Will greater personal accountability help prevent future accounting scandals?

As the Car­il­lion, Patis­serie Valerie and Thomas Cook account­ing scan­dals con­tin­ue to prompt ques­tions about stan­dards in UK cor­po­rate report­ing and audit­ing, the gov­ern­ment is putting boards under pres­sure to ensure that the infor­ma­tion they give audi­tors is cor­rect and com­plete.

The process start­ed in earnest in March 2021, when the Depart­ment for Busi­ness, Ener­gy and Indus­tri­al Strat­e­gy (BEIS) pub­lished a white paper enti­tled Restor­ing Trust in Audit and Cor­po­rate Gov­er­nance: con­sul­ta­tion on the government’s pro­pos­als.

The doc­u­ment sug­gest­ed mak­ing indi­vid­ual direc­tors, rather than boards as a whole, per­son­al­ly respon­si­ble for the accu­ra­cy of their com­pa­nies’ finan­cial state­ments as they sign off on inter­nal con­trols and risk man­age­ment. The mod­el it pro­posed was sim­i­lar to that adopt­ed in the US under the Sar­banes-Oxley Act 2002 – which was a response to one of the nation’s most noto­ri­ous fail­ures of cor­po­rate gov­er­nance, the Enron scan­dal.  

But busi­ness lead­ers soon raised their con­cerns about what they con­sid­ered to be a rad­i­cal pro­pos­al that would increase the risks faced by every­one sit­ting around the board­room table. Would board direc­tors over­see­ing depart­ments such as HR or IT, for instance, be will­ing and able to accept an oner­ous new finance-relat­ed duty that they feel is beyond their exper­tise?  

And would non-exec­u­tive direc­tors (NEDs) be pre­pared to take on the extra bur­den? The inde­pen­dent scruti­ny that these expe­ri­enced busi­ness lead­ers can offer boards has long been viewed as cru­cial in ensur­ing sound cor­po­rate gov­er­nance and report­ing. But 78% of NEDs polled in a sur­vey pub­lished by EY in August 2021 report­ed that their jobs had become increas­ing­ly com­plex and time-con­sum­ing in recent years.  

Giv­en that groups such as the Insti­tute of Direc­tors (IoD) oppose the BEIS’s sug­gest­ed diver­gence from the prin­ci­ple of col­lec­tive board respon­si­bil­i­ty, it’s wide­ly expect­ed that its pro­pos­al that indi­vid­ual direc­tors, what­ev­er their role, should be required to sign off on a firm’s inter­nal finan­cial report­ing con­trols will be watered down, if not dropped entire­ly.

Weng Yee Ng is a part­ner at Foren­sic Risk Alliance, a con­sul­tan­cy that spe­cialis­es in help­ing clients to han­dle cross-bor­der inves­ti­ga­tions, lit­i­ga­tion and com­pli­ance require­ments. She sug­gests that there’s “a bal­ance to be struck. Imple­ment­ing heavy and over­ly bur­den­some legal require­ments to catch a small pro­por­tion of mis­be­hav­ing direc­tors may end up deter­ring and, to a degree, penal­is­ing good and tal­ent­ed direc­tors. Expe­ri­ence tells us that there’ll prob­a­bly nev­er be a per­fect equi­lib­ri­um.”

CEOs should con­sid­er improv­ing the qual­i­ty of inde­pen­dent over­sight, Ng advis­es. This should help to instil con­fi­dence and pre­vent under-resourced finance teams from becom­ing over­loaded with legal bur­dens fur­ther down the road.

The BEIS has also pro­posed extend­ing the def­i­n­i­tion of ‘pub­lic-inter­est enti­ties’ to cov­er large pri­vate com­pa­nies as well as pub­licly list­ed com­pa­nies and finan­cial insti­tu­tions such as banks. If this rec­om­men­da­tion were to be imple­ment­ed, the CEOs of pri­vate com­pa­nies could find them­selves tak­ing on extra finan­cial report­ing respon­si­bil­i­ties.  

Despite its con­cerns about some of the white paper’s rec­om­men­da­tions and the tim­ing of the pos­si­ble changes, giv­en that the UK is still grap­pling with the Covid cri­sis, the IoD is “broad­ly sup­port­ive of the direc­tion of reform pro­posed by the gov­ern­ment”, stress­es Dr Roger Bark­er, the institute’s direc­tor of pol­i­cy and gov­er­nance.   

“It’s entire­ly appro­pri­ate for direc­tors to be held account­able for issues such as the robust­ness of inter­nal con­trols and cor­po­rate report­ing,” he says. “But this is already the case. The pri­ma­ry change advanced by the reforms con­cerns the enhanced enforce­ment of these respon­si­bil­i­ties by a new reg­u­la­tor, the Audit, Report­ing and Gov­er­nance Author­i­ty. Such a change would neces­si­tate a sub­stan­tial out­lay by com­pa­nies to pro­vide the nec­es­sary assur­ance. We ques­tion whether now is an appro­pri­ate junc­ture at which to impose such a reg­u­la­to­ry bur­den.”

It’s like­ly that the planned Audit, Report­ing and Gov­er­nance Author­i­ty will have greater pow­ers than the Finan­cial Report­ing Coun­cil – the account­ing watch­dog it’s expect­ed to replace next year – along with new statu­to­ry objec­tives. This would send a clear sig­nal from the gov­ern­ment about its inten­tions con­cern­ing direc­tors’ report­ing respon­si­bil­i­ties. 

“Whether it’s imposed by reg­u­la­tion or just cor­po­rate cul­ture, there will be a greater need for CEOs to ensure the integri­ty of inter­nal con­trols,” pre­dicts David Davies, a part­ner in the cor­po­rate and com­mer­cial team at law firm Kings­ley Nap­ley. “This will add to the pres­sure on them. They’ll not only have to run their busi­ness­es; they’ll also have to demon­strate the robust­ness of its gov­er­nance and inter­nal con­trols regard­ing the finances.”

Davies adds that CEOs are like­ly to have to accept a new type of bur­den: account­abil­i­ty for the effec­tive­ness of their company’s cor­po­rate gov­er­nance. This should include requir­ing oth­er board mem­bers to take respon­si­bil­i­ty for pro­vid­ing prop­er checks and bal­ances with respect to finan­cial report­ing.

“Pre­vi­ous­ly, if one board direc­tor were a lit­tle weak on finance, that per­son would feel pro­tect­ed because of the col­lec­tive respon­si­bil­i­ty of the board,” he explains. “Now, though, it looks more like­ly that the CEO will want to ensure that every mem­ber of the board has the appro­pri­ate degree of finan­cial lit­er­a­cy.”

Bark­er envis­ages that “CEOs will need to review their frame­works of inter­nal con­trol, cor­po­rate report­ing and exter­nal audit. They may need to add to their inter­nal resources in these areas and con­sid­er whether fur­ther exter­nal assur­ance will also be required.”

CEOs would be well advised to start prepar­ing for the most like­ly changes now. This would help them to avoid expend­ing so much effort on meet­ing the height­ened finan­cial report­ing demands of the forth­com­ing Audit, Report­ing and Gov­er­nance Author­i­ty that they’d be dis­tract­ed from more press­ing busi­ness issues.