Corporate Governance in the Frame 

May, 2005 - Catherine Tracey

Enron, WorldCom, Tyco International and Parmalat: names associated with tales of corruption, mismanagement and financial irregularity. But these names are now also synonymous with something else: a raft of reforms to company regulation worldwide. Two such reforms being felt in the UK are the Companies (Audit, Investigations and Community Enterprise) Act 2004, and the FTSE Institutional Shareholder Services (ISS) Corporate Governance Index Series. Both the Act and the index series are designed to ensure that companies are more open, transparent and accountable. In short, they have been drawn up to help ensure that scandals like Enron can never happen again. The Act has two main aims: to make companies more accountable, and to facilitate an increase in social enterprise. The first of these aims is intended to guard against the possibility of such financial scandals arising here. The Act, which is partially in force and will come fully into force on 1 October 2005, makes changes to the Companies Acts 1985 and 1989. It is these changes that are having an impact on the operation of companies in Scotland and the rest of the UK. For instance, the Act requires directors to take positive steps to inform auditors about the financial health of a company. Specifically, directors are now required to make 'disclosure statements' in their reports, stating that to the best of the director’s knowledge there is no relevant audit information of which the company's auditors unaware. The director also has to show that he/she has taken all steps necessary to avail him/herself of relevant audit information, and to inform the auditors of that information. A director who makes a false or reckless statement, and who fails to take steps to prevent that report being approved, is guilty of an offence. Further, the Act provides that companies may now be required to differentiate not only between audit and non-audit services (as is the case at present), but also the different types of non-audit services and break down the costs of each. It is hoped that this will enable shareholders to identify any concern about auditor independence. At present, there is no intention to extend these requirements to small or medium-sized companies under the Companies Act 1985. The Act also seeks to tighten up powers to review companies. The Act empowers the Secretary of State to appoint the Review Panel of the Financial Reporting Panel to review listed companies' interim and annual accounts and reports in order to monitor compliance with accounting requirements imposed by the Listing Rules and to report to the Financial Services Authority with its conclusions. The establishment of the FTSE ISS Corporate Governance Index Series also aims to increase company accountability, and to promote better governance. The index series, which cover 23 countries including the US and the UK, gives all listed companies a rating out of five on certain governance issues. These issues include: boardroom pay; independence and integrity of the audit process; structure and independence of the board; equity structure; and the provision of compensation for executive and non-executive directors. It is hoped that this very public naming of companies’ corporate governance performance will improve profitability, and enable investors to assess risk more easily. The extent to which the introduction of new legislation and the index series will result in greater openness, accountability and transparency has yet to be determined. It may be a case of more red tape with little practical benefit. But the irony is of course that the success of these measures will only be gauged by the absence of another Enron.


Catherine Tracey is a lawyer specialising in public law with commercial law firm Shepherd+ Wedderburn. +44 (0)131-473 5474


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