Description
The country's economy depends on the drive and efficiency of its companies. Thus the effectiveness with which their boards discharge their responsibilities determines Britain's competitive position. They must be free to drive their companies forward, but exercise that freedom within a framework of effective accountability. This is the essence of any system of good corporate governance.
0 0 R E P O R T O F T H E C O M M I T T E E O N 0 0
T HE
F I N A N C I A L A S P E C T S
OF
C O R P O R A T E G O V E R N A N C E
1 DE C E M B E R 1992
0 0 R E P O R T O F T H E C O M M I T T E E O N 0 0
THE
F I NA NC I A L A S P E C T S
OF
C O R P O R A T E G O V E R N A N C E
0 1992 The Committee on the Financial Aspects of
Corporate Governance and Gee and Co. Ltd.
Reproduction of this publication in whole or in part is
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and when it is applicable.
First published December 1992
ISBN 0 85258 913 1 (Report)
ISBN 0 85258 915 8 (Report with Code of Best Practice)
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PR E FACE
TH E
INTRO D llc1‘10 N
TH E
TH E
REASONS FOR SETTING UP THE
CORPORATE GO V E R N A N C E
REPORT CONTENT
C ODE OF B EST PR ACT I CE
COMMITTEE
COMPANIES TO WHOM DIRECTED
CODE PRINCIPLES
CiL
STATEMENT OF COMPLIANCE
KEEPING THE CODE UP TO DATE
Ai__
COMPLIANCE
BOARD
BOARD EFFECTIVENESS
THE CHAIRMAN
NO N- EXECUTIVE DIRECTORS
PROFESSIONAL ADVICE
DIKECTORS' TRAINING
BOARD STRUCTURES AND PROCEDURES
,~~~
THE COMPANY SECRETARY
DIRECTORS' RESPONSIBILITIES
STANDARDS 01: CONDUCT
NOMINATION COMMITTEES
INTEKNAL CoNTRoLs
AUDIT COMMITTEES
INTEKNAL AUDIT
B OARD REMUNERATION
_
__
PAGE
9
11
16
-
.-
20
CONTENTS
PAGE
FINANCIAL REPORTS
REPORTING PRACTI CE
PENSIONS GOVERNANCE
T H E
IMPORTANCE OF AUDI T
PROFESSIONAL OBJECTIVITY
‘ QUARANTI NI NG’ AUDIT FROM OT HE R
ROTATION OF AUDI TORS
36
SERVICES
WAYS TO INCREASE EFFECTIVENESS AND VALUE OF THE AUDI T
THE ‘ EXPECTATIONS GA P’
_
INTERNAL CONTROL
~~~~__~
GOING CONCERN
FRAUD
OTHER ILLEGAL ACTS
AUDI TORS’ LI ABI LI TY
AUDIT CONFI DENCE
SHA RE HOL DE RS 48
ACCOUNTABILITY OF BOARDS TO SHAREHOLDERS
INSTITUTIONAL SHAREHOLDERS
‘_
SHAREHOLDER
SHAREHOLDER
c 0 NC I, US I 0 N
COMMUNI CATI ONS
INFLUENCE
53
SUMMAKY OI’ ~~liCOMMENl)A1‘IONS 54
A.PPENDICES
TERMS OF I T HE C O M M I T T E E’ S M E MB E R S H I P A N D
R E F E R E N C E
2 THE ROLE OF BODIES REFERRED TO IN THE RE P O R T
3 DI RECTORS’ RESPONSI BI LI TY STATEMENT
4 AUDIT COMMI TTEES
5 CURRENT STATUTORY AND OTHER REQUI REMENTS
6 AUDI T ORS’ LI ABI L I T Y: THE CAPARO CA S E
I CONTRI BUTORS AND RELEVANT PUBLI SHED STATEMENTS
CONTENTS
PAGE
61
When our Commi ttee was formed j ust over ei ghteen months ago,
neither our title nor our work programme seemed framed to catch
the headl i nes. I n the event, the Commi ttee has become the focus
of far more attenti on than I ever envi saged when I accept ed t he
i nvi tati on to become i ts chai rman. The harsh economi c cl i mate i s
par t l y r esponsi bl e, si nce i t has exposed company r epor t s and
a c c ount s t o unus ua l l y c l os e s c r ut i ny . I t i s , howe v e r , t he
cont i nui ng concer n about st andar ds of f i nanci al r epor t i ng and
accountabi l i ty, hei ghtened by BCCI , Maxwel l and the controversy
over di rectors’ pay, whi ch has kept corporate governance i n the
publ i c eye.
Unexpect ed t hough t hi s at t ent i on may have been, i t ref l ect s a
cl i mate of opi ni on whi ch accepts that changes are needed and i t
presents an opportunity to raise standards of which we should take
f ul l advant age. Our draf t proposal s have been t horoughl y ai red
and have at t ract ed a consi derabl e wei ght of i nf ormed comment
from a wi de range of i ndi vi dual s and bodi es wi th an i nterest i n
matters of corporate governance. While it has not been uncritical,
t he gr e a t ma j or i t y of our r e s ponde nt s ha v e s uppor t e d t he
Commi ttee’ s approach and i t i s thi s consensus whi ch gi ves us a
mandate to proceed. The Committee is being looked to for a lead,
which we have a duty to provide.
I wi sh to thank the members of the Commi ttee for thei r di l i gence
and above all our Secretary, whose si ngl e-mi nded commi tment to
the Committee’s progress has enabled us to complete the task we
were set in May of last year. The report represents a shared view
of t he act i on whi ch needs t o be t aken i n t he f i el d of f i nanci al
reporti ng and accountabi l i ty and i t i s one to whi ch every member
of t he Commi t t ee has cont ri but ed. The Commi t t ee has benef i t ed
f r om t he br eadt h of i t s r epr esent at i on, whi ch has i ncl uded
me mbe r s o f t h o s e b o d i e s b e s t p l a c e d t o s u p p o r t t h e
i mpl ementati on of i ts recommendati ons.
I woul d al so l i ke on behal f of t he Commi t t ee t o expr ess our
grati tude to everyone who has contri buted to our work ei ther by
submi t t i ng evi dence 10 us di rectl y, or through the press or by
providing platforms for debates on governance issues.
PREFACE
Accept ance of t he r epor t ’ s f i ndi ngs wi l l mar k an i mpor t ant
advance in the process of establishing corporate standards. Our
r e c o mme n d a t i o n s wi l l , h o we v e r , h a v e t o b e r e v i e we d
as circumstances change and as the broader debate on governance
develops. We will continue in existence as a Committee until a
successor body -is appointed, to act as a source of authority on our
recommendations and to review their implementation.
Adrian Cadbury
Chai rman
1 December 1992
1. 1 The country’s economy depends on the drive and efficiency
of its companies. Thus the effectiveness with which their
boards discharge their responsibilities determines Britain’s
compet i t i ve posi t i on. They must be free t o dri ve t hei r
compani es forward, but exerci se t hat freedom wi t hi n a
framework of effective accountability. This is the essence
of any system of good corporate governance.
1.2 The Commi t t ee’ s r ecommendat i ons ar e f ocused on t he
control and reporting functions of boards, and on the role
of auditors. This reflects the Committee’s purpose, which
was t o r evi ew t hos e as pect s of cor por at e gover nance
s pe c i f i c a l l y r e l a t e d t o f i na nc i a l r e por t i ng a nd
a c c ount a bi l i t y. Our pr opos a l s do, howe ve r , s e e k t o
contribute positively to the promotion of good corporate
governance as a whole.
1.3
At the heart of the Committee’s recommendations is a Code
of Best Pract i ce desi gned t o achi eve t he necessary hi gh
s t andar ds of cor por at e behavi our . The London St ock
Exchange intend to require all listed companies registered
i n t he Uni t ed Ki ngdom, as a cont i nui ng obl i gat i on of
listing, to state whether they are complying with the Code
and to give reasons for any areas of non-compliance. This
requi rement wi l l enabl e sharehol ders t o know where t he
companies in which they have invested stand in relation to
the Code. The obligation will be enforced in the same way
as al l ot her l i st i ng obl i gat i ons. Thi s may i ncl ude, i n
appropriate cases, the publication of a formal statement of
censure.
1.4 The Committee will remain responsible for reviewing the
implementation of its proposals until a successor body is
appointed in two years’ time, to examine progress and to
continue the ongoing governance review. It will be for our
s pons or s t o agr ee t he r emi t of t he new body and t o
est abl i sh t he basi s of i t s suppor t . I n t he meant i me. a
programme of research wi l l be undert aken t o assi st t he
future monitoring of the Code.
1.5 By adhering to the Code, listed companies will strengthen
bot h t hei r cont rol over t hei r busi nesses and t hei r publ i c
accountability. In so doing. they will be striking the right
bal ance bet ween meet i ng t he s t andar ds of cor por at e
gover nance now expect ed of t hem and r et ai ni ng t he
essential spirit of enterprise.
THE SETTING FOR THE REPORT
1.6 Bri ngi ng greater clarity to the respective responsibilities of
di rect ors, sharehol ders and audi t ors wi l l al so st rengt hen
trust in the corporate system. Companies whose standards
of corporat e governance are hi gh are t he more l i kel y t o
gai n t he conf i dence of i nves t or s and s uppor t f or t he
development of their businesses.
1.7 The basi c syst em of corporat e governance i n Bri t ai n i s
sound. The principles are well known and widely followed.
Indeed t he Code cl osel y refl ect s exi st i ng best pract i ce.
This sets the standard which all listed companies need to
match.
1.8 Our proposals aim to strengthen the unitary board system
and increase its effectiveness, not to replace it. In law. all
di r ect or s ar e r es pons i bl e f or t he s t ewar ds hi p of t he
company’s assets. All directors, therefore, whether or not
they have executive responsibilities, have a monitoring role
and are responsible for ensuring that the necessary controls
over the activities of their companies are in place - and
working.
1.9 Had a Code such as ours been in existence in the past, we
believe that a number of the recent examples of unexpected
company failures and cases of fraud would have received
attention earlier. It must, however, be recognised that no
system of control can eliminate the risk of fraud without so
shackling companies as to impede their ability to compete
in the market place.
1.10 We believe that our approach, based on compliance with a
vol unt ary code coupl ed wi t h di scl osure, wi-II prove more
effective than a statutory code. It is directed at establishing
best practice, at encouraging pressure from shareholders to
hast en i t s wi despr ead adopt i on, and at al l owi ng some
flexibility in implementation. We recognise, however. that
i f compani es do not back our r ecommendat i ons. i t i s
probabl e t hat l egi sl at i on and ext ernal regul at i on wi l l be
sought to deal with some of the underlying problems which
t he report i dent i fi es. St at ut ory measures woul d i mpose a
mi ni mum st andard and t here woul d be a great er ri sk of
boar ds compl yi ng wi t h t he l et t er , r at her t han wi t h t he
spirit, of their requirements.
THE SETTING FOR THE REPORT
1.11 The Committee is clear that action by boards of directors
a nd a udi t or s on t he f i na nc i a l a s pe c t s of c or por a t e
governance is expected and necessary. We are encouraged
by the degree to which boards are already reviewing their
s t r u c t u r e s a n d s y s t e ms i n t h e l i g h t o f o u r d r a f t
recommendat i ons. The adopt i on of our recommendat i ons
wi l l mar k an i mpor t ant st ep f or war d i n t he cont i nui ng
process of raising standards in corporate governance.
I NTRODUCTI ON
Reasons for setting up the Committee
2.1 The Commi t t ee was set up i n May 1991 by t he Fi nanci al
Repor t i ng Counci l , t he London St ock Exchange and t he
accountancy professi on to address the fi nanci al aspects of
corporat e governance. The Commi t t ee’ s membershi p and
terms of reference are set out i n Appent/i.r 1. I t s sponsors
were concerned at t he percei ved l ow l evel of conf i dence
both in financial reporting and in the ability of auditors to
provide the safeguards which the users of company reports
sought and expected. The underl yi ng factors were seen as
t he l ooseness of account i ng st andards, t he absence of a
cl ear f r amewor k f or ensur i ng t hat di r ect or s kept under
r evi ew t he cont r ol s i n t hei r busi ness, and compet i t i ve
pressures both on companies and on auditors which made it
difficult for auditors to stand up to demanding boards.
2. 2 These concerns about the worki ng of the corporate system
wer e hei ght ened by some unexpect ed f ai l ur es of maj or
companies’ and by criticisms of the lack of effective board
accountabi l i ty for such matters as di rectors’ pay. . Further
evi dence of t he breadt h of f eel i ng t hat act i on had t o be
taken to clarify responsibilities and to raise standards came
from a number of reports on different aspects of corporate
governance whi ch had ei t her been publ i shed or were i n
preparation at that time.
2. 3 T h e C o mmi t t e e wh e r e v e r p o s s i b l e d r e w o n t h e s e
doc ume nt s , a n d a wi d e r a n g e o f s u b mi s s i o n s f r o m
i nterested parti es, i n produci ng i ts draft report whi ch was
issued for public comment on 27 May 1992.
2. 4 Si nce t hen, t he Commi t t ee has recei ved over 200 wri t t en
responses t o i t s proposal s, t he gr eat maj or i t y of whi ch
br oa dl y s uppor t t he Commi t t e e ’ s a ppr oa c h, a nd ha s
careful l y consi dered the bal ance of opi ni ons expressed on
part i cul ar i ssues. The Commi t t ee i s most grat ef ul t o al l
those who have taken the time and trouble to give us their
comments. They have helped to shape our final report and,
i n addi t i on, t hey are a val uabl e ref erence source f or our
successors. A list of contributors and of relevant published
statements appears in Appcndis 7.
.,.,. ,.,.I, ~.~...,,,,,.....,..,,,,...~. .,,. ,.,. ,. ,., . . ,,,,,.I
I NTRODUCTI ON
Corporate Governance
2.5
Corporat e governance i s t he syst em by whi ch compani es
ar e di r ect ed and cont r ol l ed. Boar ds of di r ect or s ar e
responsi bl e for t he governance of t hei r compani es. The
shareholders’ role in governance is to appoint the directors
a nd t he a udi t or s a nd t o s a t i s f y t he ms e l ve s t ha t a n
a p p r o p r i a t e g o v e r n a n c e s t r u c t u r e i s i n p l a c e . Th e
responsibilities of the board include setting the company’s
strategic aims, providing the leadership to put them into
effect , supervi si ng t he management of t he busi ness and
reporting to shareholders on their stewardship. The board’s
a c t i ons ar e s u b j e c t t o l a ws , r e g u l a t i o n s a n d t h e
shareholders in general meeting.
2.6
Wi t hi n t hat overal l framework, t he speci fi cal l y fi nanci al
aspect s of corporat: gover nance (ihe Commi t t ee’s remi t )
ar e t he way i n whi ch boar ds set f i nanci al pol i cy and
oversee its implementation, including the use of financial
c ont r ol s , and t he proces: wher eby t hey r epor t on t he
activities and progress of the company to the shareholders.
2.7 The role of the auditors is to provide the shareholders with
an external and objective check on the directors’ financial
statements which form the basis of that reporting system.
Although the reports of the directors are addressed to the
shareholders, they are important to a wider audience, not
least to employees whose interests boards have a statutory
duty to take into account.
2.8
The Committee’s objective is to help to raise the standards
of corporat e governance and t he l evel of confi dence i n
financial reporting and auditing by setting out clearly what
it sees as the respective responsibilities of those involved
and what it believes is expected of them.
Report Content
2.9 Th e r e p o r t b e g i n s b y r e v i e wi n g t h e s t r u c t u r e a n d
r esponsi bi l i t i es of boar ds of di r ect or s; here we have
s ummar i s ed our r ecommendat i ons i n a Code of Bes t
Practice. Next, we consider the role of auditors and address
a n u mb e r o f r e c o mme n d a t i o n s t o t h e a c c o u n t a n c y
pr of e s s i on. We t h e n d e a l wi t h t he r i ght s and
responsibilities of shareholders. The report concludes with
several appendi ces, i ncl udi ng at Appendix 2 not es on t he
roles of some of the bodies referred to in the report.
Companies to whom directed
3.1 The Code of Best Practice (on pages 58 to 60) is directed
to the boards of directors of all listed companies registered
i n t he UK, but we woul d e nc our a ge a s ma ny ot he r
companies as possible to aim at meeting its requirements.
Code Principles
3.2
3.3
3.4
3.5
3.6
The principles on which the Code is based are those of
openness, integrity and accountability. They go together.
Openness on the part of companies, within the limits set by
their competitive position, is the basis for the confidence
which needs to exist between business and all those who
have a st ake i n i t s success. An open appr oach t o t he
di s cl os ur e of i nf or mat i on cont r i but es t o t he ef f i ci ent
worki ng of t he market economy, prompis boards to take
ef f ect i ve act i on and al l ows shar ehol der s and ot her s t o
scrutinise companies more thoroughly.
I n t e g r i t y me a n s b o t h s t r a i g h t f o r wa r d d e a l i n g a n d
compteteness. What i s requi red of fi nanci al report i ng i s
t hat i t shoul d be honest and th~at i t shoul d pr esent a
balanced picture of the state of the company’s affairs. The
integrity of reports depends on the integrity of those who
prepare and present them.
Boards of directors are accountable to their shareholders
a n d b o t h h a v e t o p l a y t h e i r p a r t i n ma k i n g t h a t
accountability effective. Boards of directors need to do so
through the quality of the information which they provide
to shareholders, and shareholders through the.ir willingness
to exercise their responsibilities as owners.
The arguments for adhering to the Code are twofold. First,
a cl ear under st andi ng of ‘ r esponsi bi l i t i es and an open
approach to the way in which they have been discharged
wi l l assi st boar ds of di r ect or s i n f r ami ng and wi nni ng
support for their strategies. It will also assist the efficient
operat i on of capi t al market s and i ncrease confi dence i n
boar ds, audi t or s and f i nanci al r epor t i ng and hence t he
general level of confidence in business.
Second, if standards of financial reporting and of business
conduct more generally are not seen to be raised, a greater
r el i ance on r egul at i on may be i nevi t abl e. Any f ur t her
THE CODE OF BEST PRACTICE
degree of regulation would, in any event, be more likely to
be well directed, if it were to enforce what has already
been shown to be workable and effective by those setting
the standard.
Statement of Compliance
3.7 We r ecommend that listed companies reporting in respect
of year s endi ng af t er 30 June 1993 shoul d st at e i n t he
report and accounts whether they comply with the Code and
identify and give reasons for any areas of non-compliance.
The London St ock Exchange i nt ends t o r equi r e such a
statement as one of its continuing listing obligations.
3.8 We envisage, however, that many companies will wish to
go beyond the strict terms of the London Stock Exchange
r ul e and make a gener al st at ement about t he cor por at e
governance of their enterprises as some leading companies
have already done. We welcome such statements and leave
it to boards to decide the terms in which they make their
s t at ement of compl i ance. Boar ds ar e not expect ed t o
comment separately on each item of the Code witti whi ch
they are complying, but areas of non-compliance will have
to be dealt with individually.
3.9 The continuing obligations laid down by the London Stock
Ex c h a n g e s h o u l d r e q u i r e c o mp a n i e s ’ s t a t e me n t s o f
compl i ance t o have been t he subj ect of r evi ew by t he
auditors before publication. The review should cover only
t hose part s of t he compl i ance st at ement whi ch rel at e t o
p r o v i s i o n s o f t h e Co d e wh e r e c o mp l i a n c e c a n b e
obj ect i vel y ver i f i ed ( s ee f oot not e t o t he Code) . The
audi t or s s houl d not be r equi r ed t o r epor t f or mal l y a
satisfactory conclusion to their review, but if they identify
an area of non-compliance which is not properly disclosed,
t hey shoul d draw at t ent i on t o i t i n t hei r report on t he
f i nanci al st at ement s. We r e c o mme n d t hat t he Audi t i ng
Pr act i ces Boar d shoul d consi der gui dance f or audi t or s
accordi ngl y
THE CODE OF BEST PRACTICE
3.10 The Code is to be followed by individuals and companies in
the light of their own particular circumstances. They arc
responsible for ensuring that their actions meet the spirit of
the Code and in interpreting it they should give precedence
to substance over form.
Keeping the Code up to date
3.11 We have addressed those issues which appeared from the
evidence before us to require the most immediate attention.
The si t uat i on, however , i s devel opi ng. The Account i ng
Standards Board has in hand a programme of work on the
basis cf financial reporting. Revised accounting standards
and improved methods of financial presentation will result.
At the same time, views on best boardroom practice will
evolve in the light of experience, and European Community
directives and regulations may give rise to new issues. It is
essent i al , t her ef or e, that the Code, in addition to being
monitored, is kept up to date.
3. 12 We r e c omme nd t ha t our s pons or s , c onve ne d by t he
Fi na nc i a l Re por t i ng Counc i l , s houl d a ppoi nt a ne w
Committee by the end of June 1995 to examine how far
compl i ance wi t h t he Code has progressed, how far our
ot he r r e c omme nda t i ons ha ve be e n i mpl e me nt e d, a nd
whet her t he Code needs updat i ng i n l i ne wi t h emergi ng
i ssues. Our sponsors shoul d al so det ermi ne whet her t he
sponsorship of the new Committee should be broadened and
whether wider matters of corporate governance should be
i ncl uded i n i t s br i ef . In t h e me a n t i me , t h e p r e s e n t
Commi t t ee wi l l r emai n r es pons i bl e f or r evi ewi ng t he
implementation of its proposals and for identifying further
issues which its successor body might usefully consider.
The s e s t e ps wi l l e s t a bl i s h a c ont i nui ng pr oc e s s .of
governance review.
Compliance
3.13
3.14
Rai s i ng s t andar ds of cor por at e gover nance cannot be
achieved by structures and rules alone. They are important
because t hey provi de a framework whi ch wi l l encourage
and support good governance, but what counts is the way in
which they are put to use.
The responsibility for putting the Code into practice lies
directly with the boards of directors of listed companies to
THE CODE OF BEST PRACTICE
whom i t i s addr es s ed. Compl i anc e i t s el f , howev er , i s a
mat t er f or ever yone concer ned wi t h cor por at e gover nance.
We l ook t o t he f i nanci al i nst i t ut i ons and t he wi de r ange of
bodi es backi ng our wor k t o encour age t he adopt i on of our
r e c o mme n d a t i o n s b y c o mp a n i e s i n wh i c h t h e y h a v e a n
i nt er est . The medi a al so have a par t t o pl ay i n dr awi ng
at t ent i on t o gov er nanc e i s s ues of publ i c or s har ehol der
concer n. I t i s vi t al t o sei ze t he oppor t uni t y pr esent ed by a
cl i mat e of opi ni on whi ch accept s t hat changes ar e needed
and whi ch i s expect i ng t he Commi t t ee t o gi ve t he necessary
l ead.
3. 15 The Commi t t ee r ec ogni s es t hat s mal l er l i s t ed c ompani es
ma y i n i t i a l l y h a v e d i f f i c u l t y i n c o mp l y i n g wi t h s o me
a s p e c t s o f t h e C o d e a n d w e h a v e g i v e n c a r e f u l
consi der at i on t o t he r esponses t o t he dr af t r epor t whi ch
a d d r e s s e d t h i s p o i n t . T h e b o a r d s o f s ma t t e r l i s t e d
c ompani es who c annot , f or t he t i me bei ng, c ompl y wi t h
par t s of t he Code shoul d not e t hat t hey may i nst ead gi ve
t hei r r easons ftir non- c ompl i anc e. We bel i ev e, howev er ,
t hat full c ompl i anc e wi l l br i ng benef i t s t o t he boar ds of
such compani es and i t shoul d be t hei r obj ect i ve t o ensur e
t h a t t h e b e n e f i t s a r e a c h i e v e d . I n p a r t i c u l a r , t h e
appoi nt ment of appr opr i at e non- execut i ve di r ect or s shoul d
make a posi t i ve cont r i but i on t o t he devel opment of t hei r
busi nesses. Any pract i cal i ssues whi ch may ari se i n respect
of smat t er l i st ed compani es wi l t be t hor oughl y r evi ewed by
t he Commi t t ee and i t s successor.
3. 16 The Commi t t ee not es t hat c ompani es wi l l not be abl e t o
c o mp l y wi t h i t e ms 4 . 5 a n d 4 . 6 i n t h e Co d e u n t i l t h e
necessary gui dance f or compani es has been devel oped.
Board Effectiveness
4.1 Every publ i c company shoul d be headed by an effect i ve
board which can both lead and control the business. Within
the context of the UK unitary board system, this means a
board made up of a combi nat i on of execut i ve di rect ors,
wi t h t hei r i nt i mat e knowl edge of t he busi ness, and of
outside, non-executive directors, who can bring a broader
vi ew t o t he company’s act i vi t i es, under a chai rman who
accept s t he dut i es and r esponsi bi l i t i es whi ch t he post
entails.
4.2 Tests of board effectiveness include the way in which the
member,s of the board as a whole work together under the
c h a i r ma n , wh o s e r o l e i n c o r p o r a t e g o v e r n a n c e is
fundament al , and t hei r col l ect i ve abi l i t y t o provi de bot h
the leadership and the checks and balances which effective
gover nance demands. Shar ehol der s ar e r esponsi bl e f or
electing board members and it is in their interests to see
that the boards of their companies are properly constituted
and not dominated by any one individual.
4.3 All directors are equally responsible in law for the board’s
a c t i o n s a n d d e c i s i o n s . Ce r t a i n d i r e c t o r s ma y h a v e
part i cul ar responsi bi l i t i es, as execut i ve or non-execut i ve
di rect ors, for whi ch t hey are account abl e t o t he board.
Regar dl ess of speci f i c dut i es under t aken by i ndi vi dual
directors, however, it is for the board collectively to ensure
that it is meeting its obligations.
4.4 Whi l st i t i s t he boar d as a whol e whi ch i s t he f i nal
authority, executive and non-executive directors are likely
to contribute in different ways to its work. Non-executive
directors have two particularly important contributions to
make to the governance process as a consequence of their
independence from executive responsibility. Neither is in
conflict with the unitary nature of the board.
4.5 The first is in reviewing the performance of the board and
of t he execut i ve. Non-execut i ve di rect ors shoul d address
t hi s aspect of t hei r responsi bi l i t i es careful l y and shoul d
ensure that the chairman is aware of their views. If the
chairman is also the chief executive, board members should
look to a senior non-executive director, who might be the
deput y chai r man, as t he per son t o whom t hey shoul d
a ddr e s s a ny c onc e r ns a bout t he c ombi ne d of f i c e of
chai r man/ chi ef execut i ve and i t s consequences f or t he
ef f ect i veness of t he board. A number of compani es have
recogni sed t hat rol e and some have done so f ormal l y i n
thei r Arti cl es.
4. 6 The second i s i n taki ng the l ead where potenti al confl i cts
of interest arise. An important aspect of effective corporate
governance i s the recogni ti on that the speci fi c i nterests of
t he execut i ve management and t he wi der i nt erest s of t he
company may at times diverge, for example over takeovers,
boardroom successi on, or di rectors’ pay. I ndependent non-
e x e c ut i v e di r e c t or s , whose i nt er est s ar e l ess di r ect l y
affected, are well-placed to help to resolve such situations.
The Chairman
4. 7 The chai rman’ s rol e i n securi ng good corporate governance
i s cr uci al . Chai r men ar e pr i mar i l y r esponsi bl e f or t he
working of the board, for its balance of membership subject
to board and sharehol ders’ approval , for ensuri ng that al l
relevant issues are on the agenda, and for ensuring that all
di rect ors, execut i ve and non- execut i ve al i ke, are enabl ed
and encour aged t o pl ay t hei r f ul l par t i n i t s act i vi t i es.
Chairmen should be able to stand sufficiently back from the
day- t o- day r unni ng of t he busi ness t o ensur e t hat t hei r
boards are in full control of the company’s affairs and alert
to their obligations to their shareholders.
4.8 It i s for chai rmen to make certai n that thei r non-executi ve
di rect ors recei ve t i mel y, rel evant i nf ormat i on t ai l ored t o
t hei r needs, t hat t hey are properl y bri ef ed on t he i ssues
ari si ng at board meeti ngs, and that they make an effecti ve
contribution as board members in practice. It is equally for
chai rmen t o ensure t hat execut i ve di rect ors l ook beyond
t hei r execut i ve dut i es and accept t hei r f ul l shar e of t he
responsi bi l i ti es of governance.
4.9 Gi v e n t h e i mp o r t a n c e a n d p a r t i c u l a r n a t u r e o f t h e
chairman’s role, it should in principle be separate from that
of the chief executive. If the two roles are combined in one
person, it represents a considerable concentration of power.
We recommend, t heref ore, t hat t here shoul d be a cl earl y
accept ed di vi si on of r esponsi bi l i t i es at t he head of a
c o mp a n y , whi ch wi l l ensur e a bal ance of power and
aut hor i t y, such t hat no one i ndi vi dual has unf et t er ed
powers of deci si on. Where the chai rman i s al so the chi ef
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executive, it is essential that there should be a strong and
independent element on the board.
Non-Executive Directors
4. 10 The Commi t t ee bel i eves t hat t he cal i br e of t he non-
executive members of the board is of special importance in
setting and maintaining standards of corporate governance.
The emphasis in this report on the control function of non-
execut i ve di r ect or s i s a consequence of our r emi t and
s houl d not i n any way det r act f r om t he pr i mar y and
positive contribution which they are expected to make, as
equal board members, to the leadership of the company.
4.11 Non- execut i ve di r ect or s s houl d br i ng an i ndependent
j udgement t o bear on i ssues of st r at egy, per f or mance,
resources, i ncl udi ng key appoi nt ment s, and st andards of
conduct . We recommend t hat t he cal i bre and number of
non-execut i ve di rect ors on a board shoul d be such t hat
t hei r vi ews wi l l carry si gni fi cant wei ght i n t he board’s
d e c i s i o n s . T o me e t o u r r e c o mme n d a t i o n s o n t h e
composition of sub-committees of the board, all boards will
require a minimum of three non-executive directors, one of
whom may be the chairman of the company provided he or
she is not also its executive head. Additionally, two of the
three should be independent in the terms set out in the next
paragraph.
4. 12 An essent i al qual i t y whi ch non-execut i ve di rect ors shoul d
bring to the board’s deliberations is that of independence
of j udgement . We recommend t hat t he maj ori t y of non-
execut i ves on a boar d s houl d be indepen’dent of t he
company. This means that apart from their directors’ fees
a n d s h a r e h o l d i n g s , t h e y s houl d be i nde pe nde nt . of
ma n a g e me n t a n d f r e e f r o m a n y b u s i n e s s o r o t h e r
r el at i onshi p whi ch coul d mat er i al l y i nt er f er e wi t h t he
exercise of their independent judgement. It is for the board
to decide in particular cases whether this definition is met.
Information about the relevant interests of directors should
be disclosed in the Directors’ Report.
4. 13 On f ees , t h e r e i s a b a l a n c e t o b e s t r u c k b e t we e n
recogni si ng t he val ue of t he cont ri but i on made by non-
e x e c u t i v e d i r e c t o r s and not u n d e r mi n i n g t h e i r
independence. The demands which are now being made on
consci ent i ous non-execut i ve di rect ors are si gni fi cant and
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4. 14
4. 15
4. 16
4. 17
thei r fees shoul d refl ect the ti me whi ch they devote to the
company’s affairs. There is, therefore, a case for paying for
a ddi t i ona l r e s pons i bi l i t i e s t a k e n on, f or e x a mpl e , by
chai rmen of board commi ttees. I n order to safeguard thei r
i ndependent posi t i on, we regard i t as good pract i ce f or
non- execut i ve di rect ors not t o part i ci pat e i n share opt i on
schemes and f or t hei r servi ce as non- execut i ve di rect ors
not to be pensionable by the company.
Non- execut i ve di rect ors l ack t he i nsi de knowl edge of t he
company of the executive directors, but have the same right
of access t o i nf ormat i on as t hey do. Thei r ef f ect i veness
t ur ns t o a consi der abl e ext ent on t he qual i t y of t he
i nformati on whi ch they recei ve and on the use whi ch they
make of it. Boards should regularly review the form and the
extent of the information which is provided to all directors.
Gi ven the i mportance of thei r di sti ncti ve contri buti on, non-
execut i ve di r ect or s shoul d be sel ect ed wi t h t he same
i mparti al i ty and care as seni or executi ves. We recommend
that their appointment should be a matter for the board as a
whole and that there should be a formal selection process,
whi ch wi l l r ei nf or ce t he i ndependence of non- execut i ve
directors and make it evident that they have been appointed
on merit and not through any form of patronage. We regard
i t as good practi ce for a nomi nati on commi ttee (deal t wi th
bel ow) t o car r y out t he sel ect i on pr ocess and t o make
proposals to the board.
Companies have to be able to bring about changes in the
composi ti on of thei r boards to mai ntai n thei r vi tal i ty. Non-
e x e c u t i v e d i r e c t o r s ma y l o s e s o me t h i n g o f t h e i r
i ndependent edge, i f t hey r emai n on a boar d t oo l ong.
Fur t her mor e, the make-up of a board needs to change i n
l i ne wi t h new chal l enges. We recommend, t heref ore, t hat
non- execut i ve di rect ors shoul d be appoi nt ed f or speci f i ed
t erms. Thei r Let t er of Appoi nt ment shoul d set out t hei r
dut i e s , t e r m of of f i c e , r e mune r a t i on a nd i t s r e v i e w.
Reappoi nt ment shoul d not be aut omat i c, but a consci ous
decision by the board and the director concerned.
Our emphasi s on t he qual i t i es t o be l ooked fo.r i n non-
execut i ve di rect ors, combi ned wi t h t he great er demands
now being made on them, raises the question of whether the
suppl y of non-executi ve di rectors wi l l be adequate to meet
t he demand. When compani es encourage t hei r execut i ve
di rect ors t o accept appoi nt ment s on t he hoards of 0th;~
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companies, the companies and the individuals concerned all
gain. A policy of promoting this kind of appointment will
i ncr ease t he pool of pot ent i al non- execut i ve di r ect or s,
particularly if the divisional directors of larger companies
are consi dered for non-execut i ve post s, as wel l as t hei r
main board colleagues.
Professional Advice
4. 18 Occasions may arise when directors have to seek legal or
fi nanci al advi ce i n t he furt herance of t hei r dut i es. They
should always be able to consult the company’s advisers.
If, however, they consider it necessary to take independent
professional advice, we r ecommend that they should be
ent i t l ed t o do so at t he company’s expense, t hrough an
agreed procedure l ai d down formal l y, for exampl e i n a
Bo a r d Resolutiot;, i n t he Art i cl es, or i n t he Let t er of
Appointment.
Directors’ Training
4.19 The weight of responsibility carried by all directors and the
i n c r e a s i n g c o mmi t me n t wh i c h t h e i r d u t i e s r e q u i r e
emphasise the importance of the way in which they prepare
themselves for their posts. Given the varying backgrounds,
qual i f i cat i ons and exper i ence of di r ect or s, i t i s hi ghl y
desi r abl e t hat t hey shoul d al l under t ake some f or m of
internal or external training; this is particularly important
for directors, whether executive or non-executive, with no
p r e v i o u s b o a r d e x p e r i e n c e . Ne wl y - a p p o i n t e d b o a r d
members are al so ent i t l ed t o expect a prope,r process of
i nduct i on i nt o t he company’ s af f ai r s. I t is' then up t o
individual directors to keep abreast of their legislative and
broader responsibilities.
4.20 There are already courses for newly-appointed directors run
by the Institute of Directors and business schools. With the
suppor t of t he Bank of Engl and, t he Conf eder at i on of
British Industry, the Institute of Directors, and PRO NED,
a new c our s e c o v e r i n g t h e f u l l r a n g e o f b o a r d
r esponsi bi l i t i es wi l l be open t o di r ect or s shor t l y. The
training and development of directors is of importance to
good governance and i t i s one of t he i ssues whi ch we
suggest our successor body should keep under review.
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Board Structures and Procedures
4.21 The effectiveness of a board is buttressed by its structure
and procedures. One aspect of structure is the appointment
of committees of the board, such as the audit, remuneration
and nomination committees, referred to later in the report.
4.22 Another is that boards should recognise the importance of
t h e f i n a n c e f u n c t i o n b y ma k i n g i t t h e d e s i g n a t e d
responsibility of a main board director, who should be a
si gnat or y t o t he account s on behal f of t he boar d, and
should have the right of access to the Audit Committee.
