governance framework", to "establish clearer responsibilities for the detection and prevention of fraud, and ensure the audit product and audit profession are fit for the future".

While, as this suggests, much of the consultation focuses on audit practices and the role of auditors, a substantial part considers methods to increase the accountability of directors, through new reporting and attestation requirements covering the strength of internal controls, dividend and capital maintenance decisions, and resilience planning.

It's a moot point whether this changes responsibilities, or is simply focused on reporting. There's a ready analogy to the introduction in 2019 of the section 172 statement requiring directors of large companies to report on how they have had regard to the factors set out in section 172(1) of the Companies Act 2006 (the duty to act in the best interests of the company for the benefit of its members) in complying with that duty.

The duty already applied, what changed was the requirement to put in writing how the directors at a given company considered themselves to have complied with it in practice.

Similarly, the consultation suggests (for example) that directors should report in proposing a dividend that it is within known distributable reserves and will not threaten the solvency of the company in the short to medium term.  This is something that directors must already do.

The purpose of making a public statement, as the consultation makes clear, is to focus decision-making and help build external confidence that the dividend and capital maintenance rules are being respected.

What is certainly new is the proposed investigation and enforcement powers for breaches of statutory duties relating to corporate reporting and audit of large companies.

At the moment, the Financial Reporting Council (FRC) – responsible for regulating the audit and accountancy professions and generally responsible for promoting transparency and integrity in UK business – has no authority to enforce directors’ duties other than when a director is also a member of a professional accountancy body. However, it is proposed that a new regulator – the Audit, Reporting and Governance Authority (ARGA) – should have such a power, justified by, among other things, the utility in providing the new regulator with enforcement powers in relation to each of the main parties involved in reporting and audits.  ARGA would replace the FRC.

This would be a significant change to the law and to the role of directors, who currently owe their duties solely to the company they serve.  Although many of the obligations of directors are backed up by criminal offences in the Companies Act 2006, it is rare in practice that prosecutions are brought against directors of solvent companies.

The idea is that directors are more readily accountable should they fail to respond to their duties or "leave the door open to fraud".

Might such increased responsibility and regulation mean that people are less willing to become company directors, particularly of subsidiaries where, in practice, directors may not have the day-to-day control the legal framework would suggest?  Or, as with the risk of prosecution under the Companies Act, is this more about standard setting than enforcement? 

Either way, what is certain is that directors will soon have to justify publicly and in writing more of their decision-making than ever before.