The UK’s leading corporate governance regulator has raised the prospect of new US-style laws that would force finance directors and chief executives to personally attest to the veracity of their internal financial controls.
In an interview this week, Sir Jon Thompson, chief executive of the Financial Reporting Council (FRC), said he was in favour of new UK rules based on the US Sarbanes-Oxley Act (Sarbox).
The now famous Section 404 of Sarbox demands that senior management certify that their internal controls are in good order. In the US, signing off on “incorrect certification” could lead to a maximum fine of $5m, or 20 years in prison.
Sir Jon has not advocated for penalties of that magnitude in the UK. But he told Reuters that there is “a case” for considering a similar regime for Britain, saying “we are in favour” of a version of Sarbanes-Oxley. He believes a new regime would raise governance standards and improve risk and financial management, accounting and accountability within organisations.
His views emerge as speculation grows that the UK government is about to launch a consultation on new regulation that could compel directors to take personal responsibility for financial statements. The consultation has been referred to as “Kingman II” in the press, after Sir John Kingman, who has already completed one review of UK financial reporting and audit regulation.
The US Sarbanes-Oxley Act was introduced in 2002 following accounting scandals at Enron and WorldCom. Enron’s collapse also brought down the international accounting firm Arthur Andersen. The law covers many issues from whistleblowing to corporate disclosures and relationships with auditors.
However, Section 404 on internal controls is considered the most exacting part of the legislation, demanding that management and external auditors report on the adequacy of a company’s internal controls on financial reporting.
The laws have been attacked for being too costly and for affecting the competitiveness of US capital markets. Elsewhere these criticisms have been dismissed as overblown.
Discussion of a UK version has been in the wind for some time. Some observers argue Sarbanes-Oxley wouldn’t travel well if imported wholesale, while others say UK companies already face demands to address internal controls from numerous sources, including the Companies Act 2006, the UK Corporate Governance Code and UK listings rules for companies listed on public markets.
A report from the ICAEW published last year called for a public consultation on any proposed changes that would develop corporate reporting on internal controls.
That was likely in response to growing support for change. When the House of Commons business committee (BEIS) investigated the need for audit reform it uncovered support for some form of Sarbox-style change among a range of stakeholders.
In evidence given to the committee, Liz Murrall, director of stewardship and reporting at the Investment Association, a professional body for asset managers, said she would support “consideration” of Sarbox.
“We are investors,” said Murrall. “We want to invest in well-governed and controlled companies, and it is very important that somebody is looking at those internal controls and making sure they are effective.”
A more formal review of audit in the UK also produced its own recommendations. Sir Donald Brydon’s review was tasked with looking at the scope and quality of current audits and recommending changes.
He concluded that CFOs and CEOs should take direct responsibility for internal controls. They should, he proposed, “provide an annual attestation to the board as to the effectiveness of the company’s internal controls over financial reporting.”
He added: “Companies [should] be required to disclose when any material failure of their internal controls has taken place. A disclosed failure would lead to the CEO/CFO attestation being subject to audit for the following three reporting years.”
Sarbox and audit reform
Not everyone is behind the idea of a UK version of Sarbanes-Oxley. The Institute of Directors said in a statement that the experience of the US indicated that a “more litigious or punitive regime” for directors did not necessarily lead to better outcomes. A Sarbox regime, it said, could lead to more box-ticking and “impose significant costs”. There are other worries too.
“Such a move could have the unintended consequence of shrinking the available pool of experienced candidates willing to serve as directors,” the IoD stated.
“At the same time, the proposals will make very little practical difference in encouraging more effective boardroom oversight. In fact, they risk undermining the collective responsibility of the board.”
However, there is enthusiasm for the Brydon recommendations. According to Maggie McGhee, executive director for governance at ACCA, a professional body for accountants, implementation of the Brydon proposals would be welcome and reflects the need for an “end-to-end” view of audit reform that includes the role of management.
“You can’t look at audit in isolation,” McGhee said. “You need to look at financial management, financial reporting and the wider process.”
Audit reform is coming, the sheer weight of recent reviews and reports dictate that something has to happen. The government even pledged to push ahead with reform in its election manifesto last year. And though a Sarbox-style change remains speculation, the fact that a leading regulator has gone public with his support suggests executives may soon be coming to terms with new responsibilities.