4. 23 The bas i c pr ocedur al r equi r ement s ar e t hat t he boar d
should meet regularly, with due notice of the issues to be
di s cus s ed s uppor t ed by t he neces s ar y paper wor k, and
should record its conclusions. We recommend that boards
shoul d have a f or mal schedul e of mat t er s speci f i cal l y
reserved t o t hem for t hei r col l ect i ve deci si on, t o ensure
t hat t he di r ect i on and cont r ol of t he company r emai ns
f i r ml y i n t he i r ha nds a nd a s a- s a f e g u a r d a g a i n s t
misjudgements and possible illegal practices. A schedule of
these matters should be given to directors on appointment
and should be kept up to date.
4.24 We envisage that such a schedule would at least include:
(a) acquisition and disposal of assets of the company or
its subsidiaries that are material to the company;
(b) investments, capital projects, authority levels, treasury
policies, and risk management policies.
Boards should lay down rules to determine material,ity for
a ny t r a ns a c t i on, a n d s h o u l d e s t a b l i s h c l e a r l y wh i c h
t r ansact i ons r equi r e mul t i pl e boar d si gnat ur es. Boar ds
shoul d al so agree t he procedures t o be fol l owed when,
e xc e pt i ona l l y, de c i s i ons a r e r e qui r e d be t we e n boa r d
meetings.
The Company Secretary
4.25 The company secretary has a key role to play in ensuring
t hat boar d pr ocedur es ar e bot h f ol l owed and r egul ar l y
revi ewed. The chai rman and t he board wi l l l ook t o t he
company secr et ar y f o r g u i d a n c e o n what t hei r
responsibilities are under the rules and regulations to
which they are subject and on how those responsibilities
THE BOARD
4.26
4.27
should be discharged. All directors should have access to
t he advi ce and ser vi ces of t he company secr et ar y and
should recognise that the chairman is entitled to the strong
and positive support of the company secretary in ensuring
t he ef f ect i ve f unct i oni ng of t he boar d. I t s houl d be
standard practice for the company secretary to administer,
attend and prepare minutes of board proceedings.
Under t he Compani es Act t he di rect ors have a dut y t o
appoint as secretary someone who is capable of carrying
out the duties which the post entails. The responsibility for
ens ur i ng t hat t he s ecr et ar y r emai ns capabl e, and any
question of the secretary’s removal, should be a matter for
the board as a whole.
The Committee expects that the company secretary will be
a source of advice to the chairman and to the board on the
implementation of the Code of Best Practice.
Directors’ Responsibilities
4. 28 So t hat shareholders ar e cl ear wher e t he boundar i es
bet ween t he dut i es of di r ect or s and audi t or s l i e, we
r e c o mme n d t h a t a b r i e f s t a t e me n t o f d i r e c t o r s ’
responsibilities for the accounts should appear in the report
and account s, as a count er par t t o a st at ement by t he
auditors about their reporting responsibilities. The ground
which would need to be covered by the directors’ statement
is set out in Appendi x 3. The appropriate position for the
di r ect or s’ st at ement i s i mmedi at el y before t he audi t ors’
report, which in future will include a
responsibilities. The two statements
each other.
statement of auditors’
will thus. compl ement
Standards of Conduct
4.29 It i s i mpor t ant t hat al l empl oyees s houl d know what
standards of conduct are expected of them. We regard it as
good practice for boards of directors to draw up codes of
et hi cs or st at ement s of busi ness pract i ce and t o publ i sh
them both internally and externally.
THE BOARD
Nomination Committees
4.30 One approach to maki ng board appoi ntments. whi ch makes
clear how these appointments are made and assists boards
i n maki ng them, i s through the setti ng up of a nomi nati on
commi t t ee, wi t h t he r esponsi bi l i t y of pr oposi ng t o t he
board, in the first instance, any new appointments, whether
of execut i ve or of non- execut i ve di rect ors. A nomi nat i on
c ommi t t e e s houl d ha v e a ma j or i t y of non- e x e c ut i v e
di rectors on i t and be chai red ei ther by the chai rman or a
non-executi ve di rector.
internal Controls
4.31
4.32
Di rectors are responsi bl e under s.221 of the Companies Act
1985 for maintaining adequate accounting records. To meet
these responsibilities directors need in practice to maintain
a system of i nternal control over the fi nanci al management
of the company, i ncl udi ng procedures desi gned to mi ni mi se
t he ri sk of f raud. There i s, t heref ore, al ready an i mpl i ci t
requirement on directors to ensure that a proper system of
internal control is in place.
Since an effective internal control system is a key aspect of
the effi ci ent management of a company, we r e c omme nd
that the directors should make a statement in the report and
account s on t he ef f ect i veness of t hei r syst em of i nt ernal
cont rol and t hat t he audi t ors shoul~d report t hereon. The
cr i t er i a f or assessi ng ef f ect i veness and t he det ai l ed
gui dance for audi tors wi l l need to be establ i shed and our
recommendation to this effect is in paragraph 5.16.
Audit Committees
4.33 Si nce 1978, the New York Stock Exchange has requi red al l
listed companies to have audit committees composed solely
of i nde pe nde nt di r e c t or s a nd t he 1987 r epor t of t he
Ame r i c a n Treadway Commi ssi on concl uded t hat audi t
commi t t ees had a cr i t i cal r ol e t o pl ay i n ensur i ng t he
i n t e g r i t y o f U S c o mp a n y f i n a n c i a l r e p o r t s . Wh i l e
experience of audit committees in this country is shorter, it
i s encouragi ng, and around t wo- t hi rds of t he t op 250 UK
listed companies now have them in place.
4. 34 Experience in the United States has shown that, even where
audi t commi t t ees mi ght have been set up mai nl y t o meet
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l i st i ng r equi r ement s, t hey have pr oved t hei r wor t h and
d e v e l o p e d i n t o e s s e n t i a l c o mmi t t e e s o f t h e b o a r d .
S i mi l a r l y , r ecent l y publ i shed r esear ch i n t he Uni t ed
Ki ngdom concl udes t hat t he maj ori t y of compani es wi t h
audit committees are enthusiastic about their value to their
businesses. They offer added assurance to the shareholders
that the auditors, who act on their behalf, are in a position
to safeguard their interests.
4 . 3 5 The Commi t t e e t he r e f or e r e c omme nds t ha t a l l l i s t e d
companies should establish an audit committee. Our further
recommendati ons on audi t commi ttees are as fol l ows:
( a) Audi t commi t t ees shoul d be f or mal l y const i t ut ed t o
ensur e t hat t hey have a cl ear r el at i onshi p wi t h t he
boards to whom they are answerable and to whom they
shnuld report regul arl y. They shou_fd be gi ven wri t t en
t erms of ref erence whi ch deal adequat el y wi t h t hei r
member shi p, aut hor i t y and dut i es, and t hey shoul d
normally meet at least twice a year.
(b) .There s h o u l d b e a mi n i mu m o f t h r e e me mb e r s .
Membershi p shoul d be conf i ned t o t he non- execut i ve
di rect ors of t he company and a maj ori t y of t he non-
e x e c ut i v e s s e r v i ng on t he c ommi t t e e s houl d be
i nde pe nde nt , as def i ned i n par agr aph 4. 12 above.
Membershi p of t he commi t t ee shoul d be di scl osed i n
the annual report.
(cl
The ext er nal audi t or shoul d nor mal l y at t end audi t
committee meetings, as should the finance director. As
the board as a whol e i s responsi bl e for the fi nanci al
statements, other board members should also have the
r i g h t t o a t t e n d . T h e c o mmi t t e e s h o u l d h a v e a
di scussi on wi th the external audi tors, at l east once a
year , wi t hout execut i ve boar d member s pr esent , .to
ensure that there are no unresolved issues of concern.
(d) The audi t commi ttee shoul d have expl i ci t authori ty to
i nvesti gate any matters wi thi n i ts terms of reference,
the resources which it needs to do so, and full access
to information. The committee should be able to obtain
ext ernal prof essi onal advi ce and t o i nvi t e out si ders
with relevant experience to attend if necessary.
(e) The audi t commi ttee’ s duti es shoul d be determi ned i n
the l i ght of the company’ s needs but shoul d normal l y
include:
( i )
maki ng r ecommendat i ons t o t he boar d on t he
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4. 37 The Commi t t e e t he r e f or e r e ga r ds t he a ppoi nt me nt of
properly constituted audit committees as an important step
i n r a i s i ng s t a nda r ds of c or por a t e gove r na nc e . The i r
effect i veness depends on t hei r havi ng a st rong chai rman
who has the confidence of the board and of the auditors,
a nd on t he qua l i t y of t he non- e xe c ut i ve di r e c t or s .
Membershi p of an audi t commi t t ee i s a demandi ng t ask
requi ri ng commi t ment , t rai ni ng and ski l l . The di rect ors
concerned need t o have suffi ci ent underst andi ng of t he
issues to be dealt with by the committee to take an active
part in its proceedings. This is why committees should, if it
is appropriate and within their authority, be able to invite
outsiders with relevant experience to attend meetings.
4. 38 The ext er nal audi t or s s houl d be pr es ent at t he boar d
meeting when the annual report and accounts are approved
and preferably when the half-yearly report is considered as
well.
Internal Audit
4.39 The function of the internal auditors is complementary to,
but different from, that of the outside auditors. We regard
it as good practice for companies to establish internal audit
functions to undertake regular monitoring of key controls
and procedures. Such regular monitoring is an integral part
of a company’s syst em of i nt ernal cont rol and hel ps t o
ensure its effectiveness. An internal audit function is well
placed to undertake investigations on behalf of the audit
committee and to follow up any suspicion of fraud. It is
e s s e n t i a l t h a t h e a d s o f i n t e r n a l a u d i t s h o u l d h a v e
unrestricted access to the chairman of the aud‘it committee
in order to ensure the independence of their position.
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Board Remuneration
4.40 The overriding principle in respect of board remuneration
is that of openness. Shareholders are entitled to a full and
clear statement of directors’ present and future benefits,
and of how they have been determined. We r e c o mme n d
that in disclosing directors’ total emoluments and those of
the chairman and highest-paid UK director, separate figures
shoul d be gi ven for t hei r sal ary and performance-rel at ed
el ement s and t hat t he cri t eri a on whi ch performance i s
measured should be explained. Relevant information about
s t ock opt i ons , s t ock appr eci at i on r i ght s , and pens i on
contributions should also be given.
4.41 In addition, we r e c omme nd t hat fut ure servi ce cont ract s
s houl d not exceed t hr ee year s wi t hout s har ehol der s ’
approval and that the Companies Act should be amended in
l i ne wi t h t hi s r ecommendat i on. Thi s woul d st r engt hen
shareholder control over levels of compensation for loss of
office.
4 . 4 2 We a l s o r e c o mme n d t h a t b o a r d s s h o u l d a p p o i n t
remunerat i on commi t t ees, consi st i ng whol l y or mai nl y of
non-execut i ve di rect ors and chai red by a non-execut i ve
director, to recommend to the board the remuneration of
the executive directors in all its forms, drawing on outside
advi ce as necessary. Execut i ve di rect ors shoul d pl ay no
part in decisions on their own remuneration. Membership
of t he r emuner at i on commi t t ee s houl d appear i n t he
Directors’ Report. Best practice in this field is set out in
PRO NED’s Remuneration Committee guidelines, published
in 1992.
4 . 4 3 Th e Co mmi t t e e h a s r e c e i v e d p r o p o s a l s f o r g i v i n g
shareholders the opportunity to determine matters such as
directors’ pay at general meetings, but does not see how
t hese suggest i ons coul d be made workabl e. A di rect or’s
remuneration is not a matter which can be sensibly reduced
to a vote for or against; were the vote to go against a
particular remuneration package, the board would still have
to determine the remuneration of the director concerned. In
addition, there are such practical considerations as the need
to agree directors’ remuneration on appointment.
THE BOARD
4 . 4 4 Sh a r e h o l d e r s r e q u i r e t h a t t h e r e mu n e r a t i o n o f d i r e c t o r s
shoul d be bot h f ai r and compet i t i ve. St r i ki ng t hi s bal ance
i n v o l v e s d e t a i l e d c o n s i d e r a t i o n o f t h e k i n d wh i c h a
r emuner at i on commi t t ee, whose member s have no per sonal
i n t e r e s t i n t h e o u t c o me , c a n g i v e t o t h e ma t t e r .
Remuner at i on commi t t ees need t o have t he i nt er est s of t he
company and t he shar ehol der s al ways i n mi nd i n comi ng t o
t hei r deci si ons and t he chai r man of t he commi t t ee shoul d
be avai l abl e t o r espond t o any concer ns of shar ehol der s at
t he Annual Gener al Meet i ng.
4. 45 The Annual Gener al Meet i ng pr ov i des t he oppor t uni t y f or
s h a r e h o l d e r s t o ma k e t h e i r v i e ws o n s u c h ma t t e r s a s
d i r e c t o r s ’ b e n e f i t s k n o w n t o t h e i r b o a r d s . I t i s t h e
Co mmi t t e e ’ s v i e w t h a t s h a r e h o l d e r s c a n p l a y a mo r e
,oractical gov er nanc e r ol e by ai mi ng t o i nf l uenc e boar d
pol i ci es i n t hi s way, t han by seeki ng t o make t he det ai l of
board deci si ons subj ect t o t hei r vot e.
4 . 4 6 F u r t h e r c h a n g e s t o t h e r u l e s f o r d i s c l o s u r e , s u c h a s
l engt heni ng t he l i s t of di r ec t or s whos e r emuner at i on i s
i ndi v i dual l y i dent i f i ed, and t he r ol e whi c h s har ehol der s
c o u l d p l a y , e i t h e r i n v o t i n g o n p a r t i c u l a r a s p e c t s o f
r emuner at i on or i n t abl i ng advi sor y r esol ut i ons al ong l i nes
now devel opi ng i n t he USA, wi l l need t o be revi ewed i n t he
l i g h t o f e x p e r i e n c e . Di r e c t o r s ’ c o n t r a c t s a n d p a y a r e
aspect s of boar d account abi l i t y whi ch t he Commi t t ee wi l l
cont i nue t o moni t or i n t he expect at i on t hat t hey wi l l be on
t he agenda of our successor body.
Financial Reports
4.47 A b a s i c we a k n e s s i n t h e c u r r e n t s y s t e m o f f i n a n c i a l
r e p o r t i n g i s t h e p o s s i b i l i t y o f d i f f e r e n t a c c o u n t i n g
t r eat ment s bei ng appl i ed to,essentially t he same f act s, wi t h
t he consequence t hat di f f er ent r esul t s or f i nanci al posi t i ons
c oul d be r epor t ed, eac h appar ent l y c ompl y i ng wi t h t he
o v e r r i d i n g r e q u i r e me n t t o s h o w a t r u e a n d f a i r v i e w.
Regardless o f h o w f a r t h e ma r k e t c a n u n d e r s t a n d t h e
i mp l i c a t i o n s o f a l t e r n a t i v e account i ng t r eat ment s or see
t h r o u g h p r e s e n t a t i o n a l t e c h n i q u e s d e s i g n e d t o s h o w a
c ompany ’ s f i gur es i n t he mos t f l at t er i ng l i ght , t her e ar e
advant ages t o i nvest or s, anal yst s, ot her account s users and
ul t i mat el y t o t he company i t sel f i n f i nanci al r epor t i ng r ul es
whi ch l i mi t t he scope f or uncer t ai nt y and mani pul at i on.
4.48
4.49
4.50
4.5‘1
4.52
4.53
THE BOARD
The lifeblood of markets is information and barriers to the
flow of relevant information represent imperfections in the
market. The need to sift and correct the information put out
by compani es adds cost and uncert ai nt y t o t he market ’s
pricing function. The more the activities of companies are
t ransparent , t he more accurat el y wi l l t hei r securi t i es be
valued.
In addition, the wider the scope for alternative treatments,
t he l es s us ef ul f i nanci al r epor t s become i n t er ms of
comparability - over time and between companies.
What shareholders (and others) need from the report and
accounts is a coherent narrative, supported by the figures,
o f t h e c o mp a n y ’ s p e r f o r ma n c e a n d p r o s p e c t s . We
recommend that boards should pay particular attention to
t hei r dut y t o pr es ent a bal ance, : and under s t andabl e
assessment of their company’s position. Balance requires
that setbacks should be dealt with as well as successes,
whi l e t he need for t he report t o be readi l y underst ood
emphasises that words are as important as figures.
The cardi nal pri nci pl e of fi nanci al report i ng i s t hat t he
view presented should be true and fair. Further principles
ar e t hat boar ds s houl d ai m f or t he hi ghes t l evel of
di scl osur e consonant wi t h prese,nti~ng report s whi ch are
u n d e r s t a n d a b l e a n d wi t h a v o i d i n g d a ma g e t o t h e i r
competitive position. They should also aim to ensure the
integrity and consistency of their reports and they should
meet the spirit as well as the letter of reporting standards.
The Committee wholeheartedly endorses the objectives of
t he Fi nanci al Repor t i ng Counci l and t he Account i ng
St andar ds Boar d i n set t i ng r epor t i ng st andar ds. I t al so
welcomes the action being taken by the Financial Reporting
Revi ew Panel over compani es who.se accounts fall below
accepted reporting standards.
The Committee recognises the advantage to users of reports
and accounts of some explanation of the factors likely to
influence their company’s future progress. The inclusion 01
an essent i al l y f or war d- l ooki ng Oper at i ng and Fi nanci al
Revi ew, al ong t he l i nes devel oped by t he Account i ng
Standards Board for consultation, would serve this purpose.
THE BOARD
Reporting Practice
4.54 Listed companies publish full financial statements annually
and hal f-yearl y report s i n t he i nt eri m. In bet ween t hese
ma j or a n n o u n c e me n t s , b o a r d s ma y n e e d t o k e e p
shareholders and the market in touch with their company’s
progress. The guiding principle once again is openness and
boards shoul d ai m for any i nt erveni ng st at ement s t o be
wi del y ci rcul at ed, i n fai rness t o i ndi vi dual sharehol ders
and to minimise the possibility of insider trading.
4.55 If companies reported quarterly, the need for more informal
me t h o d s o f k e e p i n g i n v e s t o r s i n f o r me d wo u l d b e
di mi ni shed. Quart erl y report i ng woul d, however, i nvol ve
addi t i onal cost s for compani es and ul t i mat el y for t hei r
shar ehol der s and has not been r ecommended t o us by
s har ehol der bodi es , ‘4.ho accept t he pr esent pat t er n of
reporting by boards.
4.56 We consi der t hat i nt eri m report s shoul d be expanded i n
order to increase their value to users. We recommend t hat :
(a)
(b)
(c)
Cd)
balance sheet information should be included with the
interim report. There should not be a requirement for a
full audit, but the interim report should be reviewed by
t he audi t ors, who shoul d di scuss t hei r fi ndi ngs wi t h
the audit committee;
t he cont i nui ng obl i gat i ons l ai d down by t he London
Stock Exchange on UK companies admitted to listing
shoul d be amended t o t hat effect and t he Audi t i ng
Pr act i ces Boar d shoul d devel op appr opr i at e r evi ew
guidance;
‘.
t he Account i ng St andards Board i n conj unct i on wi t h
t he London St oc k Exc ha nge s houl d c l a r i f y. t he
accounting principles which companies should follow
in preparing interim reports;
a requirement for inclusion of cash flow information in
interim reports should be considered by our successor
body.
4.57 Resear ch has shown t hat t he most wi del y r ead par t of
company reports is the opening statement, normally by the
chai r man. I t i s t her ef or e of speci al i mpor t ance t hat i t
shoul d provi de a bal anced and readabl e summary of t he
company’s performance and prospect s and t hat i t shoul d
represent the collective view of the board.
THE BOARD
4. 58 The demand f or an ever - i ncr easi ng amount of det ai l i n
reports and accounts has to be weighed against the need for
t hem t o be under st andabl e by t he r easonabl y i nf or med
shar ehol der . Si mpl i f i ed f or ms of r epor t , i ncl udi ng t he
shortened version of the accounts, allow boards to address
shareholders who would prefer such a statement, but make
t he need f or t he assessment t o be bal anced even mor e
exacting.
4. 59 Al t hough a company’ s publ i shed r epor t s and i t s Annual
General Meeting are its primary channels of communication
with shareholders, companies and their major shareholders
may need to be in touch more frequently. The Institutional
Shar ehol der s ’ Commi t t ee’ s St at ement on t he Res pon-
s i bi l i t i es of I ns t i t ut i onal Shar ehol der s gi ves pr act i cal
gui dance on how shar ehol der s can best exer ci se t hei r
responsibilities as owners in this regard. We fully endorse
their recommendation that there should be regular contact
be t we e n c o mp a n i e s and t he i r ma j o r i n s t i t u t i o n a l
shareholders at senior level and that such matters as board
strategy and structure should be kept under review.
Pensions Governance
4. 60 There are governance i ssues rel at i ng t o company pensi on
funds, hi ghl i ght ed by t he Maxwel l affai r, but t hey fal l
wi t hi n t he remi t of t he Pensi on Law Revi ew Commi t t ee
under t he chai r manshi p of Pr of essor Goode, whi ch i s
c ur r e nt l y r e vi e wi ng t he f r a me wor k of pe ns i on f und
l e gi s l a t i on a nd r e gul a t i on. I n t he l i ght of t hi s , t he
Committee decided that it would be inappropriate for it to
deal specifically with pension fund governance issues.
Importance of Audit
5.1 The annual audit is one of the cornerstones of corporate
gover nance. Gi ven t he s epar at i on of owner s hi p f r om
management, the directors are required to report on their
stewardship by means of the annual report and financial
statements sent to the shareholders. The audit provides an
ext er nal and obj ect i ve c he c k on t he way i n whi ch t he
financial statements have been prepared and presented, and
it is an essential part of the checks and balances required.
The question is not whether there should be an audit, but
how to ensure its objectivity and effecti veness.
5.2 Audi t s ar e a r eassur ance t o al l who have a f i nanci al
i nt er est i n compani es, qui t e apar t f r om t hei r val ue t o
boards of directors. The most direct method of ensuring
that companies are accountable for their actions is through
open disclosure by boards and through audits carried out
against strict accounting standards.
5.3 The framework in which auditors operate, however, is not
well designed in certain respects to provide the objectivity
whi ch sharehol ders and t he publ i c expect of audi t ors i n
car r yi ng out t hei r f unct i on. The mai n r eas ons ar e as
follows:
(a)
(b)
Account i ng st andards and pract i ce somet i mes al l ow
boards t oo much scope for present i ng fact s and t he
f i gur es der i ved f r om t hem i n a var i et y of ways .
Audi t or s c a nnot s t a nd f i r m a ga i ns t a pa r t i c ul a r
account i ng t r eat ment i f i t i s per mi t t ed wi t hi n t he
standards.
‘.
Al t hough t he s ha r e hol de r s f or ma l l y a ppoi nt t he
auditors, and the audit is carried out in their interests,
t he sharehol ders have no effect i ve say i n t he audi t
negotiation and have no direct link with the auditors.
Indeed the Committee can see no practicable way of
establishing one. Auditors do, however, have to work
closely with those in management who have prepared
t he fi nanci al st at ement s whi ch t hey are audi t i ng i n
order to carry out their task, and audit firms, like any
ot he r bus i ne s s , wi l l wi s h t o have a cons t r uct i ve
relationship with their clients.
AUDI TI NG
(cl
Cd)
Audi t fi rms are i n compet i t i on wi t h each ot her for
business. They wish to maximise their business with
companies, of which auditing may only be a part. To
t he ext ent t hat t hey compet e on t he basi s of t hei r
professional reputation, this will act as an incentive to
maintain high standards. So will the ethical guidance
of the profession, and the threat of litigation. To the
extent however that audit firms compete on price and
on meeting the needs of their clients (the companies
they audit), this may be at the expense of meeting the
needs of the shareholders.
Compani es t oo are subj ect t o compet i t i ve pressures.
They will wish to minimise their audit costs and they
are likely to have a clear view as to the figures they
wi s h t o s e e p u b l i s h e d , i n o r d e r t o me e t t h e
expectations of th-eir shareholders.
5.4 A f ur t her pr obl em i s t he l ack of under st andi ng of t he
nature and extent of the audi
rs’ role. This is the so-called
‘expectations gap’ - the difference between what audits do
achi eve, and what i t i s t hought t hey achi eve, or shoul d
achi eve. The expect at i ons gap i s damagi ng not onl y
because i t refl ect s unreal i st i c expect at i ons of audi t s but
also because it has led to disenchantment with their value
in the wake of the Capar-o j udgment (paragraphs 5. 31 t o
5.35 below).
5.5 Steps have already been taken, within the last three years,
to strengthen the audit system through the establishment of
a new r egul at or y f r amewor k. The Fi nanci al Repor t i ng
Counci l and i t s as s oci at ed bodi es - t h e Ac c o u n t i n g
St andards Board, t he Urgent Issues Task Force, and t he
Fi nanci al Report i ng Revi ew Panel - have been set up to
i mprove and t i ght en account i ng st andards, t o deal wi t h
problem areas as they emerge, and to examine departures
by i ndi vi dual compani es from t he st at ut ory requi rement s
and account i ng st andards. The new st at ut ory regi me for
r egul at i ng audi t or s r equi r es al l audi t or s t o s at i s f y a
supervisory body as to their competence, experience and
t r ai ni ng, and t o be subj ect t o r egul ar moni t or i ng. The
arrangements for setting auditing standards have also been
reformed with the establishment of the Auditing Practices
Board.
AUDITING
5.6 The new system has only recently been established and its
ful l i mpact has yet to be fel t. I n the fol l owi ng paragraphs
we endorse the steps that are bei ng taken and recommend
addi t i onal act i on t o st rengt hen publ i c conf i dence i n t he
audit approach.
Professional objectivity
5.7 The c e nt r a l i s s ue i s t o e ns ur e t ha t a n a ppr opr i a t e
r e l a t i o n s h i p e x i s t s b e t we e n t h e a u d i t o r s a n d t h e
management whose fi nanci al statements they are audi ti ng.
Sharehol ders requi re audi tors to work wi th and not agai nst
ma na ge me nt , whi l e a l wa y s r e ma i ni ng pr of e s s i ona l l y
obj ect i ve - that is to say, applying their professional skills
i mpar t i al l y and r et ai ni ng a cr i t i cal det achment and a
consciousness of their accountability to those who formally
a p p o i n t t h e m. Ma i n t a i n i n g s u c h a p r o f e s s i o n a l a n d
obj ecti ve rel ati onshi p i s the responsi bi l i ty both of boards
of directors and of auditors, as is that of taking appropriate
action if the basis for that relationship no longer holds.
5. 8 An essent i al f i rst st ep must be t he devel opment of more
ef f ect i ve account i ng st andar ds. Account i ng st andar ds
provi de i mportant reference poi nts agai nst whi ch audi tors
exer ci se t hei r pr of essi onal j udgement . Thei r posi t i on i s
s t r e n g t h e n e d i f s t a n d a r d s d o n o t a l l o w a l t e r n a t i v e
a c c ount i ng t r e a t me nt s . The wor k of t he Ac c ount i ng
Standards Board is well in hand and has our full support.
5.9 A second st ep shoul d be t he f or mat i on by ever y l i st ed
company of an audi t commi ttee whi ch gi ves, the audi tors
di rect access to the non-executi ve members of the board.
Shareholders look to the audit committee to ensure that the
rel ati onshi p between the audi tors and management remai ns
obj ecti ve and that the audi tors are abl e to put thei r vi ews
in the event of any difference of opinion with management.
‘Quarantining’ audit from other services
5 . 1 0 Among t he pr opos i t i ons ma de t o t he Commi t t e e t o
strengthen the obj ecti ve rel ati onshi p between audi tors and
management, one was that audi t fi rms shoul d not provi de
other types of servi ce to thei r audi t cl i ents. The argument
runs that such a prohibition would remove any pressure on
the auditors to give way to management on audit matters in
order not to j eopardi se thei r other busi ness servi ces; and
AUDI TI NG
that it would remove any incentive for auditors to take on
audits at rates which could risk corner-cutting in the hope
of obtaining more remunerative non-audit work.
5.11
Such a prohibition would limit the freedom of companies to
choose t hei r sources of advi ce and coul d i ncrease t hei r
costs. The Committee was not persuaded that any potential
gains in objectivity would outweigh these disadvantages. It
does, however, strongly support full disclosure of fees paid
to audit firms for non-audit work. The essential principle is
that disclosure must enable the relative significance of the
company’s audit and non-audit fees to the audit firm to be
assessed, both in a UK context and, where appropriate, a
wo r l d wi d e c o n t e x t . We r e c o mme n d t hat t he 1991
Regulations under the Companies Act on the disclosure of
remuneration for non-audit work should be reviewed and
amended as necessary in order to apply this principle. We
also regard it as good practice for audit committees to keep
under review the non-audit fees paid to the auditor both in
relation to their significance to the auditor and in relation
to the company’s total expenditure on consultancy.
Rotation of auditors
5.12
Anot her pr opos al was t hat s ome f or m of compul s or y
rot at i on of audi t fi rms shoul d be i nt roduced, t o prevent
relationships between management and auditors becoming
too comfortable. The Committee felt that any advantages
which this could bring would be more than outweighed by
the loss of the trust and experience which are built up when
t he r el at i onshi ps ar e sound, and by t he r i sk t o audi t
effect i veness at t he changeover. The Commi t t ee agreed,
however, that in the case of listed companies a periodic
change of audit partners should be arranged to bring a fresh
approach to the audit. We recommended in our draft report
that the accountancy profession should draw up appropriate
guidelines and we support the steps which it is now taking
t o do so. We woul d expect t he gui del i nes t o al l ow a
measure of flexibility over timing to take account of the
incidence of other changes in senior personnel, both in the
audit team and in the client company, which have helped to
keep a di st i nct i on i n r el at i onshi ps bet ween cl i ent and
auditor.
AUDI TI NG
Ways to increase effectiveness and value of the audit
The ‘Expectations Gap’
5.13 An essential first step is to be clear about the respective
responsibilities of directors and auditors for preparing and
reporting on the financial statements of companies, in order
to begin to narrow the ‘expectations gap’.
5.14 The audi t or s ’ r ol e i s t o r epor t whet her t he f i nanci al
st at ement s gi ve a t r ue and f ai r vi ew, and t he audi t i s
des i gned t o pr ovi de a r eas onabl e as s ur ance t hat t he
financial statements are free of material misstatements. The
a udi t or s ’ r ol e i s not ( t o ci t e a f ew of t he mi sunder -
st andi ngs) t o pr epar e t he f i nanci al st at ement s, nor t o
provide absolute assurance that the figures in the financial
statements are correct, nor to provide a guarantee that the
c ompa ny wi l l c ont i nue i n e xi s t e nc e . Th e Au d i t i n g
Practices Board is at present developing proposals for an
expanded report which would describe the key features of
the audit process. The Committee supports this initiative.
Audi t or s ’ r e por t s s houl d s t a t e c l e a r l y t he a udi t or s ’
responsibilities for reporting on the financial statements, as
a counterpart to a statement of directors’ responsibilities
for preparing the financial statements (see paragraph 4.28
above).
5.15 The Commi t t ee s t r ongl y s uppor t s t he l ead whi ch t he
Auditing Practices Board is taking on the development of
auditing practice generally. We believe that there should be
an extension of the audit which will add to its value to all
users of accounts and bring it closer into line with public
expect at i ons. We di scuss bel ow some of t he pr oposal s
currently under consideration and have set out background
infol-mation on the current r,ules at Apper~clis 5. Wi d e n i n g
the scope of the audit is likely to require boards to widen
the scope of their reports, since auditors can normally only
audi t mat t er s on whi ch t he di r ect or s have t hemsel ves
reported.
AUDI TI NG
Internal Control
5.16
The Commi t t ee i s convi nced t hat an ef f ect i ve i nt er nal
c ont r ol s y s t e m i s a n e s s e nt i a l pa r t of t he e f f i c i e nt
management of a company. We have al ready recommended
t hat di rect ors shoul d report on t he ef f ect i veness of t hei r
syst em of i nt ernal cont rol , and t hat t he audi t ors shoul d
report on thei r statement. A great deal of detai l ed work i s
now ne c e s s a r y t o de v e l op t he s e pr opos a l s , a nd we
r e c o mme n d t I1 a t t h e a c c o u n t a n c y p r o f e s s i o n , i n
conj uncti on wi th representati ves of preparers of accounts,
should take the lead in:
(a) developing a set of criteria for assessing effectiveness;
( b) devel opi ng gui dance f or compani es on t he f or m i n
which directors should report; and
( c) devel opi ng gui dance f or audi t or s on r el evant audi t
pr ocedur es and t he f or m i n whi ch audi t or s shoul d
report.
5.17 We r ecommend t hat t he quest i on o
t hese devel opment s shoul d be dec
experi ence.
f l egi sl at i on t o back
ided i n t he l i ght of
Going Concern
5.16 U n d e r c o mp a n y l a w , a c c ount s a r e pr e pa r e d on t he
assumption that the company is a going concern. There is,
however, no expl i ci t requi rement f or di rect ors t o sat i sf y
themsel ves that i t i s reasonabl e to make thi s assumpti on,
for exampl e by the preparat-i on of an adequate cash fl ow
f or e c a s t . The r e i s a l s o s c ope f or a me ndi ng a udi t i ng
guidelines to require the auditor to take a more active role
in testing going concern assumptions.
5.19 I n vi ew of the understandabl e pub’lic criticism of the audit
pr oc e s s whe n c ompa ni e s c ol l a ps e wi t hout a ppa r e nt
warni ng, there are strong arguments for amending company
law to place an explicit requirement on directors to satisfy
themselves that the going concern basis is appropriate, and
t o r epor t accor di ngl y t o shar ehol der s. There i s al so a
strong case for extendi ng the scope of the audi t, to test
goi ng concer n assumpt i ons mor e speci f i cal l y, and f or
requi ri ng the audi tors to gi ve an opi ni on on the di rectors’
report. Many proposal s have been made to the Commi ttee
along these lines.
A U D I T I N G
5. 20 The Commi t t ee bel i eves t hat goi ng concer n pr obl ems
mor e l i kel y t o be addr es s ed s ucces s f ul l y i f t hey
i dent i f i ed ear l y. Ther e ar e, however , t wo gr ounds
concern:
(a) There must be a risk that any qualification about
are
ar e
f or
the
company’s financial viability, however it is expressed,
will precipitate the company’s collapse. There is a fine
balance to be drawn between drawing proper attention
to the conditions on which continuation of the business
depends, and not thereby bringing the business down.
(b) The Committee does not believe that the implications
of the legal presumption that the accounts are prepared
on a goi ng concern basi s are wi del y underst ood by
directors. In particular the Committee doubts that it is
g e n e r a l l y a p p r e c i a t e d t h a t ‘ g o i n g c o n c e r n ’ i s
interpreted in present auditing guidelines as meaning
t hat t he company wi l l st i l l be operat i ng si x mont hs
following the date of the audit report or one year after
the date of the balance sheet, whichever is the later.
This may be further ahead than many companies can
see, for example in a recession.
5.21 The Committee concludes that as a fundamental concept of
a c c o u n t i n g t h e g o i n g c o n c e r n p r i n c i p l e s h o u l d b e
conscientiously applied and that new guidelines should be
developed. It emphasises however that new guidelines must
strike a careful balance between drawing proper attention
to the conditions on which the continuation of the business
d e p e n d s , a n d n o t r e q u i r i n g d i r e c t o r s t o e x p r e s s
u n n e c e s s a r i l y c a u t i o u s r e s e r v a t i o n s t h a t c o u l d o f
t hemsel ves j eopardi se t he busi ness. Di rect ors shoul d be
required to satisfy themselves that the business is a going
c onc e r n on t he ba s i s t ha t t he y ha ve a r e a s o n a b l e
expect at i on that it will continue in operation for the time
period which the guidelines d,efine. Directors should not be
expected to give a firm guarantee about their company’s
prospect s because t here can never be compl et e cert ai nt y
about future trading. The guidelines should also recognise
the position of’ smaller companies.
