Making the best of second best


Jane Fuller


The UK government’s proposals on ‘Restoring trust in audit and corporate governance’ contained one clear disappointment: no UK version of the US Sarbanes-Oxley Act. SOX requires chief executives and finance directors to sign up to the truthfulness of material facts and to the proper operation of financial controls. It also requires an external audit of the effectiveness of those controls.

This missed opportunity is no surprise, even though the Financial Reporting Council (FRC) advocated for legislation. The FRC has also acknowledged the flaw in relying on the Corporate Governance Code: the good honour it but the bad do not.

Better news is that other anticipated disappointments – notably on holding directors to account – turned out better than expected. So, how do investors and others who place their trust in published financial information make the best of second best?

A positive step is that directors will have to make statements on issues of crucial importance to users of accounts, including the effectiveness of internal controls, the company’s resilience and distributable reserves, and the steps they have taken to prevent and detect fraud. 

While there is no requirement to obtain external assurance, it can be commissioned via the new audit and assurance policy. Non-executive directors should have an incentive to do this to help cover their backs where management has been economical with the truth and, more generally, to improve the information available to them.

Importantly, shareholders can push for external assurance and audit committees will be expected to gather their views. This is a challenge to investors to back up their words with time and effort.

Other important initiatives will come to fruition via the new powers promised for the Audit, Reporting and Governance Authority (ARGA), which is due to replace the FRC – but not before 2024-25. ARGA will, for instance, be able to set minimum requirements for audit committees, which are likely to include engaging with shareholders.

But it is on directors’ accountability that the proposed new powers are most tantalising. “The Government…intends to give ARGA the necessary powers to investigate and sanction breaches of corporate reporting and audit related responsibilities by PIE [Public Interest Entity] directors.” It adds that “this regime should follow similar principles to the FRC’s audit enforcement regime”.

This does not mean the creation of a new profession of director with a behavioural code and individual responsibility resembling that of a professional accountant. But it does spell out directors’ duties in providing reliable information to shareholders and in co-operating with both auditors and the regulator.

What remains is the perennial UK problem of poor enforcement of existing duties under the Companies Act, and the listing and transparency rules. Let’s hope that a newly empowered ARGA, working with the FCA and Insolvency Service, can finally improve this record.

So, the good news is that the new regulator will have more teeth alongside its expanded resources – its headcount is set to reach about 600 compared with just over 400 now. The less good news is that the government has pulled its punches in a few key areas by relying on the Corporate Governance Code rather than legislation.

The words “lighter touch” have crept back into the lexicon – that did not end well pre the financial crisis. This is coupled with a desire to make the UK more attractive as a place for companies to list (see the Hill Review). What is missing from this philosophy is that the providers of capital prefer markets (witness the US) where the quality and reliability of financial information is better verified.

With its wider stakeholder mandate and new responsibility for local government audit, FRC/ARGA is moving further away from an investor-focused mandate. That more straightforward approach is best expressed in the SEC’s mission statement: “to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation”.

Jane Fuller, a former Financial Editor of the Financial Times, is a Fellow of CFA UK, a Visiting Professor at City, University of London, and an honorary fellow of the Chartered Institute for Securities & Investment. Jane is a participant in CRUF UK.  Jane also co-authored this letter in the Financial Times on the subject.

Disclaimer: The views expressed in the blog are those of the author and do not necessarily represent the views of all CRUF participants. To read more about the CRUF’s views on this and other topics, please visit the ‘Our Views’ section of this website.


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