The working landscape for boards is about to be transformed after the government published a white paper with wide-ranging proposals giving regulators new powers to investigate and sanction directors for failings in corporate reporting, internal controls and audit committees.
A white paper issued by the Department for Business, Energy and Industrial Strategy includes proposals that would create new responsibilities for directors to report on internal controls; new standards and sanctions for audit committees; and new powers to order an expert review of company reports and potentially impose amendments.
The white paper says the financial reporting regulator’s credibility could be “undermined” if it only acts “against the auditors of a company’s accounts and reports, but not against those responsible for producing them”. For the first time, the watchdog (currently the Financial Reporting Council, but soon to be transformed into the Audit, Reporting and Governance Authority, ARGA) will be able to sanction any director over corporate reporting and audit-related responsibilities, not just accountants.
The government proposes giving powers to ARGA to set standards governing the way audit committees appoints auditors and monitor their work. The proposals would also all allow regulators to sit in on audit committee meetings as well as demand information and reports from them.
Restoring trust in corporate governance
The white paper follows extensive investigation of audit, the audit market and regulation following scandals such as the collapse of Carillion, Thomas Cook and British Home Stores (BHS), all of which significantly undermined public trust in the auditors.
Following parliamentary probes the government ordered three reports: on audit regulation (the Kingman Review); competition in the audit market (carried out by the Competition and Markets Authority); and the purpose and scope of audit (the Brydon Review).
Business secretary Kwasi Kwarteng says the new proposals aim to bolster trust in business. “By restoring trust in our corporate governance regime and encouraging greater transparency, we will provide investors with clarity and certainty, cement the UK’s position as the best place to do business and protects jobs across the country.”
Perhaps the most eye-catching proposal is for directors to review and report on the quality of internal controls, a measure broadly modelled on the US Sarbanes–Oxley Act, though the department for business says the suggested measures are less onerous. The government proposes giving ARGA the power to “investigate the accuracy and completeness of the directors’ internal control disclosure” and order amendments or an external audit of a company’s controls system.
The white paper says: “There should be effective powers to sanction directors where they have failed to establish and maintain an adequate internal controls structure and procedures for financial reporting.”
There are also plans to offer powers for ARGA to create new audit committee standards and take action against audit committee members for “breaching” audit requirements. The government says sanctions could include allowing the regulator to name and shame audit committees or deliver critical reports directly to shareholders.
The shake-up will also include changes to the structure of audit, among them the inclusion of a second, non Big-Four firm in a “managed shared audit regime” and the operational split between audit and non-audit functions inside accountancy firms.
New rules for directors
New duties are put forward for directors and auditors to detect fraud, while audits will in future also look at climate targets.
Directors will be required to write new “resilience statements” setting out “how their organisation mitigates short and long-term risks. The government aims this measures to concentrates the minds of corporate leaders on “long-term success” and on climate change.
Some observers worry the proposals could deter high-flyers from taking on director roles. The Institute of Directors (IoD) argues directors need a new “code of conduct” that would be “less legalistic”.
Roger Barker, head of policy and corporate governance at the IoD, also says the “collective responsibility” of the board should not be lost in the drive to hold directors to account. He says it would be “counterproductive if the legal and financial liabilities piled onto directors make the role excessively unattractive or risky for any capable individual to undertake”.
Others have a close eye on the “accountability” of directors too. Maggie McGhee, executive director at accountancy body ACCA, says: “Whilst we are supportive in principle of extending accountability to company directors, detailed proposals should be proportionate and carefully thought through, with any potentially negative impact fully considered.” She describes the need for directors to report on anti-fraud measures as a “big move”.
Consultation on the audit white paper will run for the next 16 weeks. Work in many areas of the proposed reforms began when the review documents were published. The FRC is on the way to becoming ARGA under the leadership of Sir Jon Thompson; plans for the operational separation of audit firms and increased enforcement have been put in place. Auditors have been braced for change for some time.
The bigger impact of the audit white paper may be on company directors. They face greater scrutiny and new sanctions. It remains to be seen what will be left once interested parties have had their say.