AUDI TI NG
5.22
Fraud
5.23
5.24
5.25
5.26
The
(a)
(b)
(c)
(d)
Committee recommends that:
directors should state in the report and accounts that
t he bus i nes s i s a goi ng concer n, wi t h s uppor t i ng
assumptions or qualifications as necessary;
the auditors should report on this statement;
t he a c c ount a nc y pr of e s s i on i n c onj unc t i on wi t h
represent at i ves of preparers of account s shoul d t ake
t he l ead i n devel opi ng gui dance for compani es and
auditors;
the question of Legislation should be decided in the
light of experience.
The prime responsibility for the prevention and detection
of fraud (and other illegal acts) is that of the board, as part
of its fiduciary responsibility for protecting the assets of
t he company. The audi t or’s responsi bi l i t y, as defi ned i n
audi t i ng gui dance, i s ‘ pr oper l y t o pl an, per f or m and
eval uat e hi s audi t wor k s o asi;. ha ve a r e a s ona bl e
expect at i on of det ect i ng mat er i al mi sst at ement s i n t he
financial statements’.
One probl em for t he audi t ors i s t hat by i t s very nat ure
f r aud, i f i t i nvol ves f or ger y, col l usi on or management
over r i de of cont r ol syst ems, is hard to detect. It is no
solution, as some have suggested, simply to place a duty on
the auditor to detect material fraud because he will never
be in a position to guarantee that no such fraud has taken
place. A higher level of safeguard against some categories
of fraud can be attempted by carrying out a more extensive
audit, but at a cost. The question is whether that extra cost
is justified.
Another problem for the auditors is when they suspect that
top management itself is implicated in the fraud, without
having the necessary evidence to back up their suspicions.
They ar e not i n a st r ong enough posi t i on t o conf r ont
ma n a g e me n t , nor have t hey a cas e t o r epor t t o t he
appropriate authorities.
These are not easy problems to resolve, but an effective
and i ndependent -mi nded audi t commi t t ee i s an essent i al
safeguard. It has an important role to play in considering
B
AUDI TI NG
whether any extra work should be undertaken in addition to
the normal audit procedures to investigate defences against
fraud. and in reviewing reports on the adequacy of internal
contol systems. The audit committee also provides a forum
i n whi ch audi tors can di scuss at board l evel any concern
t hey may have about t he possi bi l i t y of f r aud by seni or
ma na ge me nt . It can t hen c o mmi s s i o n wh a t e v e r
investigations are necessary to resolve the matter.
5. 27 One pr oposal made t o t he Commi t t ee was t hat audi t or s
shoul d have a dut y t o r epor t f r aud t o t he appr opr i at e
authori ti es. The audi tor’ s duty i s normal l y to report fraud
t o seni or management ( see Appendix 5) . Where, however,
he no l onger has confi dence that seni or management wi l l
deal adequat el y wi t h t he mat t er , he i s encour aged by
pr of e s s i ona l gui da nc e t o r e por t f r a ud t o t he pr ope r
authori ti es. Lord Justi ce Bi ngham, i n hi s recent report on
BCCI, has recommended that in the case of banks it would
be be t t e r f or t he r e t o be a s t a t ut or y dut y , a nd t he
Go v e r n me n t , i n a c c e pt i ng t he r e c omme nda t i on, ha s
announced that a si mi l ar approach wi l l be extended to the
rest of t he regulate;! sect or ( namel y bui l di ng societies:~.
insurance, and investment business).
5. 28 The Committee does not recommend that a statutory duty to
r epor t fr,aud shoul d be ext ended beyond t he r egul at ed
sector to the general i ty of compani es. The Commi ttee does
however see scope f or ext endi ng t o t he audi t or s of al l
compani es the statutory provi si ons appl yi ng to audi tors i n
the regulated sector which enable them to report reasonable
suspi ci on of f raud f reel y t o t he appropri at e i nvest i gat ory
authori ti es. Thi s woul d strengthen the positiqn of audi tors
who report fraud against the risk of a suit brought against
t hem by t hei r cl i ent f or ( f or exampl e) breach of dut y t o
mai nt ai n a conf i dent i al cl i ent rel at i onshi p or def amat i on.
We r ecommend t hat t he Gover nment shoul d consi der
introducing legislation accordingly.
Other illegal Acts
5.29 Compani es ar e now subj ect t o a wi de r ange of l egal
requi rements, many of whi ch fal l outsi de the scope of an
audit of the financial statements. Auditing guidance on the
respecti ve responsi bi l i ti es of management and the audi tor
is in preparation but there are a number of difficult issues
on which there is no clear consensus at present.
I
AUDITING
5.30 The Commi t t ee’s vi ew i s t hat i t i s t he responsi bi l i t y of
boards to establish what their legal duties are and to ensure
that they monitor compliance with them. It is also our view
that this would be enhanced if the auditors’ role were to
check that boards had established their legal requirements
and that a working system for monitoring compliance was
in place. There would be difficulty in ascribing a wider
role to auditors, for example requiring them to investigate
any i dent i fi ed fai l ures i n t he syst em and any suspect ed
i l l egal act s whi ch ar e encount er ed, becaus e t hey ar e
unlikely to have the appropriate expertise. They will not
know t he l egal requi rement s i n fi el ds whi ch are out si de
their scope, nor are they likely to have the expertise to
investigate the legality of particular acts if their suspicions
are aroused. We recommend t hat t hi s subj ect shoul d be
further considered by the accountancy and legal professions
and representatives of preparers of accounts.
Auditors’ Liability
5.31 In the Caparo juagment, the House of Lords laid down that
auditors owed a legal duty of care to the company and to
the shareholders collectively, but not to the shareholders as
i ndi vi dual s nor t o t hi r d par t i es. I t was est abl i shed i n
particular that in the absence of special features, no duty of
car e was owed t o subscr i ber s t o new shar es ( whet her
exi st i ng shar ehol der s or not ) , pur chaser s or i nt endi ng
purchasers of shares from t hi rd part i es i ncl udi ng t hose
conduct i ng t akeover bi ds, banker s or ot her l ender s, or
persons doing business with the company.
5.32 A discussion of the principles established by the Capar-o
case is at Appendi x 6. The case has aroused cont roversy
because it exposed two widely held misconceptions:
(a) that the audit report is a guarantee as to the accuracy
of the accounts, and perhaps even as to the soundness
of the company;
(b) t hat anyone (i ncl udi ng i nvest ors and credi t ors) can
rely on the audit, not only in a general sense but also
very specifically by being able to sue the auditors if
they are negligent.
In deciding the case, the House of Lords studied with great
care the complex issues involved in balancing the interests
of the parties involved and the public interest in having a
AUDI TI NG
f ai r, vi abl e and af f ordabl e syst em. The si ze of audi t ors’
pot ent i al l i abi l i t i es, t he di f f i cul t i es i n def i ni ng wi der
l i abi l i t y i n any f ai r yet pr act i cabl e way, and t he l i kel y
di ffi cul ti es i n establ i shi ng whether thi rd party l osses were
i n f act due t o rel i ance on t he account s were among t he
pri nci pal concerns underl yi ng t he concl usi ons reached by
t he House of Lords. Reari ng i n mi nd t he wi de range of
users of accounts, the Committee is unable to see how the
House of Lords could have broadened the boundaries of the
audi t or s’ l egal dut y of car e wi t hout gi vi ng r i se ( i n t he
wo r d s o f Ca r d o z o CJ d e c i d i n g a c a s e i n 1931 a n d
frequentl y quoted si nce) ‘ to a l i abi l i ty i n an i ndetermi nate
amount f or an i ndet er mi nat e t i me t o an i ndet er mi nat e
cl ass’ . Nor , i n consequence, do we recommend t hat t he
l egal posi t i on wi t h regard t o ci vi l l i abi l i t y l ai d down by
Cupar-o should be altered by statute at the present time.
5. 33
In coming to thts concl usi on, we recogni se that the current
posi t i on i s a sour ce of concer n t o bot h audi t or s and
investors. There are two main reasons:
(a)
(b)
t he scal e of exi st i ng l i t i gat i on agai nst audi t or s or
former audi tors. Audi tors are ful l y l i abl e i n negl i gence
t o t he compani es t hey audi t and t hei r sharehol ders
col l ect i vel y, and Caparo has not changed t hi s. The
si ze of settl ements has been i ncreasi ng i n Bri tai n and
auditors are concerned that this trend may continue;
t he bel i ef of some t hat , not wi t hs t a ndi ng Capa~o,
auditors should in principle be liable to those (such as
individual investors and creditors) who rely on audited
accounts.
Audi t or s ar e nat ur al l y concer ned about t he i ncr eased
l i ti gati on that woul d resul t i f thei r l i abi l i ty were extended
t o ot her account s users. They are al so concerned about
increased litigation that could arise from adapting the audit
to meet changing needs and.expectations - a process which
the Committee’s report itself is intended to encourage.
5. 34 Proponents of change argue that a better bal ance between
the i nterests of the parti es i nvol ved woul d be achi eved i f
audi t or s’ duty of care were to be extended on a defi ned
basis, but at the same time the present system under which
audi tors can be l i abl e for the ful l l oss caused were to be
repl aced by one of proporti onate l i abi l i ty, and/ or a cei l i ng
were pl aced on audi t ors’ l i abi l i t y. There woul d, however,
be maj or probl ems over such changes, some of whi ch are
AUDI TI NG
outlined in Appendix 6. Changes coul d not be undert aken
without a detailed review and wide consultation and might
well require major legal reform.
5.35 At present there is no consensus on a satisfactory way of
reconciling the conflicting interests of all those involved.
As the debate on the nature and extent of auditors’ liability
cont i nues, however , t he Commi t t ee wi l l keep wat ch on
developments.
Audit Confidence
5. 36 The account i ng pr of es s i on has done much r ecent l y t o
improve its standards and procedures. It is essential that
t hi s effort shoul d cont i nue. We wel come t he i ni t i at i ves
whi ch are bei ng t aken on professi onal conduct i ssues -
particularly the profession’s ethical rules and disciplin&ry
arrangement s. We al so support t he work whi ch i s bei ng
done by the profession’s Joint Ethics Committee to tackle
pr obl em ar eas s uch as opi ni on s hoppi ng and par t ner
rotation. A lead on these and other matters such as audit
tendering will strengthen the standing and independence of
auditors.
5.37 We have indicated our strong support for tighter accounting
s t a nda r ds , e f f e c t i ve a udi t c ommi t t e e s , r i gor ous a nd
objective auditing and action by the accountancy profession
t o i mp r o v e a n d e n f o r c e a u d i t i n g s t a n d a r d s . T h i s
combi nat i on of act i ons uncompr omi si ngl y pur sued wi l l
enhance the perceived value of the audit system.
Accountability of Boards to Shareholders
6.1
6.2
6.3
6.4
6.5
The formal relationship between the shareholders and the
boar d of di r ect or s i s t hat t he s ha r e hol de r s e l e c t t he
directors, the directors report on their stewardship to the
shareholders and the shareholders appoint the auditors to
pr ovi de an ext er nal check on t he di r ect or s’ f i nanci al
s t a t e me nt s . Thus t he s ha r e hol de r s a s owne r s of t he
company elect the directors to run the business on their
behal f and hol d t hem account abl e for i t s progress. The
i ssue for corporat e governance i s how t o st rengt hen t he
accountability of boards of directors to shareholders.
A number of pr oposal s addr essi ng t hi s i ssue wer e put
f or wa r d by i ndi vi dua l s ha r e hol de r s a nd s ha r e hol de r
organisations. One was that shareholders should be more
cl osel y i nvol ve- d i n t he appoi nt ment of di r ect or s and
a u d i t o r s t hr ough t h e f o r ma t i o n o f s h a r e h o l d e r s ’
commi t t ees. Ot her proposal s were di rect ed at maki ng i t
easier for shareholders. individually or collectively, to put
forward resolutions at general meetings.
On the first proposal, we have not seen evidence explaining
how it would be possible to form shareholder committees in
such a way that they would be both truly representative of
all the company’s shareholders and able to keep in regular
touch with their changing constituencies. Unless these tests
of legitimacy are met, the Committee is unable to see how
shar ehol der commi t t ees can become t he accept ed l i nk
between a board and its shareholders.
The second set of proposals raises such questi.ons as what
legislation would be needed to alter the present thresholds
for t abl i ng sharehol der resol ut i ons, and where t he cost s
involved in circulating shareholder communications should
fal l . How far t hese suggest i ons are fol l owed up shoul d
depend, in the Committee’s view, on the degree of support
which they command from the shareholder body as a whole.
This may be a matter which our successor body will wish to
review,
In the meantime, shareholders can make their views known
to the boards of the companies in which they have invested
by communi cat i ng wi t h t hem di r ect and t hr ough t hei r
attendance at general meetings. Shareholder organisations
set up t o represent sharehol der i nt erest s general l y may
provide individual shareholders with the choice of acting
THESHAREHOLDERS
col l ect i vel y i n t he case of part i cul ar compani es i f t hey
prefer.
6.6 Shareholders have delegated many of their responsibilities
as owners to the directors who act as their stewards. It is
for the shareholders to call the directors to book if they
appear to be failing in their stewardship and they should
use t hi s power . Whi l e t hey cannot be i nvol ved i n t he
direction and management of their company, they can insist
on a hi gh st andar d of cor por at e gover nance and good
g o v e r n a n c e i s a n e s s e n t i a l t e s t o f t h e d i r e c t o r s ’
stewardship. The accountability of boards to shareholders
wi l l , t herefore, be st rengt hened i f sharehol ders requi re
their companies to comply with the Code.
6.7 Reports and accounts are presented to shareholders at the
Annual General Meeting, when they have the opportunity to
comment on them and to put their questions. In particular,
t he Annua l Ge ne r a l Me e t i ng gi ve s a l l s ha r e hol de r s ,
whatever the size of their shareholding, direct and public
acces s t o t hei r boar ds . I f t oo many Annual Gener al
Meet i ngs ar e at pr esent an oppor t uni t y mi ssed, t hi s i s
because shareholders do not make the most of them and, in
some cases, boards do not encourage them to do so.
6.8 In the Committee’s view, both shareholders and boards of
directors should consider how the effectiveness of general
me e t i n g s c o u l d b e i n c r e a s e d a n d a s a r e s u l t t h e
a c c o u n t a b i l i t y o f b o a r d s t o a l l t h e i r s h a r e h o l d e r s
st r engt hened. Possi bl e ways f or war d i ncl ude pr ovi di ng
forms in annual reports on which shareholders could send
in written questions in advance of the meeting, in addition
to their opportunity to ask questions at the meeting itself,
and the circulation of a brief summary of points raised at
the Annual General Meeting to all shareholders after the
event. Consideration might also be given to ways of boards
keeping in touch with their shareholders, outside the annual
and half-yearly reports. The Committee encourages boards
t o experi ment wi t h ways of i mprovi ng t hei r l i nks wi t h
shareholders along the above lines and shareholders to put
proposals to their boards to the same end.
THESHAREHOLDERS
Institutional Shareholders
6.9
The pr opor t i on of s har es hel d by i ndi vi dual s and by
institutions has broadly reversed over the last thirty years,
so that institutional shareholders now own the majority of
shares of quot ed compani es. They are, however, l argel y
holding their shares on behalf of individuals, as members
of pensi on funds, hol ders of i nsurance pol i ci es and t he
like. As a result, there is an important degree of common
interest between individual and institutional shareholders.
In particular, both have the same stake in the standards of
financial reporting and of governance in the companies in
which they have invested.
6 . 1 0 Gi ven t he wei ght of t hei r vot es , t he way i n whi ch
institutional shareholders use their power to influence the
s t andar ds of cor por at e gover nance i s of f undament al
importance. Their readiness to do this turns on the degree
to which they see it as their responsibility as owners, and
in the ir:terest of those whose money they are investing, to
bring about changes in companies when necessary, rather
than selling their shares.
6.11 The Committee, therefore, warmly welcomes the statement
r ecent l y publ i s hed by t he I ns t i t ut i onal Shar ehol der s ’
Commi t t e e on t he Re s pons i bi l i t i e s of I ns t i t ut i ona l
Shareholders in the UK and we draw attention to three key
concl usi ons whi ch ar e basi c t o t he devel opment of a
const r uct i ve r el at i onshi p bet ween compani es and t hei r
owners.
I ns t i t ut i onal i nves t or s s houl d encour age r egul ar ,
s y s t e ma t i c c o n t a c t a t s e n i o r executiv’e l evel t o
e x c h a n g e v i e ws a n d i n f o r ma t i o n o n s t r a t e gy,
pe r f or ma nc e , boa r d me mbe r s hi p a nd qua l i t y of
management.
i nst i t ut i onal i nvest or s shoul d make posi t i ve use of
their voting rights, unless they have good reason for
doi ng ot her wi se. They shoul d r egi st er t hei r vot es
wherever possible on a regular basis.
Institutional investors should take a positive interest
i n t he compos i t i on of boar ds of di r ect or s , wi t h
par t i cul ar r ef er ence t o concent r at i ons of decision-
making power not formally constrained by appropriate
THESHAREHOLDERS
checks and balances, and to the appointment of
n o n - e x e c u t i v e d i r e c t o r s o f t h e n e c e s s a r y
experience and independence.
a core of
c a l i b r e ,
6. 12 The Inst i t ut i onal Sharehol ders’ Commi t t ee’s advi ce t o i t s
members to use their voting rights positively is important
in the context of corporate governance. Voting rights can
be regarded as an asset, and the use or otherwise of those
r i ght s by i ns t i t ut i ona l s ha r e hol de r s i s a s ubj e c t of
legitimate interest to those on whose behalf they invest.
We recommend that institutional investors should disclose
their policies on the use of voting rights.
Shareholder Communications
6.13 These conclusions on the role of institutional shareholders
r ai se i ssues over t he l i nes of communi cat i on bet ween
boards and t hei r sharehol ders. The fi rst i ssue i s one of
par i t y bet ween shar ehol der s. The i nst i t ut i ons ar e i n a
position to keep in touch with the boards of the companies
in which they have invested, in a way which is not feasible
for the. i ndi vi dual sharehol der. It i s not possi bl e i n t hi s
respect t o put bot h cl asses of sharehol der on t he same
footing. What boards must do, however, is to ensure that
any significant statements concerning their companies are
ma de publ i c l y a nd s o a r e e qua l l y a va i l a bl e t o a l l
shareholders.
6.14 A second issue which arises over communications between
i nst i t ut i onal i nvest or s and compani es i s t he danger of
imparting inside information. If price-sensitive information
is to be given (and it is the company’s responsibility to
decide what might be price-sensitive), it must only be with
t he pri or consent of t he sharehol der, who wi l l t hen be
una bl e t o de a l i n t he c ompa ny’ s s ha r e s unt i l t ha t
information has been made public. It is for shareholders to
decide whether their longer-term interests are impaired by
becoming insiders, because of the short-term constraints t 31
share dealing which that position imposes.
6. 15 I f l ong- t er m r el at i ons hi ps ar e t o be devel oped, i t i,
i mpor t a nt t ha t c ompa ni e s s houl d c ommuni c a t e t he i
s t r at egi es t o t hei r maj or s har ehol der s and t hat t he i
s ha r e hol de r s s houl d unde r s t a nd t he m. I t i s e qua l l y
important that shareholders should play their part in the
communication process by informing companies if there are
THESHAREHOLDERS
aspects of the business which give them cause for concern.
Both shareholders and directors have to contribute to the
building of a sound working relationship between them.
Shareholder Influence
6. 16 Because of t he i mport ance of t hei r col l ect i ve st ake, we
look to the institutions in particular, with the backing of
t he I nst i t ut i onal Shar ehol der s’ Commi t t ee, t o use t hei r
influence as owners to ensure that the companies in which
they have invested comply with the Code. The widespread
adoption of our recommendations will turn in large measure
on the support which all shareholders give to them. The
obligation on companies to state how far they comply with
the Code provides institutional and individual shareholders
wi t h a r eady- made agenda f or t hei r r epr esent at i ons t o
boar ds . I t i s up t o t hem t o put i t t o good us e. The
Commi t t ee i s pr i mar i l y l ooki ng t o s uch mar ket - bas ed
regulation to turn its proposals into action.
7.1 The Commi t t ee’s proposal s are mut ual l y support i ve and
should be taken as a whole. The Code reflects existing best
p r a c t i c e a n d f e w o f o u r r e c o mme n d a t i o n s r e q u i r e
l egi s l at i on. We bel i eve t hat t hey wi l l r ei nf or ce good
cor por at e gover nance wi t hout s t i f l i ng ent r epr eneur i al
initiative.
7.2 No syst em of corporat e governance can be t ot al l y proof
against fraud or incompetence. The test is how far such
aberrations can be discouraged and how quickly they can
be brought to light. The risks can be reduced by making the
par t i ci pant s i n t he gover nance pr oces s as ef f ect i vel y
accountable as possible. The key safeguards are properly
constituted boards, separation of the functions of chairman
a n d o f c h i e f e x e c u t i v e , a u d i t c o mmi t t e e s , v i g i l a n t
shareholders and financial reporting and auditing systems
which provide full and timely disclosure.
7.3 Al t hough t he gr e a t ma j or i t y of c ompa ni e s a r e bot h
competently run and audited under the present system of
corporate governance, it is widely accepted that standards
within the corporate sector have to be raised.
7.4 T h e wa y f o r wa r d i s t h r o u g h c l e a r d e f i n i t i o n s o f
responsibility and an acceptance by all involved that the
highest standards of efficiency and integrity are expected
o f t h e m. Ex p e c t a t i o n s o f c o r p o r a t e b e h a v i o u r a r e
continually rising and a corresponding response is looked
f or f r om s ha r e hol de r s , di r e c t or s a nd a udi t or s . The
machi ner y i s i n pl ace. What i s needed i s t he wi l l t o
improve its effectiveness.
7.5 Thi s wi l l i nvol ve a sharper sense of account abi l i t y and
responsibility all round - accountability by boards to their
shareholders, responsibility on the part of all shareholders
t o t he c ompa ni e s t he y own. a nd, a c c ount a bi l i t y by
professi onal offi cers and advi sers t o t hose who rel y on
their judgement. All three groups have a common interest
i n combi ni ng t o i mpr ove the wor ki ng of t he cor por at e
system.
Compliance with the Code of Best Practice
1 The boards of al l l i st ed compani es regi st ered i n t he UK
shoul d compl y wi th the Code of Best Practi ce set out on
pages 58 t o 60. As many ot her compani es as possi bl e
should aim at meeting its requirements (paragraph 3.1).
2 Listed companies reporting in respect of years ending after
3 0 J une 1 9 9 3 s houl d ma k e a s t a t e me nt a bout t he i r
compl i ance wi th the Code i n the report and accounts and
gi ve reasons f or any areas of non- compl i ance ( paragraph
3. 7) .
3 Compani es’ statements of compl i ance shoul d be revi ewed
by the auditors before publication. The review should cover
onl y those parts of the compl i ance statement whi ch rel ate
t o pr ov i s i ons of t he Code whe r e c ompl i a nc e c a n be
obj ect i vel y veri f i ed. The Audi t i ng Pract i ces Board shoul d
consi der gui dance for audi tors accordi ngl y (paragraph 3. 9).
4 All parties concerned with corporate governance should use
t hei r i nf l uence t o encour age compl i ance wi t h t he Code
( paragraph 3. 14) . I nst i t ut i onal sharehol ders i n part i cul ar,
wi t h t h e b a c k i n g o f t h e I n s t i t u t i o n a l Sh a r e h o l d e r s ’
Commi ttee, shoul d use thei r i nfl uence as owners to ensure
t hat t he compani es i n whi ch t hey have i nvest ed compl y
with the Code (paragraph 6.16).
Keeping the Code up to date
5 The Commi t t ee’ s sponsor s, convened by t he Fi nanci al
Reporting Council, should appoint a new Committee by the
end of June 1995 to exami ne how far compl i ance wi th the
Code has progressed, how far our other recommendati ons
ha v e be e n i mpl e me nt e d, and whet her t he Code needs
updati ng. Our sponsors shoul d al so determi ne whether the
sponsorship of the new Committee should be broadened and
whether wi der matters of corporate governance shoul d be
i n c l u d e d i n i t s b r i e f . I n t h e me a n t i me t h e p r e s e n t
Commi t t e e wi l l r e ma i n r e s pons i bl e f or r e v i e wi ng t he
i mpl ementati on of i ts proposal s (paragraph 3. 12).
SUMMARY OF RECOMMENDATIONS
Directors’ service contracts
6 The Companies Act should be amended to come into line
wi t h t he requi rement of t he Code t hat di rect ors’ servi ce
c o n t r a c t s s h o u l d n o t e x c e e d t h r e e y e a r s wi t h o u t
shareholders’ approval (paragraph 4.41).
Interim reporting
7
Companies should expand their interim reports to include
bal ance sheet i nformat i on. The London St ock Exchange
s houl d cons i der amendi ng t he cont i nui ng obl i gat i ons
accordingly. There should not be a requirement for a full
audi t , but i nt er i m r epor t s s houl d be r evi ewed by t he
auditors and the Auditing Practices Board should develop
appropriate guidance. The Accounting Standards Board in
conjunction with the London Stock Exchange should clarify
t he account i ng rul es whi ch compani es shoul d fol l ow i n
pr epar i ng i nt er i m r epor t s. The i ncl usi on of cash f l ow
i nf or mat i on shoul d be consi der ed by t he Commi t t ee’ s
successor body (paragraph 4.56).
Enhancing the perceived objectivity of the audit
8 Fees paid to audit firms for non-audit work should be fully
disclosed. The essential principle is that disclosure should
enable the relative significance of the company’s audit and
non-audit fees to the audit firm to be assessed, both in a
UK context and, where appropriate, a worldwide context.
The 1991 Regulations under the Companies Act should be
reviewed and amended as necessary (paragraph 5.1 I).
9 The accountancy profession should draw up guidelines on
the rotation of audit partners (paragraph 5.12).
Enhancing the effectiveness of the audit
10 Directors should report on the effectiveness of their system
of internal control, and the auditors should report on their
s t at ement . The account ancy pr of es s i on t oget her wi t h
represent at i ves of preparers of account s shoul d draw up
criteria for assessing effective systems of internal control
and guidance for companies and auditors (paragraphs 4.32
and 5.16).
SUMMARY OF RECOMMENDATIONS
11
Directors should state in the report and accounts that the
business is a going concern, wi t h support i ng assumpt i ons
or qual i f i cat i ons as necessar y, and t he audi t or s shoul d
r epor t on t hi s s t at ement . The account ancy pr of es s i on
t oget her wi t h r epr esent at i ves of pr epar er s of account s
s houl d devel op gui dance f or compani es and audi t or s
(paragraph 5.22).
12 The question of legislation to back the recommendations on
addi t i onal report s on i nt ernal cont rol syst ems and goi ng
concer n shoul d be deci ded i n t he l i ght of exper i ence
(paragraphs 5. I7 and 5.22).
13
The Government should consider introducing legislation to
ext end t o t he audi t or s of al l compani es t he st at ut or y
prot ect i on al ready avai l abl e t o audi t ors i n t he regul at ed
sector (banks, building societies, insurance, and investment
busi ness) so t hat t hey can report reasonabl e suspicicn of
fraud freel y t o t he appropri at e i nvest i gat ory aut hori t i es
(paragraph 5.28).
14 The a c c ount a nc y pr of e s s i on t oge t he r wi t h t he l e ga l
pr of essi on and r~epresentatives of prepareis’of a c c ount s
should consider further the question of illegal acts other
than fraud (paragraph 5.30).
15
The account i ng professi on shoul d cont i nue i t s effort s t o
improve its standards and procedures so as to strengthen
t he s t andi ng and i ndependence of audi t or s ( par agr aph
5. 36).
Voting by institutional investors
‘_
16 Institutional investors shoul d di scl ose t hei r pol i ci es on t he
use of their voting rights (paragraph 6.12).
SUMMARY OF RECOMMENDATIONS
Endorsement of work by others
17
18
19
The Committee gives its full support to the objectives of
t he Fi nanci al Repor t i ng Counci l and t he Account i ng
Standards Board. It welcomes the action by the Financial
Report i ng Revi ew Panel over compani es whose account s
fal l bel ow accept ed report i ng st andards (paragraphs 4. 52
and 5.8).
The Commi t t ee suppor t s t he i ni t i at i ve of t he Audi t i ng
Practices Board on the development of an expanded audit
report. It also gives its full support to the lead which it is
t aki ng on t he devel opment of audi t i ng pract i ce general l y
(paragraphs 5.14 and 5.15).
The Committee welcomes the statement by the Institutional
Sha r e hol de r s ’ Commi t t e e on t he Re s pons i bi l i t i e s of
Institutional Shareholders in the UK (paragraph 6.1 I).
Issues for the Committee’s successor body
2 0
I s s ue s whi c h t he Commi t t e e ha s i de nt i f i e d t ha t i t s
successor body may wish to review or consider in greater
depth include: the application of the Code to smaller listed
companies (paragraph 3. IS); directors’ training (paragraph
4.20); the rules for disclosure of directors’ remuneration,
and t he r ol e whi ch shar ehol der s coul d pl ay ( par agr aph
4.46); a requirement for inclusion of cash flow information
in interim reports (paragraph 4.56); and the procedures for
putting forward resolutions at general meetings (paragraph
6.4). The Committee and its successor will also keep watch
on devel opment s r egar di ng t he nat ur e and ext ent of
auditors’ liability (paragraph 5.35).
1 The Board of Directors
1.1
The board should meet regularly, retain full and effective
cont r ol over t he company and moni t or t he execut i ve
management.
1.2
T h e r e s h o u l d b e a c l e a r l y a c c e p t e d d i v i s i o n o f
r esponsi bi l i t i es at t he head of a company, whi ch wi l l
ensure a balance of power and authority, such that no one
i ndi vi dual has unfet t ered powers of deci si on. Where t he
chai rman i s al so t he chi ef executive, it is essential that
there should be a strong and independent element on the
board, with a recognised senior member.
1.3
The boar d s houl d i ncl ude non- execut i ve di r ect or s of
suf f i ci ent cal i br e and number f or t hei r vi ews t o car r y
significant weight in the board’s decisions.
1.4
The boar d s houl d have a f or mal s chedul e of mat t er s
specifically reserved to it for decision to ensure that the
direction and control of the company is firmly in its hands.
1.5
There should be an agreed procedure for directors in the
furtherance of their duties to take independent professional
advice if necessary, at the company’s expense.
1.6
All directors should have access to the advice and services
of the company secretary, who is responsible to the board
for ensuring that board procedures are followed and that
appl i cabl e rul es and regul at i ons are compl i ed wi t h. Any
question of the removal of the company secretary should be
a matter for the board as a whole.
‘_
2 Non-Executive Directors
2.1
Non- execut i ve di r ect or s s houl d br i ng an i ndependent
j udge me nt 10 bear on i ssues of st r at egy, per f or mance,
resources, i ncl udi ng key appoi nt ment s, and st andards of
conduct.
2.2
The maj ori t y shoul d be i ndependent of management and
free from any business or other relationship which could
materially interfere with the exercise of their independent
j udgement . apart from t hei r fees and sharehol di ng. Thei r
fees shoul d refl ect t he t i me whi ch t hey commi t t o t he
company.
THE CODE OF BEST PRACTICE
2.3 Non-executive directors should be appointed for specified
terms and reappointment should not be automatic.
2.4 Non- execut i ve di r ect or s s houl d be s el ect ed t hr ough a
formal process and both this process and their appointment
should be a matter for the board as a whole.
3 Executive Directors
3.1 Directors’ service contracts should not exceed three years
without shareholders’ approval.
3.2 There should be full and clear disclosure of directors’ total
emoluments and those of the chairman and highest-paid UK
director, including pension contributions and stock options.
Se p a r a t e f i g u r e s s h o u l d b e g i v e n f o r s a l a r y a n d
per f or mance- r el at ed el ement s and t he bas i s on whi ch
performance is measured should be explained.
3.3 Ex e c u t i v e d i r e c t o r s ’ p a y s h o u l d b e s u b j e c t t o t h e
recommendat i ons of a remunerat i on commi t t ee made up
wholly or mainly of non-executive directors.
4 Reporting and Controls
4.1 It i s t h e b o a r d ’ s d u t y t o p r e s e n t a b a l a n c e d a n d
understandable assessment of the company’s position.
4.2 The board should ensure that an objective and professional
relationship is maintained with the auditors.
4.3 The board should establish an audit committee of at least
t hr e e non- e xe c ut i ve di r e c t or s wi t h wr i t t e n t e r ms of
reference which deal clearly with its authority and duties.
4.4 The di r ect or s s houl d expl ai n t hei r r es pons i bi l i t y f or
preparing the accounts next to a statement by the auditors
about their reporting responsibilities.
4.5 The di rect ors shoul d report on t he effect i veness of t he
company’s system of internal control.
4.6 The di rect ors shoul d report t hat t he busi ness i s a goi ng
concern, with supporting assumptions or qualifications as
necessary.
THE CODE OF BEST PRACTICE
Footnote
The company’s statement of compliance should be reviewed
by the auditors in so far as it relates to paragraphs 1.4, 1.5,
2.3, 2.4, 3.1 to 3.3, and 4.3 to 4.6 of the Code.
APPENDIX 1
Terms of Reference
The Committee was set up in May 1991 by the Financial
Report i ng Counci l , t he London St ock Exchange, and t he
a c c ount a nc y pr of e s s i on. I t a dopt e d a s i t s t e r ms of
reference:
To c ons i de r t he f ol l owi ng i s s ue s i n r e l a t i on t o
f i nanci al r epor t i ng and account abi l i t y and t o make
recommendations on good practice:
(a)
(b)
Cc)
Cd)
(e)
Membership
t h e r e s p o n s i b i l i t i e s o f e x e c u t i v e a n d n o n -
executive directors for reviewing and reporting on
performance to shareholders and other financially
interested parties; and the frequency, clarity and
form in which information should be provided;
t he cas e f or audi t commi t t ees of t he boar d,
including their composition and role;
the principal responsibilities of auditors and the
extent and value of the audit;
t he l i nks be t we e n s ha r e hol de r s , boa r ds , a nd
auditors;
any other relevant matters.
The Committee’s members were as follows:
Sir Adrian Cadbury (Chairman)
Ian Butler
Coutlcil Member . CBI and f or mer Chai r man, CBI Compani es
Commitfee
Jim Butler
Seni or Partner, KPMG Peat Marwick
Jonathan Charkham
Advi ser- t o t he Gover~lor. Bunk of Engl and
Hugh Collum
Chai r man. Hundr ed Gr oup of Fi nance Di r ect or s
Sir Ron Dearing
Chai r man, Fi nanci al Repor t i ng Counci l
THE’COMMITTEE’S MEMBERSHIP AND TERMS OF
REFERENCE
Andrew Likierman
Professor of A c c o u n t i n g a n d F i n a n c i a l Co n t r o l , L o n d o n
Business School
Nigel Macdonald
Vice President, Institute of Chartered Accountants of Scotland
Mike Sandland
Chairman, Institutional Shareholder-s’ Committee
Mark Sheldon
President, Law Society
Sir Andrew Hugh Smith
Chairman, London Stack Exchange
Sir Dermot de Trafford, Bt
Chairman, Institute of Directors
Obser ver s: Mr s Sar ah Br own ( unt i l Oct ober 1991), Mr Ar t hur
Russell (from November 1991). Head of Companies Division, DTf
Secretary: Nigel Peace (on secondment from DTI)
Si r Chr i s t opher Hogg ( Chai r - man, Re ut e r s Hol di ngs PLC,
Courtaulds plc, and Courtaulds Textiles plc) acted as an adviser
to the Committee.
APPENDIX 2
Auditing Practices Board
1 The Audi t i ng Pr a c t i c e s Boa r d i s r e s pons i bl e f or t he
standa5ds.
from the Audi ti ng Practi ces Commi ttee i n 1991.
has outsi de representati on and the abi l i ty to i ssue audi ti ng
Financial Reporting Review Panel
2 The Fi nanci al Repor t i ng Counci l was set up i n 1990 t o
establ i sh and support the two bodi es under i ts aegi s, the
Account i ng St andards Board and t he Fi nanci al Reporting
Revi ew Panel , and t o pr omot e good f i nanci al r epor t i ng
gener al l y. The t hr ee bodi es dr aw t hei r f undi ng br oadl y
equal l y from the accountancy professi on, the Ci ty, and the
Government .
