BEIS issues White Paper: D&O perspective
The Department for Business Energy and Industrial Strategy (BEIS) has today released its White Paper, setting out its proposals for audit reforms and corporate governance, entitled "Restoring trust in audit and corporate governance".
The consultation on the proposals ends in July and can be found here. The proposals will have big implications for directors and officers and we set some of the main ones out below.
What is it?
The White Paper states that "stakeholder and wider public trust in the credibility of directors' reporting and the statutory audit has been shaken up by a succession of sudden and major corporate collapses which have caused serious economic and social damage". This, of course, is referring to the insolvencies of Carillon, Thomas Cook and BHS which the government suggests has damaged the UK's reputation as an investment hub.
The White Paper's aims include rebuilding confidence in the market as well ensuring businesses look further than their own financial performance at wider issues such as key climate targets. This, for example, is proposed by way of holding companies to account as the UK seeks to eliminate its contribution to climate change by 2050.
Also proposed is a new regulator, the Audit, Reporting and Governance Authority (ARGA). ARGA will have the power to impose an operational split between audit and non-audit functions in accounting firms. The objective is to reduce conflicts that may affect the standard of the audits that accounting firms provide. Overall, ARGA will have stronger powers than the current regulator and will be able to order companies to re-state their accounts instead of having to go through the Courts. ARGA will also have the power to investigate and sanction civil breaches of corporate reporting and audit-related responsibilities by directors of publicly listed companies. Whether those responsibilities will include behavioural standards, such as acting with honesty and integrity, remains under consideration.
Main implications for Directors and Officers?
Accountability and transparency are the key focus for directors. The White Paper has identified weaknesses in the current reporting requirements. It includes proposals for "new reporting and attestation requirements covering internal controls, dividend and capital maintenance decisions". As part of that, attention is given to the need for stronger internal company controls and risk management systems.
Directors will need to make sure that all necessary information about the business is disclosed in the audits. If a director seeks to conceal any information from auditors or through their failings makes the business susceptible to fraud, they could face suspension or fines. To that end the White Paper proposes "new obligations on both auditors and directors relating to the detection and prevention of material fraud", including a requirement for directors to report on the steps they have taken to tackle fraud.
The White Paper also addresses concerns regarding the payment of dividends and bonuses when a company is in financial difficulties. These proposals arose from the BEIS report following the collapse of Thomas Cook whereby high dividends and bonuses were paid prior to its insolvency. According to the new proposals, directors will need to accurately report on and make a statement in respect of the legality and affordability of any dividends. In addition, director remuneration could be clawed back in the two year period preceding any insolvency. This will raise concerns regarding the importance of dividends to pension funds and savers. The proposals state it is 'keen to understand any potential adverse effects and to avoid measures which will unnecessarily reduce the level of dividends paid by UK companies".
The use of annual 'resilience statements' has been proposed. This indicates the mitigation steps businesses are taking in respect of "business resilience over the short, medium and long-term". This statement will include two reverse stress testing scenarios as well as the existing viability statement requirements. As part of this, the mandatory assessment period will be increased from 3 to 5 years, as set out in the Brydon Review.
There are many more proposals in the White Paper that we have not touched upon here, but we will be releasing further updates in due course. The consultation is open until July so we will need to watch this space to see what the responses are.
We are pleased the reforms acknowledge the additional duties directors will be under in order to comply with climate related disclosures (these will be mandatory by 2023). However, the wider obligations will no doubt result in more claims being made. For example, stakeholders may feel a director has not sufficiently explained the effectivity of the company's internal controls over financial reporting and/or disclosed all of the relevant information to the auditor. This susceptibility to claims and investigations will reinforce the importance of directors obtaining adequate D&O insurance. Certain directors may now wish to insist on having a ring-fenced portion of the limit of indemnity reserved to them for such exposures.