3
The rol e of t he Account i ng St andards Board i s t o make,
amend, and wi t hdraw account i ng st andards. I t t ook over
f r om t he f or mer Account i ng St andar ds Commi t t ee on 1
Augus t 1 9 9 0 . The Boa r d i s a ut onomous - al t hough i t
consul ts wi del y on i ts proposal s, i t does not need outsi de
approval for its actions.
4 The Se c r e t a r y of St a t e ha s a ut hor i s e d t he Fi na nc i a l
Report i ng Revi ew Panel t o exami ne depart ures f rom t he
account i ng requi rement s of t he Compani es Act 1985 and if
necessary to seek an order from the court to remedy them.
The Panel ’ s ambit i s publ i c and l arge pri vat e compani es,
the Department of Trade and Industry dealing with all other
cases. The Panel ’ s mai n f ocus i s on mat eri al depart ures
f r om account i ng st andar ds wher e t hi s r esul t s i n t he
account s i n quest i on not gi vi ng a t rue and f ai r vi ew as
required by law. Where a company’s accounts are defective
t he Panel wi l l . wher ever possi bl e. endeavour t o secur e
revi si on by vol untary means; but i f thi s approach fai l s i t
wi l l ma k e a n a p p l i c a t i o n t o t he c our t f or a n or de r
compel l i ng the revi si on. Where accounts are revi sed at the
i nsi st ence of t he Panel , but t he company’ s audi t ors have
not qual i fi ed thei r audi t report on the defecti ve accounts,
THE ROLE OF BODIES REFERRED TO IN THE REPORT
t he panel wi l l dr aw t hi s f act t o t he at t ent i on of t he
auditors’ professional body.
Institutional Shareholders’ Committee
5 The Institutional Shareholders’ Committee (ISC) has five
members: the Association of British Insurers, the National
As s o c i a t i o n o f Pe n s i o n Fu n d s , t h e As s o c i a t i o n o f
Investment Trust Companies, the British Merchant Banking
and Secur i t i es Houses Associ at i on, and t he Uni t Tr ust
Associ at i on. Toget her t hey r epr esent t he over whel mi ng
majority of institutional shareholders in the UK. The ISC
pr ovi des a channel of communi cat i on and f or um f or
di scussi on bet ween i nst i t ut i onal shar ehol der s, cor por at e
management and others on wider issues. It also seeks to
identify areas of common ground amongst its members and
thereafter to promulgate those jointly held views. It does
not normally become involved in matters concerned with
particular investments or companies.
London Stock Exchange
6 The London St ock Exchange i s empower ed t hr ough i t s
Competent Authority status to grant listings of securities
u n d e r t h e Fi n a n c i a l Se r v i c e s Ac t 1986 a nd i t ha s
responsibility for the Unlisted Securities Market.
7 The Exchange through its rules contained in the Admission
of Securities to Listing (often known as the ‘Yellow Book’)
r equi r es i ssuer s of secur i t i es not onl y t o meet cer t ai n
disclosure requirements at the time of listing but also to
compl y wi t h a number of cont i nui ng obl i gat i ons. The
pur pose of t hi s i s t o ensur e t hat all pot ent i al l y price-
sensi t i ve i nformat i on, or i nformat i on about t he company
which might have an effect on its share price or trading in
i t s shar es, i s r el eased t o t he mar ket pr ompt l y. These
r e qui r e me nt s i mpos e s pe c i f i c c o n t e n t a n d I i m i n g
requirements in relation to the issuer’s interim and final
account s and i mpose gui del i nes gover ni ng deal i ngs by
di r ect or s of l i st ed compani es i n t hei r own compani es’
securities.
THE ROLE OF BODIES REFERRED TO IN THE REPORT
The Hundred Group of Finance Directors
8 The Hundred Group of Finance Directors has approximately
one hundred and forty members, including more than 90%
of the finance directors of those companies included in the
FT- SE 100 a nd a l s o t hos e wi t h t he hi ghe s t ma r ke t
capitalisation.
9 The main purpose of The Hundred Group is to provide a
f or um f or di s cus s i on and t o make cont r i but i ons and
r epr es ent at i ons on i s s ues of i mpor t ance f or f i nanci al
management. Members are actively involved to ensure that
t he vi ews of users and preparers of account s are ful l y
understood. Submissions are made to Government and other
or gani sat i ons hi ghl i ght i ng t he pr act i cal i mpl i cat i ons of
exi s t i ng f i nanci al pr ocedur es , r el at ed l egi s l at i on and
proposed changes.
APPENDIX 3
1 In paragraph 4.28 of the report, and in the Code of Best
Practice, the Committee recommends that a brief statement
of di r ect or s’ r esponsi bi l i t y f or pr epar i ng t he account s
should appear in the report and accounts. The purpose of
such a statement is to make clear that responsibility for
preparing the accounts rests with the board of directors,
and t o remove any mi sconcept i on t hat t he audi t ors are
r esponsi bl e f or t he account s. The di r ect or s’ st at ement
should be placed immediately before the auditors’ report
which in future will include a separate statement (currently
being developed by the Auditing Practices Board) on the
responsibility of the auditors for expressing an opinion on
the accounts. Positioning the two statements alongside each
ot her i n t hi s way wi l l achi eve maxi mum cl ar i t y about
respective responsibilities.
2 The explanation of directors’ responsibilities will require a
r el at i vel y f or mal s t at ement , whi ch s houl d cover t he
following points:
(a)
(b)
(c)
Cd )
the legal requirement for directors to prepare financial
statements for each financial year which give a true
and fair view of the state of affairs of the company (or
group) as at the end of the financial year and of the
profit and loss for that period;
t he r esponsi bi l i t y of t he di r ect or s f or mai nt ai ni ng
adequat e account i ng r ecor ds, f or saf eguar di ng t he
assets of the company (or group), and for preventing
and detecting fraud and other irregularities;
c onf i r ma t i on t ha t s ui t a bl e a c c ount i ng‘ pol i c i e s ,
consistently applied and supported by reasonable and
prudent judgements and estimates, have been used .in
the preparation of the financial statements;
confirmation that applicable accounting standards have
been f ol l owed, subj ect t o any mat er i al depar t ur es
disclosed and explained in the notes to the accounts.
3 Boards may al so wi sh t o use t he above st at ement as a
ve hi c l e f or r epor t i ng t hat t hey have mai nt ai ned an
effective system of internal control, and that the business
i s a goi ng concer n, wi t h s uppor t i ng a s s umpt i ons or
qualifications as necessary, once the necessary guidance on
these subjects has been developed (see paragraphs 5.16 and
5.22 of the main report).
DIRECTOR’S RESPONSIBILITY STATEMENT
4
statement in the notes to the accounts disclosing whether
t he account s have been pr epar ed i n accor dance wi t h
applicable accounting standards.
I
APPENDIX 4
,
1
I n the mai n body of the report the Commi ttee recommends
that al l l i sted compani es whi ch have not al ready done so
shoul d est abl i sh an audi t commi t t ee, and pl aces gr eat
emphasi s on the i mportance of properl y consti tuted audi t
committees in raising standards of corporate governance.
2 Many UK compani es al ready have an audi t commi ttee, and
a recent research study (‘ Audi t Commi ttees i n the Uni ted
Ki ngdom’ , published by the ICAEW, April 1992) has found
a steady growth in their number. Audit Committees are now
est abl i shed i n 53% of t he t op 250 i ndust ri al f i rms i n t he
Ti me s 1 0 0 0 , a nd t he f i gur e r i s e s t o 6 6 % i f unl i s t e d
compani es and forei gn subsi di ari es are excl uded from the
cal cul at i on. Most maj or UK l i st ed f i nanci al i nst i t ut i ons
have also formed an audit committee.
3 Audit Committees are well established in the United States,
where t hey have been a l i st i ng requi rement of t he New
York St ock Exchange si nce 1978. A 1989 st udy reveal ed
that 97% of maj or corporati ons had them. I n Canada, they
are a legal requirement.
4 I f t hey oper at e ef f ect i vel y, audi t commi t t ees can br i ng
si gni f i cant benef i t s. I n part i cul ar, t hey have t he pot ent i al
to:
(a)
(b)
I
Cc)
i
Cd)
(e)
(0
i mp r o v e t h e q u a l i t y o f f i n a n c i a l r e p o r t i n g , b y
r evi ewi ng t he f i nanci al st at ement s on behal f of t he
Board;
creat e a cl i mat e of di sci pl i ne and cont rol whi ch wi l l
reduce the opportunity for fraud;
enabl e t he non- execut i ve di r ect or s t o cont r i but e an
independent judgement and play a positive role;
hel p t he f i nance di r ect or . , by pr ovi di ng a f or um i n
which he can raise issues of concern, and which he can
use t o get t hi ngs done whi ch mi ght ot her wi se be
di f f i cul t ;
st r engt hen t he posi t i on of t he ext er nal audi t or , by
provi di ng a channel of communi cat i on and f orum f or
issues of concern;
provi de a framework wi thi n whi ch the external audi tor
can assert hi s i ndependence i n the event of a di spute
wi th management;
AUDI T COMMI TTEES
0 Chapter 3 of the Report by the I nsti tute of Chartered
Ac c ount a nt s o f S c o t l a n d ‘ e n t i t l e d ‘ C o r p o r a t e
Gover nance - Di rectors’ Responsi bi l i ti es for Fi nanci al
Statements’ , February 1992
0 Gui dance bookl et s pr oduced by i ndi vi dual f i r ms of
accountants
0 Chapt er 2, sect i on I V of t he Report of t he Nat i onal
Commi ssi on on Fr audul ent Fi nanci al Repor t i ng ( t he
Treadway Commi ssi on), USA, October 1987
l ‘ Au d i t Co mmi t t e e s i n t h e Un i t e d Ki n g d o m’ b y
P. Col l i er , publ i shed by t he I nst i t ut e of Char t er ed
Accountants of Engl and and Wal es, Apri l 1992.
AUDIT COMMITTEES
ANNEX
Specimen Terms of Reference for an Audit Committee
FOR GUIDANCE ONLY
Constitution
1 The Board hereby resolves to establish a Committee of the
Board to be known as the Audit Committee.
Membership
2 The Commi t t ee shal l be appoi nt ed by t he Boar d f r om
amongst the Non-Executive Directors of the Company and
shall consist of not less than three members. A quorum
shall be two members.
3 The Chairman of the Committee shall be appointed by the
Board.
Attendance at meetings
4 The Finance Director, the Head of Internal Audit, and a
r epr esent at i ve of t he ext er nal audi t or s shal l nor mal l y
attend meetings. Other Board members shall also have the
ri ght of at t endance. However, at l east once a year t he
Commi t t ee shal l meet wi t h t he ext ernal audi t ors wi t hout
executive Board members present.
5 The Company Secr et ar y shal l be t he Secr et ar y, of t he
Committee.
Frequency of meetings
6 Meet i ngs shal l be hel d not l ess t han t wi ce a year. The
external auditors may request a meeting if they consider
that one is necessary.
Authority
7 The Committee is authorised by the Board to i,nvestigate
any activity within its terms of reference. It is authorised
to seek any information it requires from any employee and
all employees are directed to co-operate with any request
I
made by the Committee.
AUDIT COMMITTEES
8 The Committee is authorised by the Board to obtain outside
l egal or ot her i ndependent pr of essi onal advi ce and t o
secure the attendance of outsiders with relevant experience
and expertise if it considers this necessary.
Duties
9 The duties of the Committee shall be:
(a)
(cl
Cd)
(e)
(0
(8)
to consider the appoi,ntment of the external auditor, the
a udi t f e e , a nd a ny que s t i ons of r e s i gna t i on or
dismissal;
to discuss with the external auditor before the audit
commences t he nat ur e and scope of t he audi t , and
ensure co-ordination where more than one audit firm is
involved;
to review the half-year and annual financial statements
before submission to the Board, focusing particularly
on:
(i)
any changes in accounting policies and practices
‘(ii) major judgemental areas
(iii) significant adjustments resulting from the audit
(iv) the going concern assumption
(v) compliance with accounting standards
( vi ) c ompl i a nc e wi t h s t oc k e xc ha nge a nd l e ga l
requirements.
to discuss problems and reservations arising from the
interim and final audits, and any matters the auditor
may wi sh t o di scuss (i n t he absence of management
where necessary);
to review the external auditor’s management letter and
management’s response;
to review the Company’s statement on internal control
systems prior to endorsement by the Board;
(where an internal audit function exists) to review the
i nt e r na l a udi t pr ogr a mme , e ns ur e c o- or di na t i on
between the internal and external auditors, and ensure
that the internal audit function is adequately resourced
and has appropriate standing within the Company;
AUDIT COMMITTEES
(h) to
c o n s i d e r t he ma j o r f i n d i n g s o f i n t e r n a l
investigations and management’s response;
(i) to consider other topics, as defined by the board.
Reporting procedures
10 The Secretary shall circulate the minutes of meetings of the
Committee to all members of the Board.
APPENDIX 5
1 Thi s a p p e n d i x s u mma r i s e s t he ma i n s t a t u t o r y
responsi bi l i t i es of di rect ors and audi t ors rel at i ng t o t he
accounts and audit, as background to the recommendation
in the Code of Best Practice that directors should explain
their responsibility for preparing the accounts alongside a
s t a t e me n t b y t h e a u d i t o r s a b o u t t h e i r r e p o r t i n g
responsibilities. It also summarises current requirements on
internal control, going concern, and fraud, as background
to the recommendations on these issues in the report.
The statutory responsibilities of directors and auditors
2 The st at ut or y r esponsi bi l i t i es of di r ect or s and audi t or s
relating to accounts and audit are laid down in Part VII
(sections 221 to 262) of the Companies Act 1985. Among
the main provisions are the following:
(i) directors
221.-(l) Ever y company shal l keep account i ng r ecor ds
whi ch are suffi ci ent t o show and expl ai n t he company’s
transactions and are such as to -
(a) di scl ose wi t h reasonabl e accuracy, at *any t i me, t he
financial position of the company at that time, and
(b) enable the directors to ensure that any balance sheet
and profit and loss account prepared under this Part
complies with the requirements of this Act.
226.-(l) The directors of every company shall prepare for
each financial year of the company -
(a) a balance sheet as at the last day of the year, and
(b) a profit and loss account
(2) The balance sheet shall give a true and fair view of the
st at e of af f ai r s of t he company as at t he end of t he
financial year; and the profit and loss account shall give a
true and fair view of the profit or loss of the company for
the financial year.
227.-(l) If at the end of a financial year a company is a
parent company t he di rect ors shal l . as wel l as prepari ng
individual accounts for the year, prepare group accounts.
CURRENT STATUTORY AND OTHER REQUIREMENTS
234. - ( I ) The di r e c t or s of a c ompa ny s ha l l f or e a c h
financial year prepare a report -
(a) cont ai ni ng a fai r revi ew of t he devel opment of t he
bus i ne s s o f t h e c o mp a n y a nd i t s s u b s i d i a r y
undert aki ngs duri ng t he fi nanci al year and of t hei r
position at the end of it, . . .
( 3) The r epor t shal l al so compl y wi t h Schedul e 7 as
regards the disclosure of matters mentioned there.
(ii) auditors
235.-(l) A company’s auditors shall make a report to the
c ompa ny’ s me mbe r s on a l l a nnua l a c c ount s of t he
company. . .
( 2) The a udi t or s ’ r e por t s ha l l s t a t e whe t he r i n t he
auditors’ opinion the annual accounts have been properly
prepared i n accordance wi t h t hi s Act , and i n part i cul ar
whether a true and fair view is given -
(a)
in the case of an individual balance sheet, of the state
of affairs of the company as at the end of the financial
year
(b) in the case of an individual profit and loss account, of
the profit or loss of the company for the financial year
(c)
in the case of group accounts, of the state of affairs as
at the end of the financial year, and the profit or loss
for the financial year, of the undertakings included in
t he consol i dat i on as a whol e, so f ar as concer ns
members of the company.
(3) The audi t ors shal l consi der whet her t he i nformat i on
gi ven i n t he di rect ors’ report for t he fi nanci al year for
which the annual accounts are prepared is consistent with.
those accounts; and if they are of the opinion that it is not
they shall state that fact in their report.
237.-(l) A company’s audi t ors shal l , i n prepari ng t hei r
report, carry out such investigations as will enable them to
form an opinion as to -
(a) whether proper accounting records have been kept by
t he company and pr oper r et ur ns adequat e f or t hei r
audit have been received from branches not visited by
them, and
CURRENT STATUTORY AND OTHER REQUIREMENTS
( b) whet her t he company’ s i ndi vi dual account s ar e i n
agreement with the accounting records and returns.
(3) If the auditors fail to obtain all the information and
expl anat i ons whi ch, t o t he best of t hei r knowl edge and
bel i ef, are necessary for t he purposes of t he audi t , t hey
shall state that fact in their report.
Current requirements on Internal Control
3
Under s.221 of the Companies Act directors are required to
mai nt ai n adequat e account i ng records t o enabl e t hem t o
di s c l os e wi t h r e a s ona bl e a c c ur a c y, a t a ny t i me , t he
financial position of the company and in order to meet this
responsibility they must in practice maintain some form of
cont rol syst em over t he company’s process of fi nanci al
management. However, there is no explicit requirement in
company law for them to maintain an effective system of
internal control.
4
Auditors in turn, as part of their usual audit procedures,
wi l l consi der how ~f-2
.~ ,,
t hey can r el y on t he company’ s
internal control systems in carrying out their audit of the
f i nanci al s t at ement s . As a nor mal par t of t hei r audi t
procedures the auditors thus evaluate the internal control
systems and, if they plan to rely on them in reaching their
audit opinion, they will test the operation of those systems.
As a by-product of this auditors will usually comment to
management on their findings in what is commonly known
as t he management l et t er. However, t here i s at present
no Companies Act requirement for auditors to report on the
adequacy of internal control systems.
Current requirements on Going Concern
5 Schedule 4 of the Companies Act 1985 requires accounts to
be prepared on the presumption that the company is a going
c o n c e r n . Th e g o i n g c o n c e r n c o n c e p t i s d e f i n e d i n
accounting standards (SSAP 2) as the assumption that ‘the
ent erpri se wi l l cont i nue i n operat i on for t he foreseeabl e
fut ure. Thi s means i n part i cul ar t hat t he profi t and l oss
account and t he bal ance sheet assume no i nt ent i on or
necessity to liquidate or curtail significantly the scale of
operation. ’ The SSAP does not define ‘foreseeable future’
but auditing guidance states ‘while the foreseeable future
must be j udged i n rel at i on t o speci fi c ci rcumst ances, i t
s houl d nor ma l l y e xt e nd t o a mi ni mum of s i x mont hs
CURRENT STATUTORY AND OTHER REQUIREMENTS
following the date of the audit report or one year after the
balance sheet date whichever period ends on the later date.’
6 Whi l st t he requi rement for di rect ors t o prepare fi nanci al
s t a t e me n t s g i v i n g a t r u e a n d f a i r v i e w c r e a t e s a
pr esumpt i on t hat t hey wi l l sat i sf y t hemsel ves t hat t he
company is not in financial difficulties and that the going
concern basis is appropriate, there is no explicit obligation
in company law that they should do so. There is similarly
no r equi r ement i n l aw f or t he di r ect or s t o r epor t t o
shareholders that they have satisfied themselves about the
going concern basis or the adequacy of financial resources.
7 Auditors in turn, whilst obliged by auditing guidance ‘to be
satisfied that the going concern basis is appropriate’, are
not obl i ge d t o pe r f or m a ny pr oc e dur e s s pe c i f i c a l l y
designed to identify any indications that the going concern
basis may be no longer valid.
Current requirements on Fraud
8 Auditing~‘guidance makes clear that the prime responsibility
for preventing and detecting fraud rests with management,
as part of i t s fi duci ary responsi bi l i t y for prot ect i ng t he
assets of the company. It goes on to state that the auditor’s
responsibility is ‘properly to plan, perform and evaluate his
audi t wor k so as t o have a r easonabl e expect at i on of
d e t e c t i n g ma t e r i a l mi s s t a t e me n t s i n t h e f i n a n c i a l
statements’. It points out, however, that even a properly
designed and executed audit may not detect material fraud
i nvol vi ng f or ger y or col l usi on, and t hat t he audi t or ’ s
r epor t , bas ed as i t i s on t he concept of r eas onabl e
assurance, does not constitute a guarantee that the financial
statements are free of misstatement.
9 So far as reporting fraud is concerned, the present legal
posi t i on i s t hat confi dent i al i t y i s an i mpl i ed t erm of an
a udi t or ’ s c ont r a c t , and t her e i s a publ i c i nt er es t i n
mai nt ai ni ng conf i dent i al cl i ent r el at i onshi ps. Nor mal l y,
therefore, it is the auditor’s duty to report fraud to senior
management . However, t here i s al so a publ i c i nt erest i n
fraud being dealt with expeditiously and this may entail
disclosing matters to a proper authority. An auditor who
discloses in such circumstances without malice is protected
from t he ri sk of breach of confi dence or defamat i on. In
r ecent year s t he l egi s l at i on appl yi ng t o t he s peci al ,
CURRENT STATUTORY AND OTHER REQUIREMENTS
regulated sectors (banks, building societies, insurance and
investment business) has been amended so as to remove any
obstacles there might be to an auditor reporting directly to
t he rel evant regul at or reasonabl e suspi ci on of fraud, or
ot her mat t ers rel evant t o t he regul at or’s funct i ons. The
l egi sl at i on al so gi ves t he Government powers t o speci fy
circumstances in which information is to be communicated
to the regulators, as an alternative to rules or guidance by
the professional bodies. In fact the accountancy profession
has developed auditing guidelines for each of the special
sectors and the Government has not exercised its powers up
t o now. However, in his report on the BCCI affair, Lord
J us t i ce Bi ngham r ecommended t hat audi t or s of banks
should be placed under a statutory duty to report relevant
mat t er s t o t he Bank of Engl and. The Gover nment has
announced that it accepts the recommendation and intends
t o i mpos e a s i mi l a r dut y on a udi t or s t o i nf or m t he
regulators in the other regulated sectors. For the generality
of companies, the profession has also developed guidance
which encourages the auditor to report fraud to the proper
a ut hor i t i e s whe r e he no l onge r ha s c onf i de nc e t ha t
management itself will deal adequately with the matter. ~’
APPENDIX 6
Outline of the case
1 Caparo Industries plc owned shares in a public company,
Fidelity plc, whose accounts for the year ended 31 Mar ch
1984 showed profits far short of the predicted figure which
resulted in a dramatic drop in the quoted share price. After
receipt of the audited accounts for the year ended 31 March
1984 Caparo purchased more shares in Fidelity and later
that year made a successful takeover bid for the company.
Following the takeover, Caparo brought an action against
t he audi t or s of t he company, al l egi ng t hat Fi del i t y’ s
account s wer e i naccur at e and mi sl eadi ng i n t hat t hey
showed a pre-tax profit of fl.2m when in fact there had
been a l oss of over &0.4m, t hat t he audi t or s had been
negl i gent i n audi t i ng t he account s , t hat Capar o had
purchased furt her shares and made t hei r t akeover bi d i n
rel i ance on t he audi t ed account s, t hat t hey had t hereby
suffered loss, and that the auditors owed them a duty of
care t o prevent t hat l oss ei t her as pot ent i al bi dders for
Fidelity because they ought to have foreseen that the 1984
results made Fidelity vulnerable to a takeover bid from one
quarter or another, or as an existing shareholder of Fidelity
interested in buying more shares.
2 The case went to the House of Lords which held that the
auditors did not owe Caparo a duty of care to prevent the
l oss suf f er ed i n consequence of pur chasi ng addi t i onal
s ha r e s , e i t he r a s pot e nt i a l i nve s t or s or a s e xi s t i ng
sharehol ders (Caparo I ndustri es plc v. Dickman and others
[I 9901 I All ER 568).
Basis for the decision
I 3
In broad terms, the House of Lords considered the issues on
the following basis:
( a ) I f A ma k e s a n e g l i g e n t s t a t e me n t , h e ma y
( i nde pe nde nt l y of a ny’ c ont r a c t ua l or f i duc i a r y
r el at i ons hi p) be l i abl e t o B i f B r el i es on t hat
statement and thereby suffers loss, provided A is under
duty of care to B to avoid or prevent that loss.
THE CAPARO CASE
(b) Such a duty of care will exist where a three-pronged
t es t of f or es eeabi l i t y, pr oxi mi t y, and f ai r nes s i s
satisfied:
(i) f o r e s e e a bi l i t y : when maki ng t he st at ement , A
shoul d r easonabl y have f or eseen t hat B mi ght
suf f er t hat l oss i f t he st at ement pr oved t o be
wrong;
(ii) p r o x i mi t y : t he r e mus t , i n r e l a t i on t o t he
statement, be a sufficient relationship between A
and B. Such a rel at i onshi p wi l l exi st i f, at t he
time he made the statement, A knew:
l that the statement would be communicated to
B, either as an individual or as a member of
an identifiable class;
0 that the statement would be so communicated
speci fi cal l y i n connect i on wi t h a part i cul ar
t ransact i on, or t ransact i ons of a part i cul ar
kind; and
0 that B would be very likely to rely on it in
deci di ng whet her or not t o ent er i nt o t hat
transaction or a transaction of that kind;
(iii) f ai rness: the Court must consider it to be fair,
just and reasonable that the law should impose the
specified duty of care on A for the benefit of B.
(c) In suggest i ng t hi s t hree-pronged t est , t he House of
Lords nevertheless recognised that there would often
be an overl ap bet ween t he t hree el ement s, t hat t he
e l e me n t s t h e ms e l v e s we r e ‘ l abel s ’ r a t he r t ha n
precisely applicable definitions, and that there was a
necessary element of pragmatism in applying the test
to any given set of circumstances.
(d) So far as concerns audited accounts, whilst it cannot
f ai r l y be s ai d t hat t he pur pos e of t he s t at ut or y
provisions as to publication is solely to assist members
and debenture holders to an informed supervision and
a ppr a i s a l of t he s t e wa r ds hi p of t he c ompa ny’ s
directors, that is nevertheless the original, central and
primary purpose of these provisions.
4 Caparo’s case foundered as a matter of law because in the
view of the House of Lords the necessary proximity did not
exi st . A rel at i onshi p of proxi mi t y coul d not be deduced
between an auditor and a member of the public who relied
THECAPAROCASE
on the accounts to buy shares in the company when to do so
would give rise to an unlimited liability on the part of the
auditor. Nor could a relationship of proximity be deduced
bet ween an audi t or and an i ndi vi dual sharehol der i n t he
company in relation to further purchases of shares in the
c o mp a n y b y t h a t s h a r e h o l d e r , s i n c e a n i n d i v i d u a l
shareholder stood in no different position from any other
investing member of the public to whom the auditor owed
no dut y, and t he audi t or s ’ s t at ut or y dut y t o pr epar e
accounts was owed to the body of shareholders as whole, to
enable them as a body to exercise informed control of the
company and not to enable individual shareholders to buy
shares with a view to profit.
Principles established
5 The case has est abl i shed t hat i n
features, auditors are not regarded
t he absence of speci al
as owing a duty of care
to prevent loss to anyone relying on their report except (a)
the company, and (b) the shareholders as a body. In the
absence of speci al feat ures, no duty of care is owed in
partictilar t o-i ndi vi dual sharehol ders, subscri bers t o new
shares, purchasers or intended purchasers of shares from
t hi r d par t i es i ncl udi ng t hose conduct i ng t akeover bi ds,
bankers or other lenders to the company, or persons doing
business with the company.
Arguments for and against extending auditors’ duty of care
6 Some of the arguments that have been expressed for and
agai nst ext endi ng audi t or s’ dut y of car e t o i ndi vi dual
shareholders, purchasers of shares, and possibly b‘ther third
parties are as follows.
I
Arguments for extension
(a)
(b)
Cc)
Third parties, to the knowledge of all, in fact rely to a
consi derabl e ext ent on t he i nt egri t y of t he audi t ed
account s - if legal liability is not imposed there is an
allegedly justified expectation gap.
Professional men are paid - they should therefore be
accountable in a wide sense.
The auditors’ liability to the company may provide an
effective remedy where the auditors have negligently
failed to discover fraud or theft from the company -
THE CAPARO CASE
but in general not where, for example, the directors
have been overval ui ng asset s or ot herwi se i nfl at i ng
profi t s. In any case, the company’s loss may be less
than that suffered in aggregate by the shareholders.
(d) The case is bad publicity for the accounting profession
and has prompted the perception that, for example:
(i)
auditors are answerable to no-one;
(ii) the requirement for the auditors to exercise due
care and skill has been lessened;
(iii) having accounts audited is of little or no benefit.
Arguments against extension
(a)
(b)
(cl
Cd)
(e)
(0
(s)
To hold the auditors liable to all and sundry for any
purpose for whi ch t hey may choose t o rel y on t he
auditors’ statement would result, in the classic words
of Cardozo CJ, in ‘liability in an indeterminate amount
for an indeterminate time to an indeterminate class’.
Quite apart from the difficulty of defining the extent
of l i abi l i t y, t her e woul d be endlessproblems i n
det ermi ni ng where l i abi l i t y was due t o rel i ance on
audited accounts and where not.
The principal purpose of the statutory provisions for
audit and the publication of the accounts is to assist
shar ehol der s and debent ur e hol der s col l ect i vel y i n
monitoring the stewardship of the directors - there is
no bas i s f or as s umi ng t hat t he l egi s l at ur e had a
secondary purpose to provide protection for the public
at large and investors in particular.
The potential magnitude of the liability is out of all
proportion to the size of the audit fee.
The primary responsibility for producing true and fair
account s l i es wi t h t he di r ect or s - and i t woul d be
unfair if, in practice, the auditors (and their insurers)
had to foot the bill on their own, or substantially on
their own.
I t i s, i n pr act i ce, di f f i cul t f or audi t or s t o obt ai n
adequate insurance cover.
The third parties have themselves paid nothing to the
auditors - why should they be able to call the auditors
to account?
THE CAPARO CASE
( h) The s cope and cos t of audi t wor k mi ght r api dl y
become uneconomic if wide-scope liability to all users
of accounts were accepted.
The Committee’s view
7 The Commi t t e e r e c ogni s e s t ha t t he Hous e of Lor ds
j udgment i nvol ved a car ef ul and compl ex bal anci ng of
interests - not just those of users of accounts and auditors,
but more generally the interests of professional people and
t h o s e wh o s u f f e r l o s s a s a r e s u l t o f p r o f e s s i o n a l
negligence, and the public interest in having a viable and
fai r syst em. The pri nci pal pract i cal concerns whi ch l ay
behi nd t he concl usi ons reached by t he House of Lords
i ncl uded t he si ze of audi t or s’ pot ent i al l i abi l i t i es, t he
di f f i cul t i es i n def i ni ng wi der l i abi l i t y i n any f ai r yet
real i st i c way, and t he l i kel y di ffi cul t i es i n est abl i shi ng
whet her t hi rd part y l osses were due t o rel i ance on t he
account s. Bear i ng i n mi nd t he wi de r ange of user s of
accounts, the Committee is unable to see a practical and
equi t abl e way i n whi ch t he House of Lords coul d have
broadened the boundaries of auditors’ legal duty of care
without giving rise to a liability that was indeterminate in
scope, t i me and amount , nor does i t consi der t hat t he
decision should be altered by statutory intervention at the
present time.
Possible ways of extending duty of care without creating open-ended
liability
8
If, not wi t hst andi ng t he Commi t t ee’s recommendat i on, i t
wer e deci ded t o change t he pr i nci pl es laid‘down by
Caparo, it would be necessary to amend the law by statute
to impose a liability on auditors to compensate accounts
user s i n gener al , or speci f i ed cl asses of user such as
investors, who suffer loss by relying on negligently audited
accounts. Those proposing such a change have suggested as
a q u i d p r o q u o t h a t a u d i t o r s ’ l i a b i l i t y s h o u l d b e
proportionate only, or that it should be limited. There are,
however, serious objections in both cases:
(a) Proport i onat e l i abi l i t y onl y: it is proposed that the
l aw shoul d be changed so t hat t hose who t oget her
cause damage should not, as at present, each be liable
for the whole of the loss, but should each only assume
a reasonable proportion of the loss. However, there are
considerable technical difficulties in this proposition,
THECAPAROCASE
not least because not all the potential defendants may
be before the court. The proposition would also need
to be considered in relation to the law as a whole, and
t her e i s no par t i cul ar r eason f or si ngl i ng out t he
auditors for special treatment. It should in any event
be recogni sed t hat even wi t h l i abi l i t y l i mi t ed t o a
proportion of the claimant’s loss, the amount payable
by the auditors could still put them out of business.
( b) Li mi t ed l i abi l i t y: it is proposed that the law should
be changed to permit auditors to limit their liabilities
by contract with the relevant company. Apart from any
pr act i cal pr obl ems i n r eachi ng agr eement wi t h t he
company, t her e i s a f undament al l egal pr obl em i n
establishing a basis on which an auditor might found a
limitation of his liability to those with whom he has no
contractual tie. Another possibility would be to impose
a statutory ‘cap’ on an auditor’s liability, either fixed
for all auditors or related to variables such as the size
of audit fee or the size of audit firm. However this
suggest i on woul d be an unsat i sfact ory compromi se.
When the cap operated it would prevent plaintiffs from
recovering the full loss suffered, whilst if the auditors
faced more claims in relation to one year than their
insurance provided cover for, they might still be put
out of busi ness and not al l t he successful pl ai nt i ffs
would be able to recover the amount of the cap.
APPENDIX 7
The Committee is nrateful to the following for submitting comments on
- its draft report:
Mr R J Alexander
Mr Gary Allen
Managing Director and Group
Chief Executi\le. IMI plc
Alliance & Leicester Building Society
Alliance of Independent Retailers and
Businesses
Mr Michael Arnold
Arthur Andersen & Co
Association of Authorised Public
Accountants
Association of British Chambers of
Commerce
Association of British Insurers
.Association of Investment Trust
Companies
Auditing Practices Board
Mr H S Axton
Chairman, Brixton Estate plc
BDO Binder Hamlyn
Mr Neville Bain
Group Chief Executive, Coats
Viyella plc
Barratt Developments plc
Mr Nicholas Beale
Scifeh
Mr V W Benjamin
Mr A G Biggart
Mr D A V Boyle
University of Excler
Mr E A Bradman
Mr C B Brayshaw
British Bankers Association
British Merchant Banking and
Securities Houses Association
British Petroleum Company plc
British Rail Pension Trustee
Company Ltd
Mr Robin Broadley
Deputy Chairman, Baring Brothers
& co L&i
Mr C R E Brooke
Chairman, Candover Investments
plc
Mr Derek Broome
Mr A C Bryant
Chairman, Bryant Group plc
Mr Donald Brydon
Building Societies Association
Building Societies Commission
Mr Gavin Burnett
Burson-Marsteller
Centre for Business and Public Sector
Ethics
Chartered Association of Certified
Accountants
Chartered Institute of Management
A c c o u n t a n t s
Chartered Institute of Marketing
Mr Jonathan Chaytor
City Capital Markets Committee
Mr J R Clark
English & Overseas Properties plc
Clark Whitehill & Co
Dr K Cleaver
University of Liverpool
Cleveland County Council
Mr Paul Collier
University of Exeter
Confederation of British Industry
CONTRIBUTORS TO THE COMMITTEE
Mr P D Cooper
Coopers & Lybrand
Sir Colin Corness
Chairman, Redland plc
Courtaulds plc
Sir Michael Craig-Cooper
Mr David Craine
Mr Paul Dare
Mr P A Davis
Deputy Chairman, Sturge Holdings
plc
Mr Nicholas Dimsdale
The Queen’s College Oxford
Dr J P Dobrowolski
Chief of Internal Auditing, Argos
Ptc
Mr Eric Dodson
Mr Stewart Douglas-Mann
Guinness Mahon & Co Ltd
Mr J C Dwek
Chairman, Bodycote
International plc
Dr Christopher Eaglen
English China Clays plc
Ernst & Young
Mr Noel Falconer
Federation of Small Businesses
Mr David Fifield
Foreign Banks and Securities Houses
Association
Mr John Franks
Mr Gavin Fryer
GKN plc
Mr Matthew Gaved
The Social Market Foundation
The General Electric Company plc
Mr Mark Gifford-Gifford
University of Exeter
Sir Paul Girolami
Chairman, Glaxo Holdings plc
Mr Dermot Glynn
National Economic Research
Associates
Catherine Gowthorpe
Lancashire Business School
Mr Nigel Graham Maw
Grand Metropolitan plc
Grant Thornton
Mr Donald Green
Sir Owen Green
Chairman, BTR plc
Sir Richard Greenbury
Chairman, Marks and Spencer plc
Mr T J Grove
Mr Anthony Habgood
Chief Executive, Bunzl plc
Mr Charles Hambro
Chairman, Hambros plc
Mr R W D Hanson
Chairman and Managing Director,
Hardys and Hansons plc
Hay Management Consultants Ltd
Mr R M Heard
Company Secretary, BPB
Industries plc
Mr A L Hempstead
Professor Brian Houlden
Warwick Business School
Gerard Howe
Howe Associates
Mr D J Hughes
Humberside County Council
The Hundred Group of Finance
Directors
Mr A Hyslop
Group Chief Internal Auditor,
Crown Agents
CONTRIBUTORS TO THE COMMITTEE
IBM United Kingdom Ltd
Institute of Business Ethics
Institute of Chartered Accountants in
England and Wales
Institute of Chartered Accountants in
Ireland
Institute of Chartered Accountants of
Scotland
Institute of Chartered Secretaries &
Administrators
Institute of Directors
Institute of Internal Auditors
Institute of Investment Management
and Research
Institute of Personnel Management
Institutional Fund Managers
Association
Investor Relations Society
Mr Michael Jackaman
Chairman, Allied-Lyons plc
Mr Edmond Jackson
Mr J B H Jackson
Mr J N C James
Executive Deputy Chairman,
Grosvenor Estate Holdings
Mr David Jefferies
Chairman, The National Grid
Company plc
Mr J Jeffreys
Mr David Jinks
Group Finance Director, Cadbury
Schweppes plc
KPMC Peat Marwick
Mr Stanley Kalms
Chairman. Dixons Group plc
MrJCKay
Mr Noel Kelleway
Kidsons Impey
Mr Christopher King
Director, BP Europe
Mr G W King
Mr Tim Knowles
Mr Adam Kounine
Lord Lane of Horse11
Mr John Lavery
Newcastle Business School
Law Society (Company Law
Committee)
Law Society of Scotland
Legal and General Group plc
Mr J L Leonard
Chairman, Eurotherm plc
The Liberal Democrats
Mr L E Linaker
Deputy Chairman & Managing
Director, M&G Group plc ~. ‘.
Mr Norman Lindsay
Mr Martin Lipton
Sir Richard Lloyd
Chairman, Vickers plc
Lloyds Bank plc
London Stock Exchange
London Stock Exchange Listed
Companies Advisory Committee
Sir Desmond Lorimer
Dr A D McCann
McCann Research
McKenna & Co
Mr Colin McLean
Managing Director, Scottish Value
Management Ltd
Mr D S McMullen
Managing Director, McMullen &
Sons Ltd
Mr Ewan Macpherson
Chief Executive, 3i Group plc
Mr D F Macquaker
CONTRIBUTORS TO THE COMMITTEE
Mr Donald Main
Mr Geoffrey Maitland Smith,
Chairman, Sears plc
Christine Mallin
University of Nottingham
Management Consultancies
Association Ltd
Mr W H Melly
Mr Paul Meredith
Chief Executive, Phillips & Drew
Fund Management Ltd
Mr Tony Merrett
Mr Ian Michell
Mr D E Midgley
The Midlands Industry Group of
Finance Directors
Rowena Mills
Rowena Mills Associates Ltd
Sir Nigel Mobbs
Chairman and Chief Executive,
Slough Estates plc
Morgan Grenfell Group plc
Mr James Morton
Mr Roger Morton
Mr Tony Morton
Mr Geoffrey Mulcahy
Chair-man and Group Chief
Executive, Kingfisher plc
Mr Michael Mumford
Lancaster- Univer%ty
Mr Paul Myners
Chairman Audit Committee,
PowerGen plc
National Association of Pension Funds
Nationalised Industries Finance Panel
Neville Russell
New Bridge Street Consultants
Mr B T O’Driscoll
Group Chief Internal Auditor, ICI
plc
Mr J F O’Mahoney
Vice Chairman, Ladhroke Group
Plc
Mr P Ormrod
University of Lil*erpool
Mr G J Osborn
General Auditor. Europe. Eli Lilly
& Company Ltd
Mr Simon Pallett
Newcastle Business School
Pannell Kerr Forster
Mr Bruce Pattullo
Cover-nor & Group Chief
Executive, Bank of Scotland
Pensions Investment Research
Consultants Ltd
Professor J P Percy
Mr D E Philpot
Sir David Plastow
Chairman, Inchcape plc
Portsmouth and Sunderland
Newspapers plc
Price Waterhouse
ProShare
Public Interest Research Centre Ltd
Dr Derek Purdy
University of Reading
Sir Alick Rankin
Chairman, Scottish &
Newcastle plc
Reads & Co
Professor William Rees
City of London Polytechnic
Mr D E Reid
Director-, Tesco plc
Mr Andrew Robb
Director, Pilkington plc
TO THE COMMITTEE CONTRI BUTORS
Sir Lewis Robertson
Sir George Russell
Chairman, Marley plc
Mr David Sainsbury
Deputy Chairman, .I Sainsbury plc
Mr Saleem Sheikh
City of London Polytechnic:
Mr John Salter
Demon Hall Burgin & Warren,
Mr John Sclater
Chairman, Foreign and Colonial
Investment Trust plc
Mr John Scott-Oldfield
The Corporate Consutting Group
Securities and Investments Board
Serious Fraud Office
Shareholder Monitor Ltd
Sir Patrick Sheehy
Chairman, BAT Industries plc
Mr J J L G Sheffield
Chairman, Norcros plc
Mr Peter Small
Crescent Management Selection
Society of Labour Lawyers
South Western Electricity plc
Stoy Hayward
Mr C M Stuart
Swiss Bank Corporation
Mr Allen Sykes
TSB Group plc
Thames Valley Commercial Group
Mr A R Threadgold
Chief Executive, Pastel Investment
Management Ltd
Lord Tombs of Brailes
Chairman, Rolls-Royce plc
Mr R C Tomkinson
Top Pay Research Group
Mr P G Totty
Touche Ross.& Co
Mr J D Traynor
Chairman, CRH plc
Unilever plc
Union of Independent Companies
Unit Trust Association
United Kingdom Shareholders
Association
Professor Gerald Vinten
Luton University College of Higher
Education
Lord Watkinson
Lord Weir
Chairman, The Weir Group plc
Mr F Williams
The Hon Geoffrey Wilson
Chairman, Delta plc
Mr N S Wilson
Mr Ralph Windle
The Committee is also grateful to all those who provided assistance at earlier
stages of its work. A full list of names was published in the Committee’s draft
report.
RELEVANT PUBLISHED STATEMENTS
Relevant published statements
The following published documents were among those drawn to the Committee’s
attention:
Chartered Institute of Management Accountants: ‘Corporate Reporting -The
Management Interface’ (1990); ‘Non-Executive Directors -Their Value to
Management’ (1992); ‘A Framework for Internal Control’ (1992)
Financial Reporting Council: ‘The State of Financial Reporting -a Review’
(November 199 I)
Institute of Business Ethics: ‘Business Ethics and Company Codes -Current Best
Practice in the United Kingdom’ (1992)
Institute of Chartered Accountants in England and Wales: ‘The Changing Role of
the Non-Executive Director’ (May 1991); ‘Audit Committees’ (April 1992)
Institute of Chartered Accountants in England and Wales and Institute of
Chartered Accountants of Scotland: ‘The Future Shape of Company Reports’
(1991)
Institute of Chartered Accountants in Ireland: Report of the Financial Reporting
Commission (January 1992)
Institute of Chartered Accountants of Scotland: ‘Corporate Governance -
Directors’ Responsibilities for Financial Statements’ (February 1992)
Institute of Chartered Secretaries & Administrators: ‘Duties of the Company
Secretary’ (1992)
Institute of Directors: ‘Guidelines for Directors’ (1990)
Institutional Shareholders Committee: ‘The Role and Duties of Directors - A
Statement of Best Practice’ (April 1991); ‘The Role and Responsibilities of
Institutional Shareholders in the UK’ (December 1991)
PRO NED: ‘Code of Recommended Practice on Non-Executive Directors’ (April
1987); ‘Remuneration Committees’ (January 1992); ‘Research into the Role
of the Non-Executive Director’ (sponsored jointly with the London Stock
Exchange, published July 1992); ‘ 10th Annual Review’ (September 1992).
doc_893368635.pdf
The country's economy depends on the drive and efficiency of its companies. Thus the effectiveness with which their boards discharge their responsibilities determines Britain's competitive position. They must be free to drive their companies forward, but exercise that freedom within a framework of effective accountability. This is the essence of any system of good corporate governance.
0 0 R E P O R T O F T H E C O M M I T T E E O N 0 0
T HE
F I N A N C I A L A S P E C T S
OF
C O R P O R A T E G O V E R N A N C E
1 DE C E M B E R 1992
0 0 R E P O R T O F T H E C O M M I T T E E O N 0 0
THE
F I NA NC I A L A S P E C T S
OF
C O R P O R A T E G O V E R N A N C E
0 1992 The Committee on the Financial Aspects of
Corporate Governance and Gee and Co. Ltd.
Reproduction of this publication in whole or in part is
unrestricted for internal communications within a given
organisation. It is otherwise subject to permission which
will not be refused but will attract a reasonable
reproduction charge. A leaflet is available from the
Publishers setting out full details of the level of the charge
and when it is applicable.
First published December 1992
ISBN 0 85258 913 1 (Report)
ISBN 0 85258 915 8 (Report with Code of Best Practice)
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P.O. Box 433
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PR E FACE
TH E
INTRO D llc1‘10 N
TH E
TH E
REASONS FOR SETTING UP THE
CORPORATE GO V E R N A N C E
REPORT CONTENT
C ODE OF B EST PR ACT I CE
COMMITTEE
COMPANIES TO WHOM DIRECTED
CODE PRINCIPLES
CiL
STATEMENT OF COMPLIANCE
KEEPING THE CODE UP TO DATE
Ai__
COMPLIANCE
BOARD
BOARD EFFECTIVENESS
THE CHAIRMAN
NO N- EXECUTIVE DIRECTORS
PROFESSIONAL ADVICE
DIKECTORS' TRAINING
BOARD STRUCTURES AND PROCEDURES
,~~~
THE COMPANY SECRETARY
DIRECTORS' RESPONSIBILITIES
STANDARDS 01: CONDUCT
NOMINATION COMMITTEES
INTEKNAL CoNTRoLs
AUDIT COMMITTEES
INTEKNAL AUDIT
B OARD REMUNERATION
_
__
PAGE
9
11
16
-
.-
20
CONTENTS
PAGE
FINANCIAL REPORTS
REPORTING PRACTI CE
PENSIONS GOVERNANCE
T H E
IMPORTANCE OF AUDI T
PROFESSIONAL OBJECTIVITY
‘ QUARANTI NI NG’ AUDIT FROM OT HE R
ROTATION OF AUDI TORS
36
SERVICES
WAYS TO INCREASE EFFECTIVENESS AND VALUE OF THE AUDI T
THE ‘ EXPECTATIONS GA P’
_
INTERNAL CONTROL
~~~~__~
GOING CONCERN
FRAUD
OTHER ILLEGAL ACTS
AUDI TORS’ LI ABI LI TY
AUDIT CONFI DENCE
SHA RE HOL DE RS 48
ACCOUNTABILITY OF BOARDS TO SHAREHOLDERS
INSTITUTIONAL SHAREHOLDERS
‘_
SHAREHOLDER
SHAREHOLDER
c 0 NC I, US I 0 N
COMMUNI CATI ONS
INFLUENCE
53
SUMMAKY OI’ ~~liCOMMENl)A1‘IONS 54
A.PPENDICES
TERMS OF I T HE C O M M I T T E E’ S M E MB E R S H I P A N D
R E F E R E N C E
2 THE ROLE OF BODIES REFERRED TO IN THE RE P O R T
3 DI RECTORS’ RESPONSI BI LI TY STATEMENT
4 AUDIT COMMI TTEES
5 CURRENT STATUTORY AND OTHER REQUI REMENTS
6 AUDI T ORS’ LI ABI L I T Y: THE CAPARO CA S E
I CONTRI BUTORS AND RELEVANT PUBLI SHED STATEMENTS
CONTENTS
PAGE
61
When our Commi ttee was formed j ust over ei ghteen months ago,
neither our title nor our work programme seemed framed to catch
the headl i nes. I n the event, the Commi ttee has become the focus
of far more attenti on than I ever envi saged when I accept ed t he
i nvi tati on to become i ts chai rman. The harsh economi c cl i mate i s
par t l y r esponsi bl e, si nce i t has exposed company r epor t s and
a c c ount s t o unus ua l l y c l os e s c r ut i ny . I t i s , howe v e r , t he
cont i nui ng concer n about st andar ds of f i nanci al r epor t i ng and
accountabi l i ty, hei ghtened by BCCI , Maxwel l and the controversy
over di rectors’ pay, whi ch has kept corporate governance i n the
publ i c eye.
Unexpect ed t hough t hi s at t ent i on may have been, i t ref l ect s a
cl i mate of opi ni on whi ch accepts that changes are needed and i t
presents an opportunity to raise standards of which we should take
f ul l advant age. Our draf t proposal s have been t horoughl y ai red
and have at t ract ed a consi derabl e wei ght of i nf ormed comment
from a wi de range of i ndi vi dual s and bodi es wi th an i nterest i n
matters of corporate governance. While it has not been uncritical,
t he gr e a t ma j or i t y of our r e s ponde nt s ha v e s uppor t e d t he
Commi ttee’ s approach and i t i s thi s consensus whi ch gi ves us a
mandate to proceed. The Committee is being looked to for a lead,
which we have a duty to provide.
I wi sh to thank the members of the Commi ttee for thei r di l i gence
and above all our Secretary, whose si ngl e-mi nded commi tment to
the Committee’s progress has enabled us to complete the task we
were set in May of last year. The report represents a shared view
of t he act i on whi ch needs t o be t aken i n t he f i el d of f i nanci al
reporti ng and accountabi l i ty and i t i s one to whi ch every member
of t he Commi t t ee has cont ri but ed. The Commi t t ee has benef i t ed
f r om t he br eadt h of i t s r epr esent at i on, whi ch has i ncl uded
me mbe r s o f t h o s e b o d i e s b e s t p l a c e d t o s u p p o r t t h e
i mpl ementati on of i ts recommendati ons.
I woul d al so l i ke on behal f of t he Commi t t ee t o expr ess our
grati tude to everyone who has contri buted to our work ei ther by
submi t t i ng evi dence 10 us di rectl y, or through the press or by
providing platforms for debates on governance issues.
PREFACE
Accept ance of t he r epor t ’ s f i ndi ngs wi l l mar k an i mpor t ant
advance in the process of establishing corporate standards. Our
r e c o mme n d a t i o n s wi l l , h o we v e r , h a v e t o b e r e v i e we d
as circumstances change and as the broader debate on governance
develops. We will continue in existence as a Committee until a
successor body -is appointed, to act as a source of authority on our
recommendations and to review their implementation.
Adrian Cadbury
Chai rman
1 December 1992
1. 1 The country’s economy depends on the drive and efficiency
of its companies. Thus the effectiveness with which their
boards discharge their responsibilities determines Britain’s
compet i t i ve posi t i on. They must be free t o dri ve t hei r
compani es forward, but exerci se t hat freedom wi t hi n a
framework of effective accountability. This is the essence
of any system of good corporate governance.
1.2 The Commi t t ee’ s r ecommendat i ons ar e f ocused on t he
control and reporting functions of boards, and on the role
of auditors. This reflects the Committee’s purpose, which
was t o r evi ew t hos e as pect s of cor por at e gover nance
s pe c i f i c a l l y r e l a t e d t o f i na nc i a l r e por t i ng a nd
a c c ount a bi l i t y. Our pr opos a l s do, howe ve r , s e e k t o
contribute positively to the promotion of good corporate
governance as a whole.
1.3
At the heart of the Committee’s recommendations is a Code
of Best Pract i ce desi gned t o achi eve t he necessary hi gh
s t andar ds of cor por at e behavi our . The London St ock
Exchange intend to require all listed companies registered
i n t he Uni t ed Ki ngdom, as a cont i nui ng obl i gat i on of
listing, to state whether they are complying with the Code
and to give reasons for any areas of non-compliance. This
requi rement wi l l enabl e sharehol ders t o know where t he
companies in which they have invested stand in relation to
the Code. The obligation will be enforced in the same way
as al l ot her l i st i ng obl i gat i ons. Thi s may i ncl ude, i n
appropriate cases, the publication of a formal statement of
censure.
1.4 The Committee will remain responsible for reviewing the
implementation of its proposals until a successor body is
appointed in two years’ time, to examine progress and to
continue the ongoing governance review. It will be for our
s pons or s t o agr ee t he r emi t of t he new body and t o
est abl i sh t he basi s of i t s suppor t . I n t he meant i me. a
programme of research wi l l be undert aken t o assi st t he
future monitoring of the Code.
1.5 By adhering to the Code, listed companies will strengthen
bot h t hei r cont rol over t hei r busi nesses and t hei r publ i c
accountability. In so doing. they will be striking the right
bal ance bet ween meet i ng t he s t andar ds of cor por at e
gover nance now expect ed of t hem and r et ai ni ng t he
essential spirit of enterprise.
THE SETTING FOR THE REPORT
1.6 Bri ngi ng greater clarity to the respective responsibilities of
di rect ors, sharehol ders and audi t ors wi l l al so st rengt hen
trust in the corporate system. Companies whose standards
of corporat e governance are hi gh are t he more l i kel y t o
gai n t he conf i dence of i nves t or s and s uppor t f or t he
development of their businesses.
1.7 The basi c syst em of corporat e governance i n Bri t ai n i s
sound. The principles are well known and widely followed.
Indeed t he Code cl osel y refl ect s exi st i ng best pract i ce.
This sets the standard which all listed companies need to
match.
1.8 Our proposals aim to strengthen the unitary board system
and increase its effectiveness, not to replace it. In law. all
di r ect or s ar e r es pons i bl e f or t he s t ewar ds hi p of t he
company’s assets. All directors, therefore, whether or not
they have executive responsibilities, have a monitoring role
and are responsible for ensuring that the necessary controls
over the activities of their companies are in place - and
working.
1.9 Had a Code such as ours been in existence in the past, we
believe that a number of the recent examples of unexpected
company failures and cases of fraud would have received
attention earlier. It must, however, be recognised that no
system of control can eliminate the risk of fraud without so
shackling companies as to impede their ability to compete
in the market place.
1.10 We believe that our approach, based on compliance with a
vol unt ary code coupl ed wi t h di scl osure, wi-II prove more
effective than a statutory code. It is directed at establishing
best practice, at encouraging pressure from shareholders to
hast en i t s wi despr ead adopt i on, and at al l owi ng some
flexibility in implementation. We recognise, however. that
i f compani es do not back our r ecommendat i ons. i t i s
probabl e t hat l egi sl at i on and ext ernal regul at i on wi l l be
sought to deal with some of the underlying problems which
t he report i dent i fi es. St at ut ory measures woul d i mpose a
mi ni mum st andard and t here woul d be a great er ri sk of
boar ds compl yi ng wi t h t he l et t er , r at her t han wi t h t he
spirit, of their requirements.
THE SETTING FOR THE REPORT
1.11 The Committee is clear that action by boards of directors
a nd a udi t or s on t he f i na nc i a l a s pe c t s of c or por a t e
governance is expected and necessary. We are encouraged
by the degree to which boards are already reviewing their
s t r u c t u r e s a n d s y s t e ms i n t h e l i g h t o f o u r d r a f t
recommendat i ons. The adopt i on of our recommendat i ons
wi l l mar k an i mpor t ant st ep f or war d i n t he cont i nui ng
process of raising standards in corporate governance.
I NTRODUCTI ON
Reasons for setting up the Committee
2.1 The Commi t t ee was set up i n May 1991 by t he Fi nanci al
Repor t i ng Counci l , t he London St ock Exchange and t he
accountancy professi on to address the fi nanci al aspects of
corporat e governance. The Commi t t ee’ s membershi p and
terms of reference are set out i n Appent/i.r 1. I t s sponsors
were concerned at t he percei ved l ow l evel of conf i dence
both in financial reporting and in the ability of auditors to
provide the safeguards which the users of company reports
sought and expected. The underl yi ng factors were seen as
t he l ooseness of account i ng st andards, t he absence of a
cl ear f r amewor k f or ensur i ng t hat di r ect or s kept under
r evi ew t he cont r ol s i n t hei r busi ness, and compet i t i ve
pressures both on companies and on auditors which made it
difficult for auditors to stand up to demanding boards.
2. 2 These concerns about the worki ng of the corporate system
wer e hei ght ened by some unexpect ed f ai l ur es of maj or
companies’ and by criticisms of the lack of effective board
accountabi l i ty for such matters as di rectors’ pay. . Further
evi dence of t he breadt h of f eel i ng t hat act i on had t o be
taken to clarify responsibilities and to raise standards came
from a number of reports on different aspects of corporate
governance whi ch had ei t her been publ i shed or were i n
preparation at that time.
2. 3 T h e C o mmi t t e e wh e r e v e r p o s s i b l e d r e w o n t h e s e
doc ume nt s , a n d a wi d e r a n g e o f s u b mi s s i o n s f r o m
i nterested parti es, i n produci ng i ts draft report whi ch was
issued for public comment on 27 May 1992.
2. 4 Si nce t hen, t he Commi t t ee has recei ved over 200 wri t t en
responses t o i t s proposal s, t he gr eat maj or i t y of whi ch
br oa dl y s uppor t t he Commi t t e e ’ s a ppr oa c h, a nd ha s
careful l y consi dered the bal ance of opi ni ons expressed on
part i cul ar i ssues. The Commi t t ee i s most grat ef ul t o al l
those who have taken the time and trouble to give us their
comments. They have helped to shape our final report and,
i n addi t i on, t hey are a val uabl e ref erence source f or our
successors. A list of contributors and of relevant published
statements appears in Appcndis 7.
.,.,. ,.,.I, ~.~...,,,,,.....,..,,,,...~. .,,. ,.,. ,. ,., . . ,,,,,.I
I NTRODUCTI ON
Corporate Governance
2.5
Corporat e governance i s t he syst em by whi ch compani es
ar e di r ect ed and cont r ol l ed. Boar ds of di r ect or s ar e
responsi bl e for t he governance of t hei r compani es. The
shareholders’ role in governance is to appoint the directors
a nd t he a udi t or s a nd t o s a t i s f y t he ms e l ve s t ha t a n
a p p r o p r i a t e g o v e r n a n c e s t r u c t u r e i s i n p l a c e . Th e
responsibilities of the board include setting the company’s
strategic aims, providing the leadership to put them into
effect , supervi si ng t he management of t he busi ness and
reporting to shareholders on their stewardship. The board’s
a c t i ons ar e s u b j e c t t o l a ws , r e g u l a t i o n s a n d t h e
shareholders in general meeting.
2.6
Wi t hi n t hat overal l framework, t he speci fi cal l y fi nanci al
aspect s of corporat: gover nance (ihe Commi t t ee’s remi t )
ar e t he way i n whi ch boar ds set f i nanci al pol i cy and
oversee its implementation, including the use of financial
c ont r ol s , and t he proces: wher eby t hey r epor t on t he
activities and progress of the company to the shareholders.
2.7 The role of the auditors is to provide the shareholders with
an external and objective check on the directors’ financial
statements which form the basis of that reporting system.
Although the reports of the directors are addressed to the
shareholders, they are important to a wider audience, not
least to employees whose interests boards have a statutory
duty to take into account.
2.8
The Committee’s objective is to help to raise the standards
of corporat e governance and t he l evel of confi dence i n
financial reporting and auditing by setting out clearly what
it sees as the respective responsibilities of those involved
and what it believes is expected of them.
Report Content
2.9 Th e r e p o r t b e g i n s b y r e v i e wi n g t h e s t r u c t u r e a n d
r esponsi bi l i t i es of boar ds of di r ect or s; here we have
s ummar i s ed our r ecommendat i ons i n a Code of Bes t
Practice. Next, we consider the role of auditors and address
a n u mb e r o f r e c o mme n d a t i o n s t o t h e a c c o u n t a n c y
pr of e s s i on. We t h e n d e a l wi t h t he r i ght s and
responsibilities of shareholders. The report concludes with
several appendi ces, i ncl udi ng at Appendix 2 not es on t he
roles of some of the bodies referred to in the report.
Companies to whom directed
3.1 The Code of Best Practice (on pages 58 to 60) is directed
to the boards of directors of all listed companies registered
i n t he UK, but we woul d e nc our a ge a s ma ny ot he r
companies as possible to aim at meeting its requirements.
Code Principles
3.2
3.3
3.4
3.5
3.6
The principles on which the Code is based are those of
openness, integrity and accountability. They go together.
Openness on the part of companies, within the limits set by
their competitive position, is the basis for the confidence
which needs to exist between business and all those who
have a st ake i n i t s success. An open appr oach t o t he
di s cl os ur e of i nf or mat i on cont r i but es t o t he ef f i ci ent
worki ng of t he market economy, prompis boards to take
ef f ect i ve act i on and al l ows shar ehol der s and ot her s t o
scrutinise companies more thoroughly.
I n t e g r i t y me a n s b o t h s t r a i g h t f o r wa r d d e a l i n g a n d
compteteness. What i s requi red of fi nanci al report i ng i s
t hat i t shoul d be honest and th~at i t shoul d pr esent a
balanced picture of the state of the company’s affairs. The
integrity of reports depends on the integrity of those who
prepare and present them.
Boards of directors are accountable to their shareholders
a n d b o t h h a v e t o p l a y t h e i r p a r t i n ma k i n g t h a t
accountability effective. Boards of directors need to do so
through the quality of the information which they provide
to shareholders, and shareholders through the.ir willingness
to exercise their responsibilities as owners.
The arguments for adhering to the Code are twofold. First,
a cl ear under st andi ng of ‘ r esponsi bi l i t i es and an open
approach to the way in which they have been discharged
wi l l assi st boar ds of di r ect or s i n f r ami ng and wi nni ng
support for their strategies. It will also assist the efficient
operat i on of capi t al market s and i ncrease confi dence i n
boar ds, audi t or s and f i nanci al r epor t i ng and hence t he
general level of confidence in business.
Second, if standards of financial reporting and of business
conduct more generally are not seen to be raised, a greater
r el i ance on r egul at i on may be i nevi t abl e. Any f ur t her
THE CODE OF BEST PRACTICE
degree of regulation would, in any event, be more likely to
be well directed, if it were to enforce what has already
been shown to be workable and effective by those setting
the standard.
Statement of Compliance
3.7 We r ecommend that listed companies reporting in respect
of year s endi ng af t er 30 June 1993 shoul d st at e i n t he
report and accounts whether they comply with the Code and
identify and give reasons for any areas of non-compliance.
The London St ock Exchange i nt ends t o r equi r e such a
statement as one of its continuing listing obligations.
3.8 We envisage, however, that many companies will wish to
go beyond the strict terms of the London Stock Exchange
r ul e and make a gener al st at ement about t he cor por at e
governance of their enterprises as some leading companies
have already done. We welcome such statements and leave
it to boards to decide the terms in which they make their
s t at ement of compl i ance. Boar ds ar e not expect ed t o
comment separately on each item of the Code witti whi ch
they are complying, but areas of non-compliance will have
to be dealt with individually.
3.9 The continuing obligations laid down by the London Stock
Ex c h a n g e s h o u l d r e q u i r e c o mp a n i e s ’ s t a t e me n t s o f
compl i ance t o have been t he subj ect of r evi ew by t he
auditors before publication. The review should cover only
t hose part s of t he compl i ance st at ement whi ch rel at e t o
p r o v i s i o n s o f t h e Co d e wh e r e c o mp l i a n c e c a n b e
obj ect i vel y ver i f i ed ( s ee f oot not e t o t he Code) . The
audi t or s s houl d not be r equi r ed t o r epor t f or mal l y a
satisfactory conclusion to their review, but if they identify
an area of non-compliance which is not properly disclosed,
t hey shoul d draw at t ent i on t o i t i n t hei r report on t he
f i nanci al st at ement s. We r e c o mme n d t hat t he Audi t i ng
Pr act i ces Boar d shoul d consi der gui dance f or audi t or s
accordi ngl y
THE CODE OF BEST PRACTICE
3.10 The Code is to be followed by individuals and companies in
the light of their own particular circumstances. They arc
responsible for ensuring that their actions meet the spirit of
the Code and in interpreting it they should give precedence
to substance over form.
Keeping the Code up to date
3.11 We have addressed those issues which appeared from the
evidence before us to require the most immediate attention.
The si t uat i on, however , i s devel opi ng. The Account i ng
Standards Board has in hand a programme of work on the
basis cf financial reporting. Revised accounting standards
and improved methods of financial presentation will result.
At the same time, views on best boardroom practice will
evolve in the light of experience, and European Community
directives and regulations may give rise to new issues. It is
essent i al , t her ef or e, that the Code, in addition to being
monitored, is kept up to date.
3. 12 We r e c omme nd t ha t our s pons or s , c onve ne d by t he
Fi na nc i a l Re por t i ng Counc i l , s houl d a ppoi nt a ne w
Committee by the end of June 1995 to examine how far
compl i ance wi t h t he Code has progressed, how far our
ot he r r e c omme nda t i ons ha ve be e n i mpl e me nt e d, a nd
whet her t he Code needs updat i ng i n l i ne wi t h emergi ng
i ssues. Our sponsors shoul d al so det ermi ne whet her t he
sponsorship of the new Committee should be broadened and
whether wider matters of corporate governance should be
i ncl uded i n i t s br i ef . In t h e me a n t i me , t h e p r e s e n t
Commi t t ee wi l l r emai n r es pons i bl e f or r evi ewi ng t he
implementation of its proposals and for identifying further
issues which its successor body might usefully consider.
The s e s t e ps wi l l e s t a bl i s h a c ont i nui ng pr oc e s s .of
governance review.
Compliance
3.13
3.14
Rai s i ng s t andar ds of cor por at e gover nance cannot be
achieved by structures and rules alone. They are important
because t hey provi de a framework whi ch wi l l encourage
and support good governance, but what counts is the way in
which they are put to use.
The responsibility for putting the Code into practice lies
directly with the boards of directors of listed companies to
THE CODE OF BEST PRACTICE
whom i t i s addr es s ed. Compl i anc e i t s el f , howev er , i s a
mat t er f or ever yone concer ned wi t h cor por at e gover nance.
We l ook t o t he f i nanci al i nst i t ut i ons and t he wi de r ange of
bodi es backi ng our wor k t o encour age t he adopt i on of our
r e c o mme n d a t i o n s b y c o mp a n i e s i n wh i c h t h e y h a v e a n
i nt er est . The medi a al so have a par t t o pl ay i n dr awi ng
at t ent i on t o gov er nanc e i s s ues of publ i c or s har ehol der
concer n. I t i s vi t al t o sei ze t he oppor t uni t y pr esent ed by a
cl i mat e of opi ni on whi ch accept s t hat changes ar e needed
and whi ch i s expect i ng t he Commi t t ee t o gi ve t he necessary
l ead.
3. 15 The Commi t t ee r ec ogni s es t hat s mal l er l i s t ed c ompani es
ma y i n i t i a l l y h a v e d i f f i c u l t y i n c o mp l y i n g wi t h s o me
a s p e c t s o f t h e C o d e a n d w e h a v e g i v e n c a r e f u l
consi der at i on t o t he r esponses t o t he dr af t r epor t whi ch
a d d r e s s e d t h i s p o i n t . T h e b o a r d s o f s ma t t e r l i s t e d
c ompani es who c annot , f or t he t i me bei ng, c ompl y wi t h
par t s of t he Code shoul d not e t hat t hey may i nst ead gi ve
t hei r r easons ftir non- c ompl i anc e. We bel i ev e, howev er ,
t hat full c ompl i anc e wi l l br i ng benef i t s t o t he boar ds of
such compani es and i t shoul d be t hei r obj ect i ve t o ensur e
t h a t t h e b e n e f i t s a r e a c h i e v e d . I n p a r t i c u l a r , t h e
appoi nt ment of appr opr i at e non- execut i ve di r ect or s shoul d
make a posi t i ve cont r i but i on t o t he devel opment of t hei r
busi nesses. Any pract i cal i ssues whi ch may ari se i n respect
of smat t er l i st ed compani es wi l t be t hor oughl y r evi ewed by
t he Commi t t ee and i t s successor.
3. 16 The Commi t t ee not es t hat c ompani es wi l l not be abl e t o
c o mp l y wi t h i t e ms 4 . 5 a n d 4 . 6 i n t h e Co d e u n t i l t h e
necessary gui dance f or compani es has been devel oped.
Board Effectiveness
4.1 Every publ i c company shoul d be headed by an effect i ve
board which can both lead and control the business. Within
the context of the UK unitary board system, this means a
board made up of a combi nat i on of execut i ve di rect ors,
wi t h t hei r i nt i mat e knowl edge of t he busi ness, and of
outside, non-executive directors, who can bring a broader
vi ew t o t he company’s act i vi t i es, under a chai rman who
accept s t he dut i es and r esponsi bi l i t i es whi ch t he post
entails.
4.2 Tests of board effectiveness include the way in which the
member,s of the board as a whole work together under the
c h a i r ma n , wh o s e r o l e i n c o r p o r a t e g o v e r n a n c e is
fundament al , and t hei r col l ect i ve abi l i t y t o provi de bot h
the leadership and the checks and balances which effective
gover nance demands. Shar ehol der s ar e r esponsi bl e f or
electing board members and it is in their interests to see
that the boards of their companies are properly constituted
and not dominated by any one individual.
4.3 All directors are equally responsible in law for the board’s
a c t i o n s a n d d e c i s i o n s . Ce r t a i n d i r e c t o r s ma y h a v e
part i cul ar responsi bi l i t i es, as execut i ve or non-execut i ve
di rect ors, for whi ch t hey are account abl e t o t he board.
Regar dl ess of speci f i c dut i es under t aken by i ndi vi dual
directors, however, it is for the board collectively to ensure
that it is meeting its obligations.
4.4 Whi l st i t i s t he boar d as a whol e whi ch i s t he f i nal
authority, executive and non-executive directors are likely
to contribute in different ways to its work. Non-executive
directors have two particularly important contributions to
make to the governance process as a consequence of their
independence from executive responsibility. Neither is in
conflict with the unitary nature of the board.
4.5 The first is in reviewing the performance of the board and
of t he execut i ve. Non-execut i ve di rect ors shoul d address
t hi s aspect of t hei r responsi bi l i t i es careful l y and shoul d
ensure that the chairman is aware of their views. If the
chairman is also the chief executive, board members should
look to a senior non-executive director, who might be the
deput y chai r man, as t he per son t o whom t hey shoul d
a ddr e s s a ny c onc e r ns a bout t he c ombi ne d of f i c e of
chai r man/ chi ef execut i ve and i t s consequences f or t he
ef f ect i veness of t he board. A number of compani es have
recogni sed t hat rol e and some have done so f ormal l y i n
thei r Arti cl es.
4. 6 The second i s i n taki ng the l ead where potenti al confl i cts
of interest arise. An important aspect of effective corporate
governance i s the recogni ti on that the speci fi c i nterests of
t he execut i ve management and t he wi der i nt erest s of t he
company may at times diverge, for example over takeovers,
boardroom successi on, or di rectors’ pay. I ndependent non-
e x e c ut i v e di r e c t or s , whose i nt er est s ar e l ess di r ect l y
affected, are well-placed to help to resolve such situations.
The Chairman
4. 7 The chai rman’ s rol e i n securi ng good corporate governance
i s cr uci al . Chai r men ar e pr i mar i l y r esponsi bl e f or t he
working of the board, for its balance of membership subject
to board and sharehol ders’ approval , for ensuri ng that al l
relevant issues are on the agenda, and for ensuring that all
di rect ors, execut i ve and non- execut i ve al i ke, are enabl ed
and encour aged t o pl ay t hei r f ul l par t i n i t s act i vi t i es.
Chairmen should be able to stand sufficiently back from the
day- t o- day r unni ng of t he busi ness t o ensur e t hat t hei r
boards are in full control of the company’s affairs and alert
to their obligations to their shareholders.
4.8 It i s for chai rmen to make certai n that thei r non-executi ve
di rect ors recei ve t i mel y, rel evant i nf ormat i on t ai l ored t o
t hei r needs, t hat t hey are properl y bri ef ed on t he i ssues
ari si ng at board meeti ngs, and that they make an effecti ve
contribution as board members in practice. It is equally for
chai rmen t o ensure t hat execut i ve di rect ors l ook beyond
t hei r execut i ve dut i es and accept t hei r f ul l shar e of t he
responsi bi l i ti es of governance.
4.9 Gi v e n t h e i mp o r t a n c e a n d p a r t i c u l a r n a t u r e o f t h e
chairman’s role, it should in principle be separate from that
of the chief executive. If the two roles are combined in one
person, it represents a considerable concentration of power.
We recommend, t heref ore, t hat t here shoul d be a cl earl y
accept ed di vi si on of r esponsi bi l i t i es at t he head of a
c o mp a n y , whi ch wi l l ensur e a bal ance of power and
aut hor i t y, such t hat no one i ndi vi dual has unf et t er ed
powers of deci si on. Where the chai rman i s al so the chi ef
THE BOARD
executive, it is essential that there should be a strong and
independent element on the board.
Non-Executive Directors
4. 10 The Commi t t ee bel i eves t hat t he cal i br e of t he non-
executive members of the board is of special importance in
setting and maintaining standards of corporate governance.
The emphasis in this report on the control function of non-
execut i ve di r ect or s i s a consequence of our r emi t and
s houl d not i n any way det r act f r om t he pr i mar y and
positive contribution which they are expected to make, as
equal board members, to the leadership of the company.
4.11 Non- execut i ve di r ect or s s houl d br i ng an i ndependent
j udgement t o bear on i ssues of st r at egy, per f or mance,
resources, i ncl udi ng key appoi nt ment s, and st andards of
conduct . We recommend t hat t he cal i bre and number of
non-execut i ve di rect ors on a board shoul d be such t hat
t hei r vi ews wi l l carry si gni fi cant wei ght i n t he board’s
d e c i s i o n s . T o me e t o u r r e c o mme n d a t i o n s o n t h e
composition of sub-committees of the board, all boards will
require a minimum of three non-executive directors, one of
whom may be the chairman of the company provided he or
she is not also its executive head. Additionally, two of the
three should be independent in the terms set out in the next
paragraph.
4. 12 An essent i al qual i t y whi ch non-execut i ve di rect ors shoul d
bring to the board’s deliberations is that of independence
of j udgement . We recommend t hat t he maj ori t y of non-
execut i ves on a boar d s houl d be indepen’dent of t he
company. This means that apart from their directors’ fees
a n d s h a r e h o l d i n g s , t h e y s houl d be i nde pe nde nt . of
ma n a g e me n t a n d f r e e f r o m a n y b u s i n e s s o r o t h e r
r el at i onshi p whi ch coul d mat er i al l y i nt er f er e wi t h t he
exercise of their independent judgement. It is for the board
to decide in particular cases whether this definition is met.
Information about the relevant interests of directors should
be disclosed in the Directors’ Report.
4. 13 On f ees , t h e r e i s a b a l a n c e t o b e s t r u c k b e t we e n
recogni si ng t he val ue of t he cont ri but i on made by non-
e x e c u t i v e d i r e c t o r s and not u n d e r mi n i n g t h e i r
independence. The demands which are now being made on
consci ent i ous non-execut i ve di rect ors are si gni fi cant and
THE BOARD
4. 14
4. 15
4. 16
4. 17
thei r fees shoul d refl ect the ti me whi ch they devote to the
company’s affairs. There is, therefore, a case for paying for
a ddi t i ona l r e s pons i bi l i t i e s t a k e n on, f or e x a mpl e , by
chai rmen of board commi ttees. I n order to safeguard thei r
i ndependent posi t i on, we regard i t as good pract i ce f or
non- execut i ve di rect ors not t o part i ci pat e i n share opt i on
schemes and f or t hei r servi ce as non- execut i ve di rect ors
not to be pensionable by the company.
Non- execut i ve di rect ors l ack t he i nsi de knowl edge of t he
company of the executive directors, but have the same right
of access t o i nf ormat i on as t hey do. Thei r ef f ect i veness
t ur ns t o a consi der abl e ext ent on t he qual i t y of t he
i nformati on whi ch they recei ve and on the use whi ch they
make of it. Boards should regularly review the form and the
extent of the information which is provided to all directors.
Gi ven the i mportance of thei r di sti ncti ve contri buti on, non-
execut i ve di r ect or s shoul d be sel ect ed wi t h t he same
i mparti al i ty and care as seni or executi ves. We recommend
that their appointment should be a matter for the board as a
whole and that there should be a formal selection process,
whi ch wi l l r ei nf or ce t he i ndependence of non- execut i ve
directors and make it evident that they have been appointed
on merit and not through any form of patronage. We regard
i t as good practi ce for a nomi nati on commi ttee (deal t wi th
bel ow) t o car r y out t he sel ect i on pr ocess and t o make
proposals to the board.
Companies have to be able to bring about changes in the
composi ti on of thei r boards to mai ntai n thei r vi tal i ty. Non-
e x e c u t i v e d i r e c t o r s ma y l o s e s o me t h i n g o f t h e i r
i ndependent edge, i f t hey r emai n on a boar d t oo l ong.
Fur t her mor e, the make-up of a board needs to change i n
l i ne wi t h new chal l enges. We recommend, t heref ore, t hat
non- execut i ve di rect ors shoul d be appoi nt ed f or speci f i ed
t erms. Thei r Let t er of Appoi nt ment shoul d set out t hei r
dut i e s , t e r m of of f i c e , r e mune r a t i on a nd i t s r e v i e w.
Reappoi nt ment shoul d not be aut omat i c, but a consci ous
decision by the board and the director concerned.
Our emphasi s on t he qual i t i es t o be l ooked fo.r i n non-
execut i ve di rect ors, combi ned wi t h t he great er demands
now being made on them, raises the question of whether the
suppl y of non-executi ve di rectors wi l l be adequate to meet
t he demand. When compani es encourage t hei r execut i ve
di rect ors t o accept appoi nt ment s on t he hoards of 0th;~
THE BOARD
companies, the companies and the individuals concerned all
gain. A policy of promoting this kind of appointment will
i ncr ease t he pool of pot ent i al non- execut i ve di r ect or s,
particularly if the divisional directors of larger companies
are consi dered for non-execut i ve post s, as wel l as t hei r
main board colleagues.
Professional Advice
4. 18 Occasions may arise when directors have to seek legal or
fi nanci al advi ce i n t he furt herance of t hei r dut i es. They
should always be able to consult the company’s advisers.
If, however, they consider it necessary to take independent
professional advice, we r ecommend that they should be
ent i t l ed t o do so at t he company’s expense, t hrough an
agreed procedure l ai d down formal l y, for exampl e i n a
Bo a r d Resolutiot;, i n t he Art i cl es, or i n t he Let t er of
Appointment.
Directors’ Training
4.19 The weight of responsibility carried by all directors and the
i n c r e a s i n g c o mmi t me n t wh i c h t h e i r d u t i e s r e q u i r e
emphasise the importance of the way in which they prepare
themselves for their posts. Given the varying backgrounds,
qual i f i cat i ons and exper i ence of di r ect or s, i t i s hi ghl y
desi r abl e t hat t hey shoul d al l under t ake some f or m of
internal or external training; this is particularly important
for directors, whether executive or non-executive, with no
p r e v i o u s b o a r d e x p e r i e n c e . Ne wl y - a p p o i n t e d b o a r d
members are al so ent i t l ed t o expect a prope,r process of
i nduct i on i nt o t he company’ s af f ai r s. I t is' then up t o
individual directors to keep abreast of their legislative and
broader responsibilities.
4.20 There are already courses for newly-appointed directors run
by the Institute of Directors and business schools. With the
suppor t of t he Bank of Engl and, t he Conf eder at i on of
British Industry, the Institute of Directors, and PRO NED,
a new c our s e c o v e r i n g t h e f u l l r a n g e o f b o a r d
r esponsi bi l i t i es wi l l be open t o di r ect or s shor t l y. The
training and development of directors is of importance to
good governance and i t i s one of t he i ssues whi ch we
suggest our successor body should keep under review.
THE BOARD
Board Structures and Procedures
4.21 The effectiveness of a board is buttressed by its structure
and procedures. One aspect of structure is the appointment
of committees of the board, such as the audit, remuneration
and nomination committees, referred to later in the report.
4.22 Another is that boards should recognise the importance of
t h e f i n a n c e f u n c t i o n b y ma k i n g i t t h e d e s i g n a t e d
responsibility of a main board director, who should be a
si gnat or y t o t he account s on behal f of t he boar d, and
should have the right of access to the Audit Committee.
4. 23 The bas i c pr ocedur al r equi r ement s ar e t hat t he boar d
should meet regularly, with due notice of the issues to be
di s cus s ed s uppor t ed by t he neces s ar y paper wor k, and
should record its conclusions. We recommend that boards
shoul d have a f or mal schedul e of mat t er s speci f i cal l y
reserved t o t hem for t hei r col l ect i ve deci si on, t o ensure
t hat t he di r ect i on and cont r ol of t he company r emai ns
f i r ml y i n t he i r ha nds a nd a s a- s a f e g u a r d a g a i n s t
misjudgements and possible illegal practices. A schedule of
these matters should be given to directors on appointment
and should be kept up to date.
4.24 We envisage that such a schedule would at least include:
(a) acquisition and disposal of assets of the company or
its subsidiaries that are material to the company;
(b) investments, capital projects, authority levels, treasury
policies, and risk management policies.
Boards should lay down rules to determine material,ity for
a ny t r a ns a c t i on, a n d s h o u l d e s t a b l i s h c l e a r l y wh i c h
t r ansact i ons r equi r e mul t i pl e boar d si gnat ur es. Boar ds
shoul d al so agree t he procedures t o be fol l owed when,
e xc e pt i ona l l y, de c i s i ons a r e r e qui r e d be t we e n boa r d
meetings.
The Company Secretary
4.25 The company secretary has a key role to play in ensuring
t hat boar d pr ocedur es ar e bot h f ol l owed and r egul ar l y
revi ewed. The chai rman and t he board wi l l l ook t o t he
company secr et ar y f o r g u i d a n c e o n what t hei r
responsibilities are under the rules and regulations to
which they are subject and on how those responsibilities
THE BOARD
4.26
4.27
should be discharged. All directors should have access to
t he advi ce and ser vi ces of t he company secr et ar y and
should recognise that the chairman is entitled to the strong
and positive support of the company secretary in ensuring
t he ef f ect i ve f unct i oni ng of t he boar d. I t s houl d be
standard practice for the company secretary to administer,
attend and prepare minutes of board proceedings.
Under t he Compani es Act t he di rect ors have a dut y t o
appoint as secretary someone who is capable of carrying
out the duties which the post entails. The responsibility for
ens ur i ng t hat t he s ecr et ar y r emai ns capabl e, and any
question of the secretary’s removal, should be a matter for
the board as a whole.
The Committee expects that the company secretary will be
a source of advice to the chairman and to the board on the
implementation of the Code of Best Practice.
Directors’ Responsibilities
4. 28 So t hat shareholders ar e cl ear wher e t he boundar i es
bet ween t he dut i es of di r ect or s and audi t or s l i e, we
r e c o mme n d t h a t a b r i e f s t a t e me n t o f d i r e c t o r s ’
responsibilities for the accounts should appear in the report
and account s, as a count er par t t o a st at ement by t he
auditors about their reporting responsibilities. The ground
which would need to be covered by the directors’ statement
is set out in Appendi x 3. The appropriate position for the
di r ect or s’ st at ement i s i mmedi at el y before t he audi t ors’
report, which in future will include a
responsibilities. The two statements
each other.
statement of auditors’
will thus. compl ement
Standards of Conduct
4.29 It i s i mpor t ant t hat al l empl oyees s houl d know what
standards of conduct are expected of them. We regard it as
good practice for boards of directors to draw up codes of
et hi cs or st at ement s of busi ness pract i ce and t o publ i sh
them both internally and externally.
THE BOARD
Nomination Committees
4.30 One approach to maki ng board appoi ntments. whi ch makes
clear how these appointments are made and assists boards
i n maki ng them, i s through the setti ng up of a nomi nati on
commi t t ee, wi t h t he r esponsi bi l i t y of pr oposi ng t o t he
board, in the first instance, any new appointments, whether
of execut i ve or of non- execut i ve di rect ors. A nomi nat i on
c ommi t t e e s houl d ha v e a ma j or i t y of non- e x e c ut i v e
di rectors on i t and be chai red ei ther by the chai rman or a
non-executi ve di rector.
internal Controls
4.31
4.32
Di rectors are responsi bl e under s.221 of the Companies Act
1985 for maintaining adequate accounting records. To meet
these responsibilities directors need in practice to maintain
a system of i nternal control over the fi nanci al management
of the company, i ncl udi ng procedures desi gned to mi ni mi se
t he ri sk of f raud. There i s, t heref ore, al ready an i mpl i ci t
requirement on directors to ensure that a proper system of
internal control is in place.
Since an effective internal control system is a key aspect of
the effi ci ent management of a company, we r e c omme nd
that the directors should make a statement in the report and
account s on t he ef f ect i veness of t hei r syst em of i nt ernal
cont rol and t hat t he audi t ors shoul~d report t hereon. The
cr i t er i a f or assessi ng ef f ect i veness and t he det ai l ed
gui dance for audi tors wi l l need to be establ i shed and our
recommendation to this effect is in paragraph 5.16.
Audit Committees
4.33 Si nce 1978, the New York Stock Exchange has requi red al l
listed companies to have audit committees composed solely
of i nde pe nde nt di r e c t or s a nd t he 1987 r epor t of t he
Ame r i c a n Treadway Commi ssi on concl uded t hat audi t
commi t t ees had a cr i t i cal r ol e t o pl ay i n ensur i ng t he
i n t e g r i t y o f U S c o mp a n y f i n a n c i a l r e p o r t s . Wh i l e
experience of audit committees in this country is shorter, it
i s encouragi ng, and around t wo- t hi rds of t he t op 250 UK
listed companies now have them in place.
4. 34 Experience in the United States has shown that, even where
audi t commi t t ees mi ght have been set up mai nl y t o meet
THE BOARD
l i st i ng r equi r ement s, t hey have pr oved t hei r wor t h and
d e v e l o p e d i n t o e s s e n t i a l c o mmi t t e e s o f t h e b o a r d .
S i mi l a r l y , r ecent l y publ i shed r esear ch i n t he Uni t ed
Ki ngdom concl udes t hat t he maj ori t y of compani es wi t h
audit committees are enthusiastic about their value to their
businesses. They offer added assurance to the shareholders
that the auditors, who act on their behalf, are in a position
to safeguard their interests.
4 . 3 5 The Commi t t e e t he r e f or e r e c omme nds t ha t a l l l i s t e d
companies should establish an audit committee. Our further
recommendati ons on audi t commi ttees are as fol l ows:
( a) Audi t commi t t ees shoul d be f or mal l y const i t ut ed t o
ensur e t hat t hey have a cl ear r el at i onshi p wi t h t he
boards to whom they are answerable and to whom they
shnuld report regul arl y. They shou_fd be gi ven wri t t en
t erms of ref erence whi ch deal adequat el y wi t h t hei r
member shi p, aut hor i t y and dut i es, and t hey shoul d
normally meet at least twice a year.
(b) .There s h o u l d b e a mi n i mu m o f t h r e e me mb e r s .
Membershi p shoul d be conf i ned t o t he non- execut i ve
di rect ors of t he company and a maj ori t y of t he non-
e x e c ut i v e s s e r v i ng on t he c ommi t t e e s houl d be
i nde pe nde nt , as def i ned i n par agr aph 4. 12 above.
Membershi p of t he commi t t ee shoul d be di scl osed i n
the annual report.
(cl
The ext er nal audi t or shoul d nor mal l y at t end audi t
committee meetings, as should the finance director. As
the board as a whol e i s responsi bl e for the fi nanci al
statements, other board members should also have the
r i g h t t o a t t e n d . T h e c o mmi t t e e s h o u l d h a v e a
di scussi on wi th the external audi tors, at l east once a
year , wi t hout execut i ve boar d member s pr esent , .to
ensure that there are no unresolved issues of concern.
(d) The audi t commi ttee shoul d have expl i ci t authori ty to
i nvesti gate any matters wi thi n i ts terms of reference,
the resources which it needs to do so, and full access
to information. The committee should be able to obtain
ext ernal prof essi onal advi ce and t o i nvi t e out si ders
with relevant experience to attend if necessary.
(e) The audi t commi ttee’ s duti es shoul d be determi ned i n
the l i ght of the company’ s needs but shoul d normal l y
include:
( i )
maki ng r ecommendat i ons t o t he boar d on t he
THE BOARD
4. 37 The Commi t t e e t he r e f or e r e ga r ds t he a ppoi nt me nt of
properly constituted audit committees as an important step
i n r a i s i ng s t a nda r ds of c or por a t e gove r na nc e . The i r
effect i veness depends on t hei r havi ng a st rong chai rman
who has the confidence of the board and of the auditors,
a nd on t he qua l i t y of t he non- e xe c ut i ve di r e c t or s .
Membershi p of an audi t commi t t ee i s a demandi ng t ask
requi ri ng commi t ment , t rai ni ng and ski l l . The di rect ors
concerned need t o have suffi ci ent underst andi ng of t he
issues to be dealt with by the committee to take an active
part in its proceedings. This is why committees should, if it
is appropriate and within their authority, be able to invite
outsiders with relevant experience to attend meetings.
4. 38 The ext er nal audi t or s s houl d be pr es ent at t he boar d
meeting when the annual report and accounts are approved
and preferably when the half-yearly report is considered as
well.
Internal Audit
4.39 The function of the internal auditors is complementary to,
but different from, that of the outside auditors. We regard
it as good practice for companies to establish internal audit
functions to undertake regular monitoring of key controls
and procedures. Such regular monitoring is an integral part
of a company’s syst em of i nt ernal cont rol and hel ps t o
ensure its effectiveness. An internal audit function is well
placed to undertake investigations on behalf of the audit
committee and to follow up any suspicion of fraud. It is
e s s e n t i a l t h a t h e a d s o f i n t e r n a l a u d i t s h o u l d h a v e
unrestricted access to the chairman of the aud‘it committee
in order to ensure the independence of their position.
THE BOARD
Board Remuneration
4.40 The overriding principle in respect of board remuneration
is that of openness. Shareholders are entitled to a full and
clear statement of directors’ present and future benefits,
and of how they have been determined. We r e c o mme n d
that in disclosing directors’ total emoluments and those of
the chairman and highest-paid UK director, separate figures
shoul d be gi ven for t hei r sal ary and performance-rel at ed
el ement s and t hat t he cri t eri a on whi ch performance i s
measured should be explained. Relevant information about
s t ock opt i ons , s t ock appr eci at i on r i ght s , and pens i on
contributions should also be given.
4.41 In addition, we r e c omme nd t hat fut ure servi ce cont ract s
s houl d not exceed t hr ee year s wi t hout s har ehol der s ’
approval and that the Companies Act should be amended in
l i ne wi t h t hi s r ecommendat i on. Thi s woul d st r engt hen
shareholder control over levels of compensation for loss of
office.
4 . 4 2 We a l s o r e c o mme n d t h a t b o a r d s s h o u l d a p p o i n t
remunerat i on commi t t ees, consi st i ng whol l y or mai nl y of
non-execut i ve di rect ors and chai red by a non-execut i ve
director, to recommend to the board the remuneration of
the executive directors in all its forms, drawing on outside
advi ce as necessary. Execut i ve di rect ors shoul d pl ay no
part in decisions on their own remuneration. Membership
of t he r emuner at i on commi t t ee s houl d appear i n t he
Directors’ Report. Best practice in this field is set out in
PRO NED’s Remuneration Committee guidelines, published
in 1992.
4 . 4 3 Th e Co mmi t t e e h a s r e c e i v e d p r o p o s a l s f o r g i v i n g
shareholders the opportunity to determine matters such as
directors’ pay at general meetings, but does not see how
t hese suggest i ons coul d be made workabl e. A di rect or’s
remuneration is not a matter which can be sensibly reduced
to a vote for or against; were the vote to go against a
particular remuneration package, the board would still have
to determine the remuneration of the director concerned. In
addition, there are such practical considerations as the need
to agree directors’ remuneration on appointment.
THE BOARD
4 . 4 4 Sh a r e h o l d e r s r e q u i r e t h a t t h e r e mu n e r a t i o n o f d i r e c t o r s
shoul d be bot h f ai r and compet i t i ve. St r i ki ng t hi s bal ance
i n v o l v e s d e t a i l e d c o n s i d e r a t i o n o f t h e k i n d wh i c h a
r emuner at i on commi t t ee, whose member s have no per sonal
i n t e r e s t i n t h e o u t c o me , c a n g i v e t o t h e ma t t e r .
Remuner at i on commi t t ees need t o have t he i nt er est s of t he
company and t he shar ehol der s al ways i n mi nd i n comi ng t o
t hei r deci si ons and t he chai r man of t he commi t t ee shoul d
be avai l abl e t o r espond t o any concer ns of shar ehol der s at
t he Annual Gener al Meet i ng.
4. 45 The Annual Gener al Meet i ng pr ov i des t he oppor t uni t y f or
s h a r e h o l d e r s t o ma k e t h e i r v i e ws o n s u c h ma t t e r s a s
d i r e c t o r s ’ b e n e f i t s k n o w n t o t h e i r b o a r d s . I t i s t h e
Co mmi t t e e ’ s v i e w t h a t s h a r e h o l d e r s c a n p l a y a mo r e
,oractical gov er nanc e r ol e by ai mi ng t o i nf l uenc e boar d
pol i ci es i n t hi s way, t han by seeki ng t o make t he det ai l of
board deci si ons subj ect t o t hei r vot e.
4 . 4 6 F u r t h e r c h a n g e s t o t h e r u l e s f o r d i s c l o s u r e , s u c h a s
l engt heni ng t he l i s t of di r ec t or s whos e r emuner at i on i s
i ndi v i dual l y i dent i f i ed, and t he r ol e whi c h s har ehol der s
c o u l d p l a y , e i t h e r i n v o t i n g o n p a r t i c u l a r a s p e c t s o f
r emuner at i on or i n t abl i ng advi sor y r esol ut i ons al ong l i nes
now devel opi ng i n t he USA, wi l l need t o be revi ewed i n t he
l i g h t o f e x p e r i e n c e . Di r e c t o r s ’ c o n t r a c t s a n d p a y a r e
aspect s of boar d account abi l i t y whi ch t he Commi t t ee wi l l
cont i nue t o moni t or i n t he expect at i on t hat t hey wi l l be on
t he agenda of our successor body.
Financial Reports
4.47 A b a s i c we a k n e s s i n t h e c u r r e n t s y s t e m o f f i n a n c i a l
r e p o r t i n g i s t h e p o s s i b i l i t y o f d i f f e r e n t a c c o u n t i n g
t r eat ment s bei ng appl i ed to,essentially t he same f act s, wi t h
t he consequence t hat di f f er ent r esul t s or f i nanci al posi t i ons
c oul d be r epor t ed, eac h appar ent l y c ompl y i ng wi t h t he
o v e r r i d i n g r e q u i r e me n t t o s h o w a t r u e a n d f a i r v i e w.
Regardless o f h o w f a r t h e ma r k e t c a n u n d e r s t a n d t h e
i mp l i c a t i o n s o f a l t e r n a t i v e account i ng t r eat ment s or see
t h r o u g h p r e s e n t a t i o n a l t e c h n i q u e s d e s i g n e d t o s h o w a
c ompany ’ s f i gur es i n t he mos t f l at t er i ng l i ght , t her e ar e
advant ages t o i nvest or s, anal yst s, ot her account s users and
ul t i mat el y t o t he company i t sel f i n f i nanci al r epor t i ng r ul es
whi ch l i mi t t he scope f or uncer t ai nt y and mani pul at i on.
4.48
4.49
4.50
4.5‘1
4.52
4.53
THE BOARD
The lifeblood of markets is information and barriers to the
flow of relevant information represent imperfections in the
market. The need to sift and correct the information put out
by compani es adds cost and uncert ai nt y t o t he market ’s
pricing function. The more the activities of companies are
t ransparent , t he more accurat el y wi l l t hei r securi t i es be
valued.
In addition, the wider the scope for alternative treatments,
t he l es s us ef ul f i nanci al r epor t s become i n t er ms of
comparability - over time and between companies.
What shareholders (and others) need from the report and
accounts is a coherent narrative, supported by the figures,
o f t h e c o mp a n y ’ s p e r f o r ma n c e a n d p r o s p e c t s . We
recommend that boards should pay particular attention to
t hei r dut y t o pr es ent a bal ance, : and under s t andabl e
assessment of their company’s position. Balance requires
that setbacks should be dealt with as well as successes,
whi l e t he need for t he report t o be readi l y underst ood
emphasises that words are as important as figures.
The cardi nal pri nci pl e of fi nanci al report i ng i s t hat t he
view presented should be true and fair. Further principles
ar e t hat boar ds s houl d ai m f or t he hi ghes t l evel of
di scl osur e consonant wi t h prese,nti~ng report s whi ch are
u n d e r s t a n d a b l e a n d wi t h a v o i d i n g d a ma g e t o t h e i r
competitive position. They should also aim to ensure the
integrity and consistency of their reports and they should
meet the spirit as well as the letter of reporting standards.
The Committee wholeheartedly endorses the objectives of
t he Fi nanci al Repor t i ng Counci l and t he Account i ng
St andar ds Boar d i n set t i ng r epor t i ng st andar ds. I t al so
welcomes the action being taken by the Financial Reporting
Revi ew Panel over compani es who.se accounts fall below
accepted reporting standards.
The Committee recognises the advantage to users of reports
and accounts of some explanation of the factors likely to
influence their company’s future progress. The inclusion 01
an essent i al l y f or war d- l ooki ng Oper at i ng and Fi nanci al
Revi ew, al ong t he l i nes devel oped by t he Account i ng
Standards Board for consultation, would serve this purpose.
THE BOARD
Reporting Practice
4.54 Listed companies publish full financial statements annually
and hal f-yearl y report s i n t he i nt eri m. In bet ween t hese
ma j or a n n o u n c e me n t s , b o a r d s ma y n e e d t o k e e p
shareholders and the market in touch with their company’s
progress. The guiding principle once again is openness and
boards shoul d ai m for any i nt erveni ng st at ement s t o be
wi del y ci rcul at ed, i n fai rness t o i ndi vi dual sharehol ders
and to minimise the possibility of insider trading.
4.55 If companies reported quarterly, the need for more informal
me t h o d s o f k e e p i n g i n v e s t o r s i n f o r me d wo u l d b e
di mi ni shed. Quart erl y report i ng woul d, however, i nvol ve
addi t i onal cost s for compani es and ul t i mat el y for t hei r
shar ehol der s and has not been r ecommended t o us by
s har ehol der bodi es , ‘4.ho accept t he pr esent pat t er n of
reporting by boards.
4.56 We consi der t hat i nt eri m report s shoul d be expanded i n
order to increase their value to users. We recommend t hat :
(a)
(b)
(c)
Cd)
balance sheet information should be included with the
interim report. There should not be a requirement for a
full audit, but the interim report should be reviewed by
t he audi t ors, who shoul d di scuss t hei r fi ndi ngs wi t h
the audit committee;
t he cont i nui ng obl i gat i ons l ai d down by t he London
Stock Exchange on UK companies admitted to listing
shoul d be amended t o t hat effect and t he Audi t i ng
Pr act i ces Boar d shoul d devel op appr opr i at e r evi ew
guidance;
‘.
t he Account i ng St andards Board i n conj unct i on wi t h
t he London St oc k Exc ha nge s houl d c l a r i f y. t he
accounting principles which companies should follow
in preparing interim reports;
a requirement for inclusion of cash flow information in
interim reports should be considered by our successor
body.
4.57 Resear ch has shown t hat t he most wi del y r ead par t of
company reports is the opening statement, normally by the
chai r man. I t i s t her ef or e of speci al i mpor t ance t hat i t
shoul d provi de a bal anced and readabl e summary of t he
company’s performance and prospect s and t hat i t shoul d
represent the collective view of the board.
THE BOARD
4. 58 The demand f or an ever - i ncr easi ng amount of det ai l i n
reports and accounts has to be weighed against the need for
t hem t o be under st andabl e by t he r easonabl y i nf or med
shar ehol der . Si mpl i f i ed f or ms of r epor t , i ncl udi ng t he
shortened version of the accounts, allow boards to address
shareholders who would prefer such a statement, but make
t he need f or t he assessment t o be bal anced even mor e
exacting.
4. 59 Al t hough a company’ s publ i shed r epor t s and i t s Annual
General Meeting are its primary channels of communication
with shareholders, companies and their major shareholders
may need to be in touch more frequently. The Institutional
Shar ehol der s ’ Commi t t ee’ s St at ement on t he Res pon-
s i bi l i t i es of I ns t i t ut i onal Shar ehol der s gi ves pr act i cal
gui dance on how shar ehol der s can best exer ci se t hei r
responsibilities as owners in this regard. We fully endorse
their recommendation that there should be regular contact
be t we e n c o mp a n i e s and t he i r ma j o r i n s t i t u t i o n a l
shareholders at senior level and that such matters as board
strategy and structure should be kept under review.
Pensions Governance
4. 60 There are governance i ssues rel at i ng t o company pensi on
funds, hi ghl i ght ed by t he Maxwel l affai r, but t hey fal l
wi t hi n t he remi t of t he Pensi on Law Revi ew Commi t t ee
under t he chai r manshi p of Pr of essor Goode, whi ch i s
c ur r e nt l y r e vi e wi ng t he f r a me wor k of pe ns i on f und
l e gi s l a t i on a nd r e gul a t i on. I n t he l i ght of t hi s , t he
Committee decided that it would be inappropriate for it to
deal specifically with pension fund governance issues.
Importance of Audit
5.1 The annual audit is one of the cornerstones of corporate
gover nance. Gi ven t he s epar at i on of owner s hi p f r om
management, the directors are required to report on their
stewardship by means of the annual report and financial
statements sent to the shareholders. The audit provides an
ext er nal and obj ect i ve c he c k on t he way i n whi ch t he
financial statements have been prepared and presented, and
it is an essential part of the checks and balances required.
The question is not whether there should be an audit, but
how to ensure its objectivity and effecti veness.
5.2 Audi t s ar e a r eassur ance t o al l who have a f i nanci al
i nt er est i n compani es, qui t e apar t f r om t hei r val ue t o
boards of directors. The most direct method of ensuring
that companies are accountable for their actions is through
open disclosure by boards and through audits carried out
against strict accounting standards.
5.3 The framework in which auditors operate, however, is not
well designed in certain respects to provide the objectivity
whi ch sharehol ders and t he publ i c expect of audi t ors i n
car r yi ng out t hei r f unct i on. The mai n r eas ons ar e as
follows:
(a)
(b)
Account i ng st andards and pract i ce somet i mes al l ow
boards t oo much scope for present i ng fact s and t he
f i gur es der i ved f r om t hem i n a var i et y of ways .
Audi t or s c a nnot s t a nd f i r m a ga i ns t a pa r t i c ul a r
account i ng t r eat ment i f i t i s per mi t t ed wi t hi n t he
standards.
‘.
Al t hough t he s ha r e hol de r s f or ma l l y a ppoi nt t he
auditors, and the audit is carried out in their interests,
t he sharehol ders have no effect i ve say i n t he audi t
negotiation and have no direct link with the auditors.
Indeed the Committee can see no practicable way of
establishing one. Auditors do, however, have to work
closely with those in management who have prepared
t he fi nanci al st at ement s whi ch t hey are audi t i ng i n
order to carry out their task, and audit firms, like any
ot he r bus i ne s s , wi l l wi s h t o have a cons t r uct i ve
relationship with their clients.
AUDI TI NG
(cl
Cd)
Audi t fi rms are i n compet i t i on wi t h each ot her for
business. They wish to maximise their business with
companies, of which auditing may only be a part. To
t he ext ent t hat t hey compet e on t he basi s of t hei r
professional reputation, this will act as an incentive to
maintain high standards. So will the ethical guidance
of the profession, and the threat of litigation. To the
extent however that audit firms compete on price and
on meeting the needs of their clients (the companies
they audit), this may be at the expense of meeting the
needs of the shareholders.
Compani es t oo are subj ect t o compet i t i ve pressures.
They will wish to minimise their audit costs and they
are likely to have a clear view as to the figures they
wi s h t o s e e p u b l i s h e d , i n o r d e r t o me e t t h e
expectations of th-eir shareholders.
5.4 A f ur t her pr obl em i s t he l ack of under st andi ng of t he
nature and extent of the audi
rs’ role. This is the so-called‘expectations gap’ - the difference between what audits do
achi eve, and what i t i s t hought t hey achi eve, or shoul d
achi eve. The expect at i ons gap i s damagi ng not onl y
because i t refl ect s unreal i st i c expect at i ons of audi t s but
also because it has led to disenchantment with their value
in the wake of the Capar-o j udgment (paragraphs 5. 31 t o
5.35 below).
5.5 Steps have already been taken, within the last three years,
to strengthen the audit system through the establishment of
a new r egul at or y f r amewor k. The Fi nanci al Repor t i ng
Counci l and i t s as s oci at ed bodi es - t h e Ac c o u n t i n g
St andards Board, t he Urgent Issues Task Force, and t he
Fi nanci al Report i ng Revi ew Panel - have been set up to
i mprove and t i ght en account i ng st andards, t o deal wi t h
problem areas as they emerge, and to examine departures
by i ndi vi dual compani es from t he st at ut ory requi rement s
and account i ng st andards. The new st at ut ory regi me for
r egul at i ng audi t or s r equi r es al l audi t or s t o s at i s f y a
supervisory body as to their competence, experience and
t r ai ni ng, and t o be subj ect t o r egul ar moni t or i ng. The
arrangements for setting auditing standards have also been
reformed with the establishment of the Auditing Practices
Board.
AUDITING
5.6 The new system has only recently been established and its
ful l i mpact has yet to be fel t. I n the fol l owi ng paragraphs
we endorse the steps that are bei ng taken and recommend
addi t i onal act i on t o st rengt hen publ i c conf i dence i n t he
audit approach.
Professional objectivity
5.7 The c e nt r a l i s s ue i s t o e ns ur e t ha t a n a ppr opr i a t e
r e l a t i o n s h i p e x i s t s b e t we e n t h e a u d i t o r s a n d t h e
management whose fi nanci al statements they are audi ti ng.
Sharehol ders requi re audi tors to work wi th and not agai nst
ma na ge me nt , whi l e a l wa y s r e ma i ni ng pr of e s s i ona l l y
obj ect i ve - that is to say, applying their professional skills
i mpar t i al l y and r et ai ni ng a cr i t i cal det achment and a
consciousness of their accountability to those who formally
a p p o i n t t h e m. Ma i n t a i n i n g s u c h a p r o f e s s i o n a l a n d
obj ecti ve rel ati onshi p i s the responsi bi l i ty both of boards
of directors and of auditors, as is that of taking appropriate
action if the basis for that relationship no longer holds.
5. 8 An essent i al f i rst st ep must be t he devel opment of more
ef f ect i ve account i ng st andar ds. Account i ng st andar ds
provi de i mportant reference poi nts agai nst whi ch audi tors
exer ci se t hei r pr of essi onal j udgement . Thei r posi t i on i s
s t r e n g t h e n e d i f s t a n d a r d s d o n o t a l l o w a l t e r n a t i v e
a c c ount i ng t r e a t me nt s . The wor k of t he Ac c ount i ng
Standards Board is well in hand and has our full support.
5.9 A second st ep shoul d be t he f or mat i on by ever y l i st ed
company of an audi t commi ttee whi ch gi ves, the audi tors
di rect access to the non-executi ve members of the board.
Shareholders look to the audit committee to ensure that the
rel ati onshi p between the audi tors and management remai ns
obj ecti ve and that the audi tors are abl e to put thei r vi ews
in the event of any difference of opinion with management.
‘Quarantining’ audit from other services
5 . 1 0 Among t he pr opos i t i ons ma de t o t he Commi t t e e t o
strengthen the obj ecti ve rel ati onshi p between audi tors and
management, one was that audi t fi rms shoul d not provi de
other types of servi ce to thei r audi t cl i ents. The argument
runs that such a prohibition would remove any pressure on
the auditors to give way to management on audit matters in
order not to j eopardi se thei r other busi ness servi ces; and
AUDI TI NG
that it would remove any incentive for auditors to take on
audits at rates which could risk corner-cutting in the hope
of obtaining more remunerative non-audit work.
5.11
Such a prohibition would limit the freedom of companies to
choose t hei r sources of advi ce and coul d i ncrease t hei r
costs. The Committee was not persuaded that any potential
gains in objectivity would outweigh these disadvantages. It
does, however, strongly support full disclosure of fees paid
to audit firms for non-audit work. The essential principle is
that disclosure must enable the relative significance of the
company’s audit and non-audit fees to the audit firm to be
assessed, both in a UK context and, where appropriate, a
wo r l d wi d e c o n t e x t . We r e c o mme n d t hat t he 1991
Regulations under the Companies Act on the disclosure of
remuneration for non-audit work should be reviewed and
amended as necessary in order to apply this principle. We
also regard it as good practice for audit committees to keep
under review the non-audit fees paid to the auditor both in
relation to their significance to the auditor and in relation
to the company’s total expenditure on consultancy.
Rotation of auditors
5.12
Anot her pr opos al was t hat s ome f or m of compul s or y
rot at i on of audi t fi rms shoul d be i nt roduced, t o prevent
relationships between management and auditors becoming
too comfortable. The Committee felt that any advantages
which this could bring would be more than outweighed by
the loss of the trust and experience which are built up when
t he r el at i onshi ps ar e sound, and by t he r i sk t o audi t
effect i veness at t he changeover. The Commi t t ee agreed,
however, that in the case of listed companies a periodic
change of audit partners should be arranged to bring a fresh
approach to the audit. We recommended in our draft report
that the accountancy profession should draw up appropriate
guidelines and we support the steps which it is now taking
t o do so. We woul d expect t he gui del i nes t o al l ow a
measure of flexibility over timing to take account of the
incidence of other changes in senior personnel, both in the
audit team and in the client company, which have helped to
keep a di st i nct i on i n r el at i onshi ps bet ween cl i ent and
auditor.
AUDI TI NG
Ways to increase effectiveness and value of the audit
The ‘Expectations Gap’
5.13 An essential first step is to be clear about the respective
responsibilities of directors and auditors for preparing and
reporting on the financial statements of companies, in order
to begin to narrow the ‘expectations gap’.
5.14 The audi t or s ’ r ol e i s t o r epor t whet her t he f i nanci al
st at ement s gi ve a t r ue and f ai r vi ew, and t he audi t i s
des i gned t o pr ovi de a r eas onabl e as s ur ance t hat t he
financial statements are free of material misstatements. The
a udi t or s ’ r ol e i s not ( t o ci t e a f ew of t he mi sunder -
st andi ngs) t o pr epar e t he f i nanci al st at ement s, nor t o
provide absolute assurance that the figures in the financial
statements are correct, nor to provide a guarantee that the
c ompa ny wi l l c ont i nue i n e xi s t e nc e . Th e Au d i t i n g
Practices Board is at present developing proposals for an
expanded report which would describe the key features of
the audit process. The Committee supports this initiative.
Audi t or s ’ r e por t s s houl d s t a t e c l e a r l y t he a udi t or s ’
responsibilities for reporting on the financial statements, as
a counterpart to a statement of directors’ responsibilities
for preparing the financial statements (see paragraph 4.28
above).
5.15 The Commi t t ee s t r ongl y s uppor t s t he l ead whi ch t he
Auditing Practices Board is taking on the development of
auditing practice generally. We believe that there should be
an extension of the audit which will add to its value to all
users of accounts and bring it closer into line with public
expect at i ons. We di scuss bel ow some of t he pr oposal s
currently under consideration and have set out background
infol-mation on the current r,ules at Apper~clis 5. Wi d e n i n g
the scope of the audit is likely to require boards to widen
the scope of their reports, since auditors can normally only
audi t mat t er s on whi ch t he di r ect or s have t hemsel ves
reported.
AUDI TI NG
Internal Control
5.16
The Commi t t ee i s convi nced t hat an ef f ect i ve i nt er nal
c ont r ol s y s t e m i s a n e s s e nt i a l pa r t of t he e f f i c i e nt
management of a company. We have al ready recommended
t hat di rect ors shoul d report on t he ef f ect i veness of t hei r
syst em of i nt ernal cont rol , and t hat t he audi t ors shoul d
report on thei r statement. A great deal of detai l ed work i s
now ne c e s s a r y t o de v e l op t he s e pr opos a l s , a nd we
r e c o mme n d t I1 a t t h e a c c o u n t a n c y p r o f e s s i o n , i n
conj uncti on wi th representati ves of preparers of accounts,
should take the lead in:
(a) developing a set of criteria for assessing effectiveness;
( b) devel opi ng gui dance f or compani es on t he f or m i n
which directors should report; and
( c) devel opi ng gui dance f or audi t or s on r el evant audi t
pr ocedur es and t he f or m i n whi ch audi t or s shoul d
report.
5.17 We r ecommend t hat t he quest i on o
t hese devel opment s shoul d be dec
experi ence.
f l egi sl at i on t o back
ided i n t he l i ght of
Going Concern
5.16 U n d e r c o mp a n y l a w , a c c ount s a r e pr e pa r e d on t he
assumption that the company is a going concern. There is,
however, no expl i ci t requi rement f or di rect ors t o sat i sf y
themsel ves that i t i s reasonabl e to make thi s assumpti on,
for exampl e by the preparat-i on of an adequate cash fl ow
f or e c a s t . The r e i s a l s o s c ope f or a me ndi ng a udi t i ng
guidelines to require the auditor to take a more active role
in testing going concern assumptions.
5.19 I n vi ew of the understandabl e pub’lic criticism of the audit
pr oc e s s whe n c ompa ni e s c ol l a ps e wi t hout a ppa r e nt
warni ng, there are strong arguments for amending company
law to place an explicit requirement on directors to satisfy
themselves that the going concern basis is appropriate, and
t o r epor t accor di ngl y t o shar ehol der s. There i s al so a
strong case for extendi ng the scope of the audi t, to test
goi ng concer n assumpt i ons mor e speci f i cal l y, and f or
requi ri ng the audi tors to gi ve an opi ni on on the di rectors’
report. Many proposal s have been made to the Commi ttee
along these lines.
A U D I T I N G
5. 20 The Commi t t ee bel i eves t hat goi ng concer n pr obl ems
mor e l i kel y t o be addr es s ed s ucces s f ul l y i f t hey
i dent i f i ed ear l y. Ther e ar e, however , t wo gr ounds
concern:
(a) There must be a risk that any qualification about
are
ar e
f or
the
company’s financial viability, however it is expressed,
will precipitate the company’s collapse. There is a fine
balance to be drawn between drawing proper attention
to the conditions on which continuation of the business
depends, and not thereby bringing the business down.
(b) The Committee does not believe that the implications
of the legal presumption that the accounts are prepared
on a goi ng concern basi s are wi del y underst ood by
directors. In particular the Committee doubts that it is
g e n e r a l l y a p p r e c i a t e d t h a t ‘ g o i n g c o n c e r n ’ i s
interpreted in present auditing guidelines as meaning
t hat t he company wi l l st i l l be operat i ng si x mont hs
following the date of the audit report or one year after
the date of the balance sheet, whichever is the later.
This may be further ahead than many companies can
see, for example in a recession.
5.21 The Committee concludes that as a fundamental concept of
a c c o u n t i n g t h e g o i n g c o n c e r n p r i n c i p l e s h o u l d b e
conscientiously applied and that new guidelines should be
developed. It emphasises however that new guidelines must
strike a careful balance between drawing proper attention
to the conditions on which the continuation of the business
d e p e n d s , a n d n o t r e q u i r i n g d i r e c t o r s t o e x p r e s s
u n n e c e s s a r i l y c a u t i o u s r e s e r v a t i o n s t h a t c o u l d o f
t hemsel ves j eopardi se t he busi ness. Di rect ors shoul d be
required to satisfy themselves that the business is a going
c onc e r n on t he ba s i s t ha t t he y ha ve a r e a s o n a b l e
expect at i on that it will continue in operation for the time
period which the guidelines d,efine. Directors should not be
expected to give a firm guarantee about their company’s
prospect s because t here can never be compl et e cert ai nt y
about future trading. The guidelines should also recognise
the position of’ smaller companies.
AUDI TI NG
5.22
Fraud
5.23
5.24
5.25
5.26
The
(a)
(b)
(c)
(d)
Committee recommends that:
directors should state in the report and accounts that
t he bus i nes s i s a goi ng concer n, wi t h s uppor t i ng
assumptions or qualifications as necessary;
the auditors should report on this statement;
t he a c c ount a nc y pr of e s s i on i n c onj unc t i on wi t h
represent at i ves of preparers of account s shoul d t ake
t he l ead i n devel opi ng gui dance for compani es and
auditors;
the question of Legislation should be decided in the
light of experience.
The prime responsibility for the prevention and detection
of fraud (and other illegal acts) is that of the board, as part
of its fiduciary responsibility for protecting the assets of
t he company. The audi t or’s responsi bi l i t y, as defi ned i n
audi t i ng gui dance, i s ‘ pr oper l y t o pl an, per f or m and
eval uat e hi s audi t wor k s o asi;. ha ve a r e a s ona bl e
expect at i on of det ect i ng mat er i al mi sst at ement s i n t he
financial statements’.
One probl em for t he audi t ors i s t hat by i t s very nat ure
f r aud, i f i t i nvol ves f or ger y, col l usi on or management
over r i de of cont r ol syst ems, is hard to detect. It is no
solution, as some have suggested, simply to place a duty on
the auditor to detect material fraud because he will never
be in a position to guarantee that no such fraud has taken
place. A higher level of safeguard against some categories
of fraud can be attempted by carrying out a more extensive
audit, but at a cost. The question is whether that extra cost
is justified.
Another problem for the auditors is when they suspect that
top management itself is implicated in the fraud, without
having the necessary evidence to back up their suspicions.
They ar e not i n a st r ong enough posi t i on t o conf r ont
ma n a g e me n t , nor have t hey a cas e t o r epor t t o t he
appropriate authorities.
These are not easy problems to resolve, but an effective
and i ndependent -mi nded audi t commi t t ee i s an essent i al
safeguard. It has an important role to play in considering
B
AUDI TI NG
whether any extra work should be undertaken in addition to
the normal audit procedures to investigate defences against
fraud. and in reviewing reports on the adequacy of internal
contol systems. The audit committee also provides a forum
i n whi ch audi tors can di scuss at board l evel any concern
t hey may have about t he possi bi l i t y of f r aud by seni or
ma na ge me nt . It can t hen c o mmi s s i o n wh a t e v e r
investigations are necessary to resolve the matter.
5. 27 One pr oposal made t o t he Commi t t ee was t hat audi t or s
shoul d have a dut y t o r epor t f r aud t o t he appr opr i at e
authori ti es. The audi tor’ s duty i s normal l y to report fraud
t o seni or management ( see Appendix 5) . Where, however,
he no l onger has confi dence that seni or management wi l l
deal adequat el y wi t h t he mat t er , he i s encour aged by
pr of e s s i ona l gui da nc e t o r e por t f r a ud t o t he pr ope r
authori ti es. Lord Justi ce Bi ngham, i n hi s recent report on
BCCI, has recommended that in the case of banks it would
be be t t e r f or t he r e t o be a s t a t ut or y dut y , a nd t he
Go v e r n me n t , i n a c c e pt i ng t he r e c omme nda t i on, ha s
announced that a si mi l ar approach wi l l be extended to the
rest of t he regulate;! sect or ( namel y bui l di ng societies:~.
insurance, and investment business).
5. 28 The Committee does not recommend that a statutory duty to
r epor t fr,aud shoul d be ext ended beyond t he r egul at ed
sector to the general i ty of compani es. The Commi ttee does
however see scope f or ext endi ng t o t he audi t or s of al l
compani es the statutory provi si ons appl yi ng to audi tors i n
the regulated sector which enable them to report reasonable
suspi ci on of f raud f reel y t o t he appropri at e i nvest i gat ory
authori ti es. Thi s woul d strengthen the positiqn of audi tors
who report fraud against the risk of a suit brought against
t hem by t hei r cl i ent f or ( f or exampl e) breach of dut y t o
mai nt ai n a conf i dent i al cl i ent rel at i onshi p or def amat i on.
We r ecommend t hat t he Gover nment shoul d consi der
introducing legislation accordingly.
Other illegal Acts
5.29 Compani es ar e now subj ect t o a wi de r ange of l egal
requi rements, many of whi ch fal l outsi de the scope of an
audit of the financial statements. Auditing guidance on the
respecti ve responsi bi l i ti es of management and the audi tor
is in preparation but there are a number of difficult issues
on which there is no clear consensus at present.
I
AUDITING
5.30 The Commi t t ee’s vi ew i s t hat i t i s t he responsi bi l i t y of
boards to establish what their legal duties are and to ensure
that they monitor compliance with them. It is also our view
that this would be enhanced if the auditors’ role were to
check that boards had established their legal requirements
and that a working system for monitoring compliance was
in place. There would be difficulty in ascribing a wider
role to auditors, for example requiring them to investigate
any i dent i fi ed fai l ures i n t he syst em and any suspect ed
i l l egal act s whi ch ar e encount er ed, becaus e t hey ar e
unlikely to have the appropriate expertise. They will not
know t he l egal requi rement s i n fi el ds whi ch are out si de
their scope, nor are they likely to have the expertise to
investigate the legality of particular acts if their suspicions
are aroused. We recommend t hat t hi s subj ect shoul d be
further considered by the accountancy and legal professions
and representatives of preparers of accounts.
Auditors’ Liability
5.31 In the Caparo juagment, the House of Lords laid down that
auditors owed a legal duty of care to the company and to
the shareholders collectively, but not to the shareholders as
i ndi vi dual s nor t o t hi r d par t i es. I t was est abl i shed i n
particular that in the absence of special features, no duty of
car e was owed t o subscr i ber s t o new shar es ( whet her
exi st i ng shar ehol der s or not ) , pur chaser s or i nt endi ng
purchasers of shares from t hi rd part i es i ncl udi ng t hose
conduct i ng t akeover bi ds, banker s or ot her l ender s, or
persons doing business with the company.
5.32 A discussion of the principles established by the Capar-o
case is at Appendi x 6. The case has aroused cont roversy
because it exposed two widely held misconceptions:
(a) that the audit report is a guarantee as to the accuracy
of the accounts, and perhaps even as to the soundness
of the company;
(b) t hat anyone (i ncl udi ng i nvest ors and credi t ors) can
rely on the audit, not only in a general sense but also
very specifically by being able to sue the auditors if
they are negligent.
In deciding the case, the House of Lords studied with great
care the complex issues involved in balancing the interests
of the parties involved and the public interest in having a
AUDI TI NG
f ai r, vi abl e and af f ordabl e syst em. The si ze of audi t ors’
pot ent i al l i abi l i t i es, t he di f f i cul t i es i n def i ni ng wi der
l i abi l i t y i n any f ai r yet pr act i cabl e way, and t he l i kel y
di ffi cul ti es i n establ i shi ng whether thi rd party l osses were
i n f act due t o rel i ance on t he account s were among t he
pri nci pal concerns underl yi ng t he concl usi ons reached by
t he House of Lords. Reari ng i n mi nd t he wi de range of
users of accounts, the Committee is unable to see how the
House of Lords could have broadened the boundaries of the
audi t or s’ l egal dut y of car e wi t hout gi vi ng r i se ( i n t he
wo r d s o f Ca r d o z o CJ d e c i d i n g a c a s e i n 1931 a n d
frequentl y quoted si nce) ‘ to a l i abi l i ty i n an i ndetermi nate
amount f or an i ndet er mi nat e t i me t o an i ndet er mi nat e
cl ass’ . Nor , i n consequence, do we recommend t hat t he
l egal posi t i on wi t h regard t o ci vi l l i abi l i t y l ai d down by
Cupar-o should be altered by statute at the present time.
5. 33
In coming to thts concl usi on, we recogni se that the current
posi t i on i s a sour ce of concer n t o bot h audi t or s and
investors. There are two main reasons:
(a)
(b)
t he scal e of exi st i ng l i t i gat i on agai nst audi t or s or
former audi tors. Audi tors are ful l y l i abl e i n negl i gence
t o t he compani es t hey audi t and t hei r sharehol ders
col l ect i vel y, and Caparo has not changed t hi s. The
si ze of settl ements has been i ncreasi ng i n Bri tai n and
auditors are concerned that this trend may continue;
t he bel i ef of some t hat , not wi t hs t a ndi ng Capa~o,
auditors should in principle be liable to those (such as
individual investors and creditors) who rely on audited
accounts.
Audi t or s ar e nat ur al l y concer ned about t he i ncr eased
l i ti gati on that woul d resul t i f thei r l i abi l i ty were extended
t o ot her account s users. They are al so concerned about
increased litigation that could arise from adapting the audit
to meet changing needs and.expectations - a process which
the Committee’s report itself is intended to encourage.
5. 34 Proponents of change argue that a better bal ance between
the i nterests of the parti es i nvol ved woul d be achi eved i f
audi t or s’ duty of care were to be extended on a defi ned
basis, but at the same time the present system under which
audi tors can be l i abl e for the ful l l oss caused were to be
repl aced by one of proporti onate l i abi l i ty, and/ or a cei l i ng
were pl aced on audi t ors’ l i abi l i t y. There woul d, however,
be maj or probl ems over such changes, some of whi ch are
AUDI TI NG
outlined in Appendix 6. Changes coul d not be undert aken
without a detailed review and wide consultation and might
well require major legal reform.
5.35 At present there is no consensus on a satisfactory way of
reconciling the conflicting interests of all those involved.
As the debate on the nature and extent of auditors’ liability
cont i nues, however , t he Commi t t ee wi l l keep wat ch on
developments.
Audit Confidence
5. 36 The account i ng pr of es s i on has done much r ecent l y t o
improve its standards and procedures. It is essential that
t hi s effort shoul d cont i nue. We wel come t he i ni t i at i ves
whi ch are bei ng t aken on professi onal conduct i ssues -
particularly the profession’s ethical rules and disciplin&ry
arrangement s. We al so support t he work whi ch i s bei ng
done by the profession’s Joint Ethics Committee to tackle
pr obl em ar eas s uch as opi ni on s hoppi ng and par t ner
rotation. A lead on these and other matters such as audit
tendering will strengthen the standing and independence of
auditors.
5.37 We have indicated our strong support for tighter accounting
s t a nda r ds , e f f e c t i ve a udi t c ommi t t e e s , r i gor ous a nd
objective auditing and action by the accountancy profession
t o i mp r o v e a n d e n f o r c e a u d i t i n g s t a n d a r d s . T h i s
combi nat i on of act i ons uncompr omi si ngl y pur sued wi l l
enhance the perceived value of the audit system.
Accountability of Boards to Shareholders
6.1
6.2
6.3
6.4
6.5
The formal relationship between the shareholders and the
boar d of di r ect or s i s t hat t he s ha r e hol de r s e l e c t t he
directors, the directors report on their stewardship to the
shareholders and the shareholders appoint the auditors to
pr ovi de an ext er nal check on t he di r ect or s’ f i nanci al
s t a t e me nt s . Thus t he s ha r e hol de r s a s owne r s of t he
company elect the directors to run the business on their
behal f and hol d t hem account abl e for i t s progress. The
i ssue for corporat e governance i s how t o st rengt hen t he
accountability of boards of directors to shareholders.
A number of pr oposal s addr essi ng t hi s i ssue wer e put
f or wa r d by i ndi vi dua l s ha r e hol de r s a nd s ha r e hol de r
organisations. One was that shareholders should be more
cl osel y i nvol ve- d i n t he appoi nt ment of di r ect or s and
a u d i t o r s t hr ough t h e f o r ma t i o n o f s h a r e h o l d e r s ’
commi t t ees. Ot her proposal s were di rect ed at maki ng i t
easier for shareholders. individually or collectively, to put
forward resolutions at general meetings.
On the first proposal, we have not seen evidence explaining
how it would be possible to form shareholder committees in
such a way that they would be both truly representative of
all the company’s shareholders and able to keep in regular
touch with their changing constituencies. Unless these tests
of legitimacy are met, the Committee is unable to see how
shar ehol der commi t t ees can become t he accept ed l i nk
between a board and its shareholders.
The second set of proposals raises such questi.ons as what
legislation would be needed to alter the present thresholds
for t abl i ng sharehol der resol ut i ons, and where t he cost s
involved in circulating shareholder communications should
fal l . How far t hese suggest i ons are fol l owed up shoul d
depend, in the Committee’s view, on the degree of support
which they command from the shareholder body as a whole.
This may be a matter which our successor body will wish to
review,
In the meantime, shareholders can make their views known
to the boards of the companies in which they have invested
by communi cat i ng wi t h t hem di r ect and t hr ough t hei r
attendance at general meetings. Shareholder organisations
set up t o represent sharehol der i nt erest s general l y may
provide individual shareholders with the choice of acting
THESHAREHOLDERS
col l ect i vel y i n t he case of part i cul ar compani es i f t hey
prefer.
6.6 Shareholders have delegated many of their responsibilities
as owners to the directors who act as their stewards. It is
for the shareholders to call the directors to book if they
appear to be failing in their stewardship and they should
use t hi s power . Whi l e t hey cannot be i nvol ved i n t he
direction and management of their company, they can insist
on a hi gh st andar d of cor por at e gover nance and good
g o v e r n a n c e i s a n e s s e n t i a l t e s t o f t h e d i r e c t o r s ’
stewardship. The accountability of boards to shareholders
wi l l , t herefore, be st rengt hened i f sharehol ders requi re
their companies to comply with the Code.
6.7 Reports and accounts are presented to shareholders at the
Annual General Meeting, when they have the opportunity to
comment on them and to put their questions. In particular,
t he Annua l Ge ne r a l Me e t i ng gi ve s a l l s ha r e hol de r s ,
whatever the size of their shareholding, direct and public
acces s t o t hei r boar ds . I f t oo many Annual Gener al
Meet i ngs ar e at pr esent an oppor t uni t y mi ssed, t hi s i s
because shareholders do not make the most of them and, in
some cases, boards do not encourage them to do so.
6.8 In the Committee’s view, both shareholders and boards of
directors should consider how the effectiveness of general
me e t i n g s c o u l d b e i n c r e a s e d a n d a s a r e s u l t t h e
a c c o u n t a b i l i t y o f b o a r d s t o a l l t h e i r s h a r e h o l d e r s
st r engt hened. Possi bl e ways f or war d i ncl ude pr ovi di ng
forms in annual reports on which shareholders could send
in written questions in advance of the meeting, in addition
to their opportunity to ask questions at the meeting itself,
and the circulation of a brief summary of points raised at
the Annual General Meeting to all shareholders after the
event. Consideration might also be given to ways of boards
keeping in touch with their shareholders, outside the annual
and half-yearly reports. The Committee encourages boards
t o experi ment wi t h ways of i mprovi ng t hei r l i nks wi t h
shareholders along the above lines and shareholders to put
proposals to their boards to the same end.
THESHAREHOLDERS
Institutional Shareholders
6.9
The pr opor t i on of s har es hel d by i ndi vi dual s and by
institutions has broadly reversed over the last thirty years,
so that institutional shareholders now own the majority of
shares of quot ed compani es. They are, however, l argel y
holding their shares on behalf of individuals, as members
of pensi on funds, hol ders of i nsurance pol i ci es and t he
like. As a result, there is an important degree of common
interest between individual and institutional shareholders.
In particular, both have the same stake in the standards of
financial reporting and of governance in the companies in
which they have invested.
6 . 1 0 Gi ven t he wei ght of t hei r vot es , t he way i n whi ch
institutional shareholders use their power to influence the
s t andar ds of cor por at e gover nance i s of f undament al
importance. Their readiness to do this turns on the degree
to which they see it as their responsibility as owners, and
in the ir:terest of those whose money they are investing, to
bring about changes in companies when necessary, rather
than selling their shares.
6.11 The Committee, therefore, warmly welcomes the statement
r ecent l y publ i s hed by t he I ns t i t ut i onal Shar ehol der s ’
Commi t t e e on t he Re s pons i bi l i t i e s of I ns t i t ut i ona l
Shareholders in the UK and we draw attention to three key
concl usi ons whi ch ar e basi c t o t he devel opment of a
const r uct i ve r el at i onshi p bet ween compani es and t hei r
owners.
I ns t i t ut i onal i nves t or s s houl d encour age r egul ar ,
s y s t e ma t i c c o n t a c t a t s e n i o r executiv’e l evel t o
e x c h a n g e v i e ws a n d i n f o r ma t i o n o n s t r a t e gy,
pe r f or ma nc e , boa r d me mbe r s hi p a nd qua l i t y of
management.
i nst i t ut i onal i nvest or s shoul d make posi t i ve use of
their voting rights, unless they have good reason for
doi ng ot her wi se. They shoul d r egi st er t hei r vot es
wherever possible on a regular basis.
Institutional investors should take a positive interest
i n t he compos i t i on of boar ds of di r ect or s , wi t h
par t i cul ar r ef er ence t o concent r at i ons of decision-
making power not formally constrained by appropriate
THESHAREHOLDERS
checks and balances, and to the appointment of
n o n - e x e c u t i v e d i r e c t o r s o f t h e n e c e s s a r y
experience and independence.
a core of
c a l i b r e ,
6. 12 The Inst i t ut i onal Sharehol ders’ Commi t t ee’s advi ce t o i t s
members to use their voting rights positively is important
in the context of corporate governance. Voting rights can
be regarded as an asset, and the use or otherwise of those
r i ght s by i ns t i t ut i ona l s ha r e hol de r s i s a s ubj e c t of
legitimate interest to those on whose behalf they invest.
We recommend that institutional investors should disclose
their policies on the use of voting rights.
Shareholder Communications
6.13 These conclusions on the role of institutional shareholders
r ai se i ssues over t he l i nes of communi cat i on bet ween
boards and t hei r sharehol ders. The fi rst i ssue i s one of
par i t y bet ween shar ehol der s. The i nst i t ut i ons ar e i n a
position to keep in touch with the boards of the companies
in which they have invested, in a way which is not feasible
for the. i ndi vi dual sharehol der. It i s not possi bl e i n t hi s
respect t o put bot h cl asses of sharehol der on t he same
footing. What boards must do, however, is to ensure that
any significant statements concerning their companies are
ma de publ i c l y a nd s o a r e e qua l l y a va i l a bl e t o a l l
shareholders.
6.14 A second issue which arises over communications between
i nst i t ut i onal i nvest or s and compani es i s t he danger of
imparting inside information. If price-sensitive information
is to be given (and it is the company’s responsibility to
decide what might be price-sensitive), it must only be with
t he pri or consent of t he sharehol der, who wi l l t hen be
una bl e t o de a l i n t he c ompa ny’ s s ha r e s unt i l t ha t
information has been made public. It is for shareholders to
decide whether their longer-term interests are impaired by
becoming insiders, because of the short-term constraints t 31
share dealing which that position imposes.
6. 15 I f l ong- t er m r el at i ons hi ps ar e t o be devel oped, i t i,
i mpor t a nt t ha t c ompa ni e s s houl d c ommuni c a t e t he i
s t r at egi es t o t hei r maj or s har ehol der s and t hat t he i
s ha r e hol de r s s houl d unde r s t a nd t he m. I t i s e qua l l y
important that shareholders should play their part in the
communication process by informing companies if there are
THESHAREHOLDERS
aspects of the business which give them cause for concern.
Both shareholders and directors have to contribute to the
building of a sound working relationship between them.
Shareholder Influence
6. 16 Because of t he i mport ance of t hei r col l ect i ve st ake, we
look to the institutions in particular, with the backing of
t he I nst i t ut i onal Shar ehol der s’ Commi t t ee, t o use t hei r
influence as owners to ensure that the companies in which
they have invested comply with the Code. The widespread
adoption of our recommendations will turn in large measure
on the support which all shareholders give to them. The
obligation on companies to state how far they comply with
the Code provides institutional and individual shareholders
wi t h a r eady- made agenda f or t hei r r epr esent at i ons t o
boar ds . I t i s up t o t hem t o put i t t o good us e. The
Commi t t ee i s pr i mar i l y l ooki ng t o s uch mar ket - bas ed
regulation to turn its proposals into action.
7.1 The Commi t t ee’s proposal s are mut ual l y support i ve and
should be taken as a whole. The Code reflects existing best
p r a c t i c e a n d f e w o f o u r r e c o mme n d a t i o n s r e q u i r e
l egi s l at i on. We bel i eve t hat t hey wi l l r ei nf or ce good
cor por at e gover nance wi t hout s t i f l i ng ent r epr eneur i al
initiative.
7.2 No syst em of corporat e governance can be t ot al l y proof
against fraud or incompetence. The test is how far such
aberrations can be discouraged and how quickly they can
be brought to light. The risks can be reduced by making the
par t i ci pant s i n t he gover nance pr oces s as ef f ect i vel y
accountable as possible. The key safeguards are properly
constituted boards, separation of the functions of chairman
a n d o f c h i e f e x e c u t i v e , a u d i t c o mmi t t e e s , v i g i l a n t
shareholders and financial reporting and auditing systems
which provide full and timely disclosure.
7.3 Al t hough t he gr e a t ma j or i t y of c ompa ni e s a r e bot h
competently run and audited under the present system of
corporate governance, it is widely accepted that standards
within the corporate sector have to be raised.
7.4 T h e wa y f o r wa r d i s t h r o u g h c l e a r d e f i n i t i o n s o f
responsibility and an acceptance by all involved that the
highest standards of efficiency and integrity are expected
o f t h e m. Ex p e c t a t i o n s o f c o r p o r a t e b e h a v i o u r a r e
continually rising and a corresponding response is looked
f or f r om s ha r e hol de r s , di r e c t or s a nd a udi t or s . The
machi ner y i s i n pl ace. What i s needed i s t he wi l l t o
improve its effectiveness.
7.5 Thi s wi l l i nvol ve a sharper sense of account abi l i t y and
responsibility all round - accountability by boards to their
shareholders, responsibility on the part of all shareholders
t o t he c ompa ni e s t he y own. a nd, a c c ount a bi l i t y by
professi onal offi cers and advi sers t o t hose who rel y on
their judgement. All three groups have a common interest
i n combi ni ng t o i mpr ove the wor ki ng of t he cor por at e
system.
Compliance with the Code of Best Practice
1 The boards of al l l i st ed compani es regi st ered i n t he UK
shoul d compl y wi th the Code of Best Practi ce set out on
pages 58 t o 60. As many ot her compani es as possi bl e
should aim at meeting its requirements (paragraph 3.1).
2 Listed companies reporting in respect of years ending after
3 0 J une 1 9 9 3 s houl d ma k e a s t a t e me nt a bout t he i r
compl i ance wi th the Code i n the report and accounts and
gi ve reasons f or any areas of non- compl i ance ( paragraph
3. 7) .
3 Compani es’ statements of compl i ance shoul d be revi ewed
by the auditors before publication. The review should cover
onl y those parts of the compl i ance statement whi ch rel ate
t o pr ov i s i ons of t he Code whe r e c ompl i a nc e c a n be
obj ect i vel y veri f i ed. The Audi t i ng Pract i ces Board shoul d
consi der gui dance for audi tors accordi ngl y (paragraph 3. 9).
4 All parties concerned with corporate governance should use
t hei r i nf l uence t o encour age compl i ance wi t h t he Code
( paragraph 3. 14) . I nst i t ut i onal sharehol ders i n part i cul ar,
wi t h t h e b a c k i n g o f t h e I n s t i t u t i o n a l Sh a r e h o l d e r s ’
Commi ttee, shoul d use thei r i nfl uence as owners to ensure
t hat t he compani es i n whi ch t hey have i nvest ed compl y
with the Code (paragraph 6.16).
Keeping the Code up to date
5 The Commi t t ee’ s sponsor s, convened by t he Fi nanci al
Reporting Council, should appoint a new Committee by the
end of June 1995 to exami ne how far compl i ance wi th the
Code has progressed, how far our other recommendati ons
ha v e be e n i mpl e me nt e d, and whet her t he Code needs
updati ng. Our sponsors shoul d al so determi ne whether the
sponsorship of the new Committee should be broadened and
whether wi der matters of corporate governance shoul d be
i n c l u d e d i n i t s b r i e f . I n t h e me a n t i me t h e p r e s e n t
Commi t t e e wi l l r e ma i n r e s pons i bl e f or r e v i e wi ng t he
i mpl ementati on of i ts proposal s (paragraph 3. 12).
SUMMARY OF RECOMMENDATIONS
Directors’ service contracts
6 The Companies Act should be amended to come into line
wi t h t he requi rement of t he Code t hat di rect ors’ servi ce
c o n t r a c t s s h o u l d n o t e x c e e d t h r e e y e a r s wi t h o u t
shareholders’ approval (paragraph 4.41).
Interim reporting
7
Companies should expand their interim reports to include
bal ance sheet i nformat i on. The London St ock Exchange
s houl d cons i der amendi ng t he cont i nui ng obl i gat i ons
accordingly. There should not be a requirement for a full
audi t , but i nt er i m r epor t s s houl d be r evi ewed by t he
auditors and the Auditing Practices Board should develop
appropriate guidance. The Accounting Standards Board in
conjunction with the London Stock Exchange should clarify
t he account i ng rul es whi ch compani es shoul d fol l ow i n
pr epar i ng i nt er i m r epor t s. The i ncl usi on of cash f l ow
i nf or mat i on shoul d be consi der ed by t he Commi t t ee’ s
successor body (paragraph 4.56).
Enhancing the perceived objectivity of the audit
8 Fees paid to audit firms for non-audit work should be fully
disclosed. The essential principle is that disclosure should
enable the relative significance of the company’s audit and
non-audit fees to the audit firm to be assessed, both in a
UK context and, where appropriate, a worldwide context.
The 1991 Regulations under the Companies Act should be
reviewed and amended as necessary (paragraph 5.1 I).
9 The accountancy profession should draw up guidelines on
the rotation of audit partners (paragraph 5.12).
Enhancing the effectiveness of the audit
10 Directors should report on the effectiveness of their system
of internal control, and the auditors should report on their
s t at ement . The account ancy pr of es s i on t oget her wi t h
represent at i ves of preparers of account s shoul d draw up
criteria for assessing effective systems of internal control
and guidance for companies and auditors (paragraphs 4.32
and 5.16).
SUMMARY OF RECOMMENDATIONS
11
Directors should state in the report and accounts that the
business is a going concern, wi t h support i ng assumpt i ons
or qual i f i cat i ons as necessar y, and t he audi t or s shoul d
r epor t on t hi s s t at ement . The account ancy pr of es s i on
t oget her wi t h r epr esent at i ves of pr epar er s of account s
s houl d devel op gui dance f or compani es and audi t or s
(paragraph 5.22).
12 The question of legislation to back the recommendations on
addi t i onal report s on i nt ernal cont rol syst ems and goi ng
concer n shoul d be deci ded i n t he l i ght of exper i ence
(paragraphs 5. I7 and 5.22).
13
The Government should consider introducing legislation to
ext end t o t he audi t or s of al l compani es t he st at ut or y
prot ect i on al ready avai l abl e t o audi t ors i n t he regul at ed
sector (banks, building societies, insurance, and investment
busi ness) so t hat t hey can report reasonabl e suspicicn of
fraud freel y t o t he appropri at e i nvest i gat ory aut hori t i es
(paragraph 5.28).
14 The a c c ount a nc y pr of e s s i on t oge t he r wi t h t he l e ga l
pr of essi on and r~epresentatives of prepareis’of a c c ount s
should consider further the question of illegal acts other
than fraud (paragraph 5.30).
15
The account i ng professi on shoul d cont i nue i t s effort s t o
improve its standards and procedures so as to strengthen
t he s t andi ng and i ndependence of audi t or s ( par agr aph
5. 36).
Voting by institutional investors
‘_
16 Institutional investors shoul d di scl ose t hei r pol i ci es on t he
use of their voting rights (paragraph 6.12).
SUMMARY OF RECOMMENDATIONS
Endorsement of work by others
17
18
19
The Committee gives its full support to the objectives of
t he Fi nanci al Repor t i ng Counci l and t he Account i ng
Standards Board. It welcomes the action by the Financial
Report i ng Revi ew Panel over compani es whose account s
fal l bel ow accept ed report i ng st andards (paragraphs 4. 52
and 5.8).
The Commi t t ee suppor t s t he i ni t i at i ve of t he Audi t i ng
Practices Board on the development of an expanded audit
report. It also gives its full support to the lead which it is
t aki ng on t he devel opment of audi t i ng pract i ce general l y
(paragraphs 5.14 and 5.15).
The Committee welcomes the statement by the Institutional
Sha r e hol de r s ’ Commi t t e e on t he Re s pons i bi l i t i e s of
Institutional Shareholders in the UK (paragraph 6.1 I).
Issues for the Committee’s successor body
2 0
I s s ue s whi c h t he Commi t t e e ha s i de nt i f i e d t ha t i t s
successor body may wish to review or consider in greater
depth include: the application of the Code to smaller listed
companies (paragraph 3. IS); directors’ training (paragraph
4.20); the rules for disclosure of directors’ remuneration,
and t he r ol e whi ch shar ehol der s coul d pl ay ( par agr aph
4.46); a requirement for inclusion of cash flow information
in interim reports (paragraph 4.56); and the procedures for
putting forward resolutions at general meetings (paragraph
6.4). The Committee and its successor will also keep watch
on devel opment s r egar di ng t he nat ur e and ext ent of
auditors’ liability (paragraph 5.35).
1 The Board of Directors
1.1
The board should meet regularly, retain full and effective
cont r ol over t he company and moni t or t he execut i ve
management.
1.2
T h e r e s h o u l d b e a c l e a r l y a c c e p t e d d i v i s i o n o f
r esponsi bi l i t i es at t he head of a company, whi ch wi l l
ensure a balance of power and authority, such that no one
i ndi vi dual has unfet t ered powers of deci si on. Where t he
chai rman i s al so t he chi ef executive, it is essential that
there should be a strong and independent element on the
board, with a recognised senior member.
1.3
The boar d s houl d i ncl ude non- execut i ve di r ect or s of
suf f i ci ent cal i br e and number f or t hei r vi ews t o car r y
significant weight in the board’s decisions.
1.4
The boar d s houl d have a f or mal s chedul e of mat t er s
specifically reserved to it for decision to ensure that the
direction and control of the company is firmly in its hands.
1.5
There should be an agreed procedure for directors in the
furtherance of their duties to take independent professional
advice if necessary, at the company’s expense.
1.6
All directors should have access to the advice and services
of the company secretary, who is responsible to the board
for ensuring that board procedures are followed and that
appl i cabl e rul es and regul at i ons are compl i ed wi t h. Any
question of the removal of the company secretary should be
a matter for the board as a whole.
‘_
2 Non-Executive Directors
2.1
Non- execut i ve di r ect or s s houl d br i ng an i ndependent
j udge me nt 10 bear on i ssues of st r at egy, per f or mance,
resources, i ncl udi ng key appoi nt ment s, and st andards of
conduct.
2.2
The maj ori t y shoul d be i ndependent of management and
free from any business or other relationship which could
materially interfere with the exercise of their independent
j udgement . apart from t hei r fees and sharehol di ng. Thei r
fees shoul d refl ect t he t i me whi ch t hey commi t t o t he
company.
THE CODE OF BEST PRACTICE
2.3 Non-executive directors should be appointed for specified
terms and reappointment should not be automatic.
2.4 Non- execut i ve di r ect or s s houl d be s el ect ed t hr ough a
formal process and both this process and their appointment
should be a matter for the board as a whole.
3 Executive Directors
3.1 Directors’ service contracts should not exceed three years
without shareholders’ approval.
3.2 There should be full and clear disclosure of directors’ total
emoluments and those of the chairman and highest-paid UK
director, including pension contributions and stock options.
Se p a r a t e f i g u r e s s h o u l d b e g i v e n f o r s a l a r y a n d
per f or mance- r el at ed el ement s and t he bas i s on whi ch
performance is measured should be explained.
3.3 Ex e c u t i v e d i r e c t o r s ’ p a y s h o u l d b e s u b j e c t t o t h e
recommendat i ons of a remunerat i on commi t t ee made up
wholly or mainly of non-executive directors.
4 Reporting and Controls
4.1 It i s t h e b o a r d ’ s d u t y t o p r e s e n t a b a l a n c e d a n d
understandable assessment of the company’s position.
4.2 The board should ensure that an objective and professional
relationship is maintained with the auditors.
4.3 The board should establish an audit committee of at least
t hr e e non- e xe c ut i ve di r e c t or s wi t h wr i t t e n t e r ms of
reference which deal clearly with its authority and duties.
4.4 The di r ect or s s houl d expl ai n t hei r r es pons i bi l i t y f or
preparing the accounts next to a statement by the auditors
about their reporting responsibilities.
4.5 The di rect ors shoul d report on t he effect i veness of t he
company’s system of internal control.
4.6 The di rect ors shoul d report t hat t he busi ness i s a goi ng
concern, with supporting assumptions or qualifications as
necessary.
THE CODE OF BEST PRACTICE
Footnote
The company’s statement of compliance should be reviewed
by the auditors in so far as it relates to paragraphs 1.4, 1.5,
2.3, 2.4, 3.1 to 3.3, and 4.3 to 4.6 of the Code.
APPENDIX 1
Terms of Reference
The Committee was set up in May 1991 by the Financial
Report i ng Counci l , t he London St ock Exchange, and t he
a c c ount a nc y pr of e s s i on. I t a dopt e d a s i t s t e r ms of
reference:
To c ons i de r t he f ol l owi ng i s s ue s i n r e l a t i on t o
f i nanci al r epor t i ng and account abi l i t y and t o make
recommendations on good practice:
(a)
(b)
Cc)
Cd)
(e)
Membership
t h e r e s p o n s i b i l i t i e s o f e x e c u t i v e a n d n o n -
executive directors for reviewing and reporting on
performance to shareholders and other financially
interested parties; and the frequency, clarity and
form in which information should be provided;
t he cas e f or audi t commi t t ees of t he boar d,
including their composition and role;
the principal responsibilities of auditors and the
extent and value of the audit;
t he l i nks be t we e n s ha r e hol de r s , boa r ds , a nd
auditors;
any other relevant matters.
The Committee’s members were as follows:
Sir Adrian Cadbury (Chairman)
Ian Butler
Coutlcil Member . CBI and f or mer Chai r man, CBI Compani es
Commitfee
Jim Butler
Seni or Partner, KPMG Peat Marwick
Jonathan Charkham
Advi ser- t o t he Gover~lor. Bunk of Engl and
Hugh Collum
Chai r man. Hundr ed Gr oup of Fi nance Di r ect or s
Sir Ron Dearing
Chai r man, Fi nanci al Repor t i ng Counci l
THE’COMMITTEE’S MEMBERSHIP AND TERMS OF
REFERENCE
Andrew Likierman
Professor of A c c o u n t i n g a n d F i n a n c i a l Co n t r o l , L o n d o n
Business School
Nigel Macdonald
Vice President, Institute of Chartered Accountants of Scotland
Mike Sandland
Chairman, Institutional Shareholder-s’ Committee
Mark Sheldon
President, Law Society
Sir Andrew Hugh Smith
Chairman, London Stack Exchange
Sir Dermot de Trafford, Bt
Chairman, Institute of Directors
Obser ver s: Mr s Sar ah Br own ( unt i l Oct ober 1991), Mr Ar t hur
Russell (from November 1991). Head of Companies Division, DTf
Secretary: Nigel Peace (on secondment from DTI)
Si r Chr i s t opher Hogg ( Chai r - man, Re ut e r s Hol di ngs PLC,
Courtaulds plc, and Courtaulds Textiles plc) acted as an adviser
to the Committee.
APPENDIX 2
Auditing Practices Board
1 The Audi t i ng Pr a c t i c e s Boa r d i s r e s pons i bl e f or t he
standa5ds.
from the Audi ti ng Practi ces Commi ttee i n 1991.
has outsi de representati on and the abi l i ty to i ssue audi ti ng
Financial Reporting Review Panel
2 The Fi nanci al Repor t i ng Counci l was set up i n 1990 t o
establ i sh and support the two bodi es under i ts aegi s, the
Account i ng St andards Board and t he Fi nanci al Reporting
Revi ew Panel , and t o pr omot e good f i nanci al r epor t i ng
gener al l y. The t hr ee bodi es dr aw t hei r f undi ng br oadl y
equal l y from the accountancy professi on, the Ci ty, and the
Government .
3
The rol e of t he Account i ng St andards Board i s t o make,
amend, and wi t hdraw account i ng st andards. I t t ook over
f r om t he f or mer Account i ng St andar ds Commi t t ee on 1
Augus t 1 9 9 0 . The Boa r d i s a ut onomous - al t hough i t
consul ts wi del y on i ts proposal s, i t does not need outsi de
approval for its actions.
4 The Se c r e t a r y of St a t e ha s a ut hor i s e d t he Fi na nc i a l
Report i ng Revi ew Panel t o exami ne depart ures f rom t he
account i ng requi rement s of t he Compani es Act 1985 and if
necessary to seek an order from the court to remedy them.
The Panel ’ s ambit i s publ i c and l arge pri vat e compani es,
the Department of Trade and Industry dealing with all other
cases. The Panel ’ s mai n f ocus i s on mat eri al depart ures
f r om account i ng st andar ds wher e t hi s r esul t s i n t he
account s i n quest i on not gi vi ng a t rue and f ai r vi ew as
required by law. Where a company’s accounts are defective
t he Panel wi l l . wher ever possi bl e. endeavour t o secur e
revi si on by vol untary means; but i f thi s approach fai l s i t
wi l l ma k e a n a p p l i c a t i o n t o t he c our t f or a n or de r
compel l i ng the revi si on. Where accounts are revi sed at the
i nsi st ence of t he Panel , but t he company’ s audi t ors have
not qual i fi ed thei r audi t report on the defecti ve accounts,
THE ROLE OF BODIES REFERRED TO IN THE REPORT
t he panel wi l l dr aw t hi s f act t o t he at t ent i on of t he
auditors’ professional body.
Institutional Shareholders’ Committee
5 The Institutional Shareholders’ Committee (ISC) has five
members: the Association of British Insurers, the National
As s o c i a t i o n o f Pe n s i o n Fu n d s , t h e As s o c i a t i o n o f
Investment Trust Companies, the British Merchant Banking
and Secur i t i es Houses Associ at i on, and t he Uni t Tr ust
Associ at i on. Toget her t hey r epr esent t he over whel mi ng
majority of institutional shareholders in the UK. The ISC
pr ovi des a channel of communi cat i on and f or um f or
di scussi on bet ween i nst i t ut i onal shar ehol der s, cor por at e
management and others on wider issues. It also seeks to
identify areas of common ground amongst its members and
thereafter to promulgate those jointly held views. It does
not normally become involved in matters concerned with
particular investments or companies.
London Stock Exchange
6 The London St ock Exchange i s empower ed t hr ough i t s
Competent Authority status to grant listings of securities
u n d e r t h e Fi n a n c i a l Se r v i c e s Ac t 1986 a nd i t ha s
responsibility for the Unlisted Securities Market.
7 The Exchange through its rules contained in the Admission
of Securities to Listing (often known as the ‘Yellow Book’)
r equi r es i ssuer s of secur i t i es not onl y t o meet cer t ai n
disclosure requirements at the time of listing but also to
compl y wi t h a number of cont i nui ng obl i gat i ons. The
pur pose of t hi s i s t o ensur e t hat all pot ent i al l y price-
sensi t i ve i nformat i on, or i nformat i on about t he company
which might have an effect on its share price or trading in
i t s shar es, i s r el eased t o t he mar ket pr ompt l y. These
r e qui r e me nt s i mpos e s pe c i f i c c o n t e n t a n d I i m i n g
requirements in relation to the issuer’s interim and final
account s and i mpose gui del i nes gover ni ng deal i ngs by
di r ect or s of l i st ed compani es i n t hei r own compani es’
securities.
THE ROLE OF BODIES REFERRED TO IN THE REPORT
The Hundred Group of Finance Directors
8 The Hundred Group of Finance Directors has approximately
one hundred and forty members, including more than 90%
of the finance directors of those companies included in the
FT- SE 100 a nd a l s o t hos e wi t h t he hi ghe s t ma r ke t
capitalisation.
9 The main purpose of The Hundred Group is to provide a
f or um f or di s cus s i on and t o make cont r i but i ons and
r epr es ent at i ons on i s s ues of i mpor t ance f or f i nanci al
management. Members are actively involved to ensure that
t he vi ews of users and preparers of account s are ful l y
understood. Submissions are made to Government and other
or gani sat i ons hi ghl i ght i ng t he pr act i cal i mpl i cat i ons of
exi s t i ng f i nanci al pr ocedur es , r el at ed l egi s l at i on and
proposed changes.
APPENDIX 3
1 In paragraph 4.28 of the report, and in the Code of Best
Practice, the Committee recommends that a brief statement
of di r ect or s’ r esponsi bi l i t y f or pr epar i ng t he account s
should appear in the report and accounts. The purpose of
such a statement is to make clear that responsibility for
preparing the accounts rests with the board of directors,
and t o remove any mi sconcept i on t hat t he audi t ors are
r esponsi bl e f or t he account s. The di r ect or s’ st at ement
should be placed immediately before the auditors’ report
which in future will include a separate statement (currently
being developed by the Auditing Practices Board) on the
responsibility of the auditors for expressing an opinion on
the accounts. Positioning the two statements alongside each
ot her i n t hi s way wi l l achi eve maxi mum cl ar i t y about
respective responsibilities.
2 The explanation of directors’ responsibilities will require a
r el at i vel y f or mal s t at ement , whi ch s houl d cover t he
following points:
(a)
(b)
(c)
Cd )
the legal requirement for directors to prepare financial
statements for each financial year which give a true
and fair view of the state of affairs of the company (or
group) as at the end of the financial year and of the
profit and loss for that period;
t he r esponsi bi l i t y of t he di r ect or s f or mai nt ai ni ng
adequat e account i ng r ecor ds, f or saf eguar di ng t he
assets of the company (or group), and for preventing
and detecting fraud and other irregularities;
c onf i r ma t i on t ha t s ui t a bl e a c c ount i ng‘ pol i c i e s ,
consistently applied and supported by reasonable and
prudent judgements and estimates, have been used .in
the preparation of the financial statements;
confirmation that applicable accounting standards have
been f ol l owed, subj ect t o any mat er i al depar t ur es
disclosed and explained in the notes to the accounts.
3 Boards may al so wi sh t o use t he above st at ement as a
ve hi c l e f or r epor t i ng t hat t hey have mai nt ai ned an
effective system of internal control, and that the business
i s a goi ng concer n, wi t h s uppor t i ng a s s umpt i ons or
qualifications as necessary, once the necessary guidance on
these subjects has been developed (see paragraphs 5.16 and
5.22 of the main report).
DIRECTOR’S RESPONSIBILITY STATEMENT
4
statement in the notes to the accounts disclosing whether
t he account s have been pr epar ed i n accor dance wi t h
applicable accounting standards.
I
APPENDIX 4
,
1
I n the mai n body of the report the Commi ttee recommends
that al l l i sted compani es whi ch have not al ready done so
shoul d est abl i sh an audi t commi t t ee, and pl aces gr eat
emphasi s on the i mportance of properl y consti tuted audi t
committees in raising standards of corporate governance.
2 Many UK compani es al ready have an audi t commi ttee, and
a recent research study (‘ Audi t Commi ttees i n the Uni ted
Ki ngdom’ , published by the ICAEW, April 1992) has found
a steady growth in their number. Audit Committees are now
est abl i shed i n 53% of t he t op 250 i ndust ri al f i rms i n t he
Ti me s 1 0 0 0 , a nd t he f i gur e r i s e s t o 6 6 % i f unl i s t e d
compani es and forei gn subsi di ari es are excl uded from the
cal cul at i on. Most maj or UK l i st ed f i nanci al i nst i t ut i ons
have also formed an audit committee.
3 Audit Committees are well established in the United States,
where t hey have been a l i st i ng requi rement of t he New
York St ock Exchange si nce 1978. A 1989 st udy reveal ed
that 97% of maj or corporati ons had them. I n Canada, they
are a legal requirement.
4 I f t hey oper at e ef f ect i vel y, audi t commi t t ees can br i ng
si gni f i cant benef i t s. I n part i cul ar, t hey have t he pot ent i al
to:
(a)
(b)
I
Cc)
i
Cd)
(e)
(0
i mp r o v e t h e q u a l i t y o f f i n a n c i a l r e p o r t i n g , b y
r evi ewi ng t he f i nanci al st at ement s on behal f of t he
Board;
creat e a cl i mat e of di sci pl i ne and cont rol whi ch wi l l
reduce the opportunity for fraud;
enabl e t he non- execut i ve di r ect or s t o cont r i but e an
independent judgement and play a positive role;
hel p t he f i nance di r ect or . , by pr ovi di ng a f or um i n
which he can raise issues of concern, and which he can
use t o get t hi ngs done whi ch mi ght ot her wi se be
di f f i cul t ;
st r engt hen t he posi t i on of t he ext er nal audi t or , by
provi di ng a channel of communi cat i on and f orum f or
issues of concern;
provi de a framework wi thi n whi ch the external audi tor
can assert hi s i ndependence i n the event of a di spute
wi th management;
AUDI T COMMI TTEES
0 Chapter 3 of the Report by the I nsti tute of Chartered
Ac c ount a nt s o f S c o t l a n d ‘ e n t i t l e d ‘ C o r p o r a t e
Gover nance - Di rectors’ Responsi bi l i ti es for Fi nanci al
Statements’ , February 1992
0 Gui dance bookl et s pr oduced by i ndi vi dual f i r ms of
accountants
0 Chapt er 2, sect i on I V of t he Report of t he Nat i onal
Commi ssi on on Fr audul ent Fi nanci al Repor t i ng ( t he
Treadway Commi ssi on), USA, October 1987
l ‘ Au d i t Co mmi t t e e s i n t h e Un i t e d Ki n g d o m’ b y
P. Col l i er , publ i shed by t he I nst i t ut e of Char t er ed
Accountants of Engl and and Wal es, Apri l 1992.
AUDIT COMMITTEES
ANNEX
Specimen Terms of Reference for an Audit Committee
FOR GUIDANCE ONLY
Constitution
1 The Board hereby resolves to establish a Committee of the
Board to be known as the Audit Committee.
Membership
2 The Commi t t ee shal l be appoi nt ed by t he Boar d f r om
amongst the Non-Executive Directors of the Company and
shall consist of not less than three members. A quorum
shall be two members.
3 The Chairman of the Committee shall be appointed by the
Board.
Attendance at meetings
4 The Finance Director, the Head of Internal Audit, and a
r epr esent at i ve of t he ext er nal audi t or s shal l nor mal l y
attend meetings. Other Board members shall also have the
ri ght of at t endance. However, at l east once a year t he
Commi t t ee shal l meet wi t h t he ext ernal audi t ors wi t hout
executive Board members present.
5 The Company Secr et ar y shal l be t he Secr et ar y, of t he
Committee.
Frequency of meetings
6 Meet i ngs shal l be hel d not l ess t han t wi ce a year. The
external auditors may request a meeting if they consider
that one is necessary.
Authority
7 The Committee is authorised by the Board to i,nvestigate
any activity within its terms of reference. It is authorised
to seek any information it requires from any employee and
all employees are directed to co-operate with any request
I
made by the Committee.
AUDIT COMMITTEES
8 The Committee is authorised by the Board to obtain outside
l egal or ot her i ndependent pr of essi onal advi ce and t o
secure the attendance of outsiders with relevant experience
and expertise if it considers this necessary.
Duties
9 The duties of the Committee shall be:
(a)
(cl
Cd)
(e)
(0
(8)
to consider the appoi,ntment of the external auditor, the
a udi t f e e , a nd a ny que s t i ons of r e s i gna t i on or
dismissal;
to discuss with the external auditor before the audit
commences t he nat ur e and scope of t he audi t , and
ensure co-ordination where more than one audit firm is
involved;
to review the half-year and annual financial statements
before submission to the Board, focusing particularly
on:
(i)
any changes in accounting policies and practices
‘(ii) major judgemental areas
(iii) significant adjustments resulting from the audit
(iv) the going concern assumption
(v) compliance with accounting standards
( vi ) c ompl i a nc e wi t h s t oc k e xc ha nge a nd l e ga l
requirements.
to discuss problems and reservations arising from the
interim and final audits, and any matters the auditor
may wi sh t o di scuss (i n t he absence of management
where necessary);
to review the external auditor’s management letter and
management’s response;
to review the Company’s statement on internal control
systems prior to endorsement by the Board;
(where an internal audit function exists) to review the
i nt e r na l a udi t pr ogr a mme , e ns ur e c o- or di na t i on
between the internal and external auditors, and ensure
that the internal audit function is adequately resourced
and has appropriate standing within the Company;
AUDIT COMMITTEES
(h) to
c o n s i d e r t he ma j o r f i n d i n g s o f i n t e r n a l
investigations and management’s response;
(i) to consider other topics, as defined by the board.
Reporting procedures
10 The Secretary shall circulate the minutes of meetings of the
Committee to all members of the Board.
APPENDIX 5
1 Thi s a p p e n d i x s u mma r i s e s t he ma i n s t a t u t o r y
responsi bi l i t i es of di rect ors and audi t ors rel at i ng t o t he
accounts and audit, as background to the recommendation
in the Code of Best Practice that directors should explain
their responsibility for preparing the accounts alongside a
s t a t e me n t b y t h e a u d i t o r s a b o u t t h e i r r e p o r t i n g
responsibilities. It also summarises current requirements on
internal control, going concern, and fraud, as background
to the recommendations on these issues in the report.
The statutory responsibilities of directors and auditors
2 The st at ut or y r esponsi bi l i t i es of di r ect or s and audi t or s
relating to accounts and audit are laid down in Part VII
(sections 221 to 262) of the Companies Act 1985. Among
the main provisions are the following:
(i) directors
221.-(l) Ever y company shal l keep account i ng r ecor ds
whi ch are suffi ci ent t o show and expl ai n t he company’s
transactions and are such as to -
(a) di scl ose wi t h reasonabl e accuracy, at *any t i me, t he
financial position of the company at that time, and
(b) enable the directors to ensure that any balance sheet
and profit and loss account prepared under this Part
complies with the requirements of this Act.
226.-(l) The directors of every company shall prepare for
each financial year of the company -
(a) a balance sheet as at the last day of the year, and
(b) a profit and loss account
(2) The balance sheet shall give a true and fair view of the
st at e of af f ai r s of t he company as at t he end of t he
financial year; and the profit and loss account shall give a
true and fair view of the profit or loss of the company for
the financial year.
227.-(l) If at the end of a financial year a company is a
parent company t he di rect ors shal l . as wel l as prepari ng
individual accounts for the year, prepare group accounts.
CURRENT STATUTORY AND OTHER REQUIREMENTS
234. - ( I ) The di r e c t or s of a c ompa ny s ha l l f or e a c h
financial year prepare a report -
(a) cont ai ni ng a fai r revi ew of t he devel opment of t he
bus i ne s s o f t h e c o mp a n y a nd i t s s u b s i d i a r y
undert aki ngs duri ng t he fi nanci al year and of t hei r
position at the end of it, . . .
( 3) The r epor t shal l al so compl y wi t h Schedul e 7 as
regards the disclosure of matters mentioned there.
(ii) auditors
235.-(l) A company’s auditors shall make a report to the
c ompa ny’ s me mbe r s on a l l a nnua l a c c ount s of t he
company. . .
( 2) The a udi t or s ’ r e por t s ha l l s t a t e whe t he r i n t he
auditors’ opinion the annual accounts have been properly
prepared i n accordance wi t h t hi s Act , and i n part i cul ar
whether a true and fair view is given -
(a)
in the case of an individual balance sheet, of the state
of affairs of the company as at the end of the financial
year
(b) in the case of an individual profit and loss account, of
the profit or loss of the company for the financial year
(c)
in the case of group accounts, of the state of affairs as
at the end of the financial year, and the profit or loss
for the financial year, of the undertakings included in
t he consol i dat i on as a whol e, so f ar as concer ns
members of the company.
(3) The audi t ors shal l consi der whet her t he i nformat i on
gi ven i n t he di rect ors’ report for t he fi nanci al year for
which the annual accounts are prepared is consistent with.
those accounts; and if they are of the opinion that it is not
they shall state that fact in their report.
237.-(l) A company’s audi t ors shal l , i n prepari ng t hei r
report, carry out such investigations as will enable them to
form an opinion as to -
(a) whether proper accounting records have been kept by
t he company and pr oper r et ur ns adequat e f or t hei r
audit have been received from branches not visited by
them, and
CURRENT STATUTORY AND OTHER REQUIREMENTS
( b) whet her t he company’ s i ndi vi dual account s ar e i n
agreement with the accounting records and returns.
(3) If the auditors fail to obtain all the information and
expl anat i ons whi ch, t o t he best of t hei r knowl edge and
bel i ef, are necessary for t he purposes of t he audi t , t hey
shall state that fact in their report.
Current requirements on Internal Control
3
Under s.221 of the Companies Act directors are required to
mai nt ai n adequat e account i ng records t o enabl e t hem t o
di s c l os e wi t h r e a s ona bl e a c c ur a c y, a t a ny t i me , t he
financial position of the company and in order to meet this
responsibility they must in practice maintain some form of
cont rol syst em over t he company’s process of fi nanci al
management. However, there is no explicit requirement in
company law for them to maintain an effective system of
internal control.
4
Auditors in turn, as part of their usual audit procedures,
wi l l consi der how ~f-2
.~ ,,
t hey can r el y on t he company’ s
internal control systems in carrying out their audit of the
f i nanci al s t at ement s . As a nor mal par t of t hei r audi t
procedures the auditors thus evaluate the internal control
systems and, if they plan to rely on them in reaching their
audit opinion, they will test the operation of those systems.
As a by-product of this auditors will usually comment to
management on their findings in what is commonly known
as t he management l et t er. However, t here i s at present
no Companies Act requirement for auditors to report on the
adequacy of internal control systems.
Current requirements on Going Concern
5 Schedule 4 of the Companies Act 1985 requires accounts to
be prepared on the presumption that the company is a going
c o n c e r n . Th e g o i n g c o n c e r n c o n c e p t i s d e f i n e d i n
accounting standards (SSAP 2) as the assumption that ‘the
ent erpri se wi l l cont i nue i n operat i on for t he foreseeabl e
fut ure. Thi s means i n part i cul ar t hat t he profi t and l oss
account and t he bal ance sheet assume no i nt ent i on or
necessity to liquidate or curtail significantly the scale of
operation. ’ The SSAP does not define ‘foreseeable future’
but auditing guidance states ‘while the foreseeable future
must be j udged i n rel at i on t o speci fi c ci rcumst ances, i t
s houl d nor ma l l y e xt e nd t o a mi ni mum of s i x mont hs
CURRENT STATUTORY AND OTHER REQUIREMENTS
following the date of the audit report or one year after the
balance sheet date whichever period ends on the later date.’
6 Whi l st t he requi rement for di rect ors t o prepare fi nanci al
s t a t e me n t s g i v i n g a t r u e a n d f a i r v i e w c r e a t e s a
pr esumpt i on t hat t hey wi l l sat i sf y t hemsel ves t hat t he
company is not in financial difficulties and that the going
concern basis is appropriate, there is no explicit obligation
in company law that they should do so. There is similarly
no r equi r ement i n l aw f or t he di r ect or s t o r epor t t o
shareholders that they have satisfied themselves about the
going concern basis or the adequacy of financial resources.
7 Auditors in turn, whilst obliged by auditing guidance ‘to be
satisfied that the going concern basis is appropriate’, are
not obl i ge d t o pe r f or m a ny pr oc e dur e s s pe c i f i c a l l y
designed to identify any indications that the going concern
basis may be no longer valid.
Current requirements on Fraud
8 Auditing~‘guidance makes clear that the prime responsibility
for preventing and detecting fraud rests with management,
as part of i t s fi duci ary responsi bi l i t y for prot ect i ng t he
assets of the company. It goes on to state that the auditor’s
responsibility is ‘properly to plan, perform and evaluate his
audi t wor k so as t o have a r easonabl e expect at i on of
d e t e c t i n g ma t e r i a l mi s s t a t e me n t s i n t h e f i n a n c i a l
statements’. It points out, however, that even a properly
designed and executed audit may not detect material fraud
i nvol vi ng f or ger y or col l usi on, and t hat t he audi t or ’ s
r epor t , bas ed as i t i s on t he concept of r eas onabl e
assurance, does not constitute a guarantee that the financial
statements are free of misstatement.
9 So far as reporting fraud is concerned, the present legal
posi t i on i s t hat confi dent i al i t y i s an i mpl i ed t erm of an
a udi t or ’ s c ont r a c t , and t her e i s a publ i c i nt er es t i n
mai nt ai ni ng conf i dent i al cl i ent r el at i onshi ps. Nor mal l y,
therefore, it is the auditor’s duty to report fraud to senior
management . However, t here i s al so a publ i c i nt erest i n
fraud being dealt with expeditiously and this may entail
disclosing matters to a proper authority. An auditor who
discloses in such circumstances without malice is protected
from t he ri sk of breach of confi dence or defamat i on. In
r ecent year s t he l egi s l at i on appl yi ng t o t he s peci al ,
CURRENT STATUTORY AND OTHER REQUIREMENTS
regulated sectors (banks, building societies, insurance and
investment business) has been amended so as to remove any
obstacles there might be to an auditor reporting directly to
t he rel evant regul at or reasonabl e suspi ci on of fraud, or
ot her mat t ers rel evant t o t he regul at or’s funct i ons. The
l egi sl at i on al so gi ves t he Government powers t o speci fy
circumstances in which information is to be communicated
to the regulators, as an alternative to rules or guidance by
the professional bodies. In fact the accountancy profession
has developed auditing guidelines for each of the special
sectors and the Government has not exercised its powers up
t o now. However, in his report on the BCCI affair, Lord
J us t i ce Bi ngham r ecommended t hat audi t or s of banks
should be placed under a statutory duty to report relevant
mat t er s t o t he Bank of Engl and. The Gover nment has
announced that it accepts the recommendation and intends
t o i mpos e a s i mi l a r dut y on a udi t or s t o i nf or m t he
regulators in the other regulated sectors. For the generality
of companies, the profession has also developed guidance
which encourages the auditor to report fraud to the proper
a ut hor i t i e s whe r e he no l onge r ha s c onf i de nc e t ha t
management itself will deal adequately with the matter. ~’
APPENDIX 6
Outline of the case
1 Caparo Industries plc owned shares in a public company,
Fidelity plc, whose accounts for the year ended 31 Mar ch
1984 showed profits far short of the predicted figure which
resulted in a dramatic drop in the quoted share price. After
receipt of the audited accounts for the year ended 31 March
1984 Caparo purchased more shares in Fidelity and later
that year made a successful takeover bid for the company.
Following the takeover, Caparo brought an action against
t he audi t or s of t he company, al l egi ng t hat Fi del i t y’ s
account s wer e i naccur at e and mi sl eadi ng i n t hat t hey
showed a pre-tax profit of fl.2m when in fact there had
been a l oss of over &0.4m, t hat t he audi t or s had been
negl i gent i n audi t i ng t he account s , t hat Capar o had
purchased furt her shares and made t hei r t akeover bi d i n
rel i ance on t he audi t ed account s, t hat t hey had t hereby
suffered loss, and that the auditors owed them a duty of
care t o prevent t hat l oss ei t her as pot ent i al bi dders for
Fidelity because they ought to have foreseen that the 1984
results made Fidelity vulnerable to a takeover bid from one
quarter or another, or as an existing shareholder of Fidelity
interested in buying more shares.
2 The case went to the House of Lords which held that the
auditors did not owe Caparo a duty of care to prevent the
l oss suf f er ed i n consequence of pur chasi ng addi t i onal
s ha r e s , e i t he r a s pot e nt i a l i nve s t or s or a s e xi s t i ng
sharehol ders (Caparo I ndustri es plc v. Dickman and others
[I 9901 I All ER 568).
Basis for the decision
I 3
In broad terms, the House of Lords considered the issues on
the following basis:
( a ) I f A ma k e s a n e g l i g e n t s t a t e me n t , h e ma y
( i nde pe nde nt l y of a ny’ c ont r a c t ua l or f i duc i a r y
r el at i ons hi p) be l i abl e t o B i f B r el i es on t hat
statement and thereby suffers loss, provided A is under
duty of care to B to avoid or prevent that loss.
THE CAPARO CASE
(b) Such a duty of care will exist where a three-pronged
t es t of f or es eeabi l i t y, pr oxi mi t y, and f ai r nes s i s
satisfied:
(i) f o r e s e e a bi l i t y : when maki ng t he st at ement , A
shoul d r easonabl y have f or eseen t hat B mi ght
suf f er t hat l oss i f t he st at ement pr oved t o be
wrong;
(ii) p r o x i mi t y : t he r e mus t , i n r e l a t i on t o t he
statement, be a sufficient relationship between A
and B. Such a rel at i onshi p wi l l exi st i f, at t he
time he made the statement, A knew:
l that the statement would be communicated to
B, either as an individual or as a member of
an identifiable class;
0 that the statement would be so communicated
speci fi cal l y i n connect i on wi t h a part i cul ar
t ransact i on, or t ransact i ons of a part i cul ar
kind; and
0 that B would be very likely to rely on it in
deci di ng whet her or not t o ent er i nt o t hat
transaction or a transaction of that kind;
(iii) f ai rness: the Court must consider it to be fair,
just and reasonable that the law should impose the
specified duty of care on A for the benefit of B.
(c) In suggest i ng t hi s t hree-pronged t est , t he House of
Lords nevertheless recognised that there would often
be an overl ap bet ween t he t hree el ement s, t hat t he
e l e me n t s t h e ms e l v e s we r e ‘ l abel s ’ r a t he r t ha n
precisely applicable definitions, and that there was a
necessary element of pragmatism in applying the test
to any given set of circumstances.
(d) So far as concerns audited accounts, whilst it cannot
f ai r l y be s ai d t hat t he pur pos e of t he s t at ut or y
provisions as to publication is solely to assist members
and debenture holders to an informed supervision and
a ppr a i s a l of t he s t e wa r ds hi p of t he c ompa ny’ s
directors, that is nevertheless the original, central and
primary purpose of these provisions.
4 Caparo’s case foundered as a matter of law because in the
view of the House of Lords the necessary proximity did not
exi st . A rel at i onshi p of proxi mi t y coul d not be deduced
between an auditor and a member of the public who relied
THECAPAROCASE
on the accounts to buy shares in the company when to do so
would give rise to an unlimited liability on the part of the
auditor. Nor could a relationship of proximity be deduced
bet ween an audi t or and an i ndi vi dual sharehol der i n t he
company in relation to further purchases of shares in the
c o mp a n y b y t h a t s h a r e h o l d e r , s i n c e a n i n d i v i d u a l
shareholder stood in no different position from any other
investing member of the public to whom the auditor owed
no dut y, and t he audi t or s ’ s t at ut or y dut y t o pr epar e
accounts was owed to the body of shareholders as whole, to
enable them as a body to exercise informed control of the
company and not to enable individual shareholders to buy
shares with a view to profit.
Principles established
5 The case has est abl i shed t hat i n
features, auditors are not regarded
t he absence of speci al
as owing a duty of care
to prevent loss to anyone relying on their report except (a)
the company, and (b) the shareholders as a body. In the
absence of speci al feat ures, no duty of care is owed in
partictilar t o-i ndi vi dual sharehol ders, subscri bers t o new
shares, purchasers or intended purchasers of shares from
t hi r d par t i es i ncl udi ng t hose conduct i ng t akeover bi ds,
bankers or other lenders to the company, or persons doing
business with the company.
Arguments for and against extending auditors’ duty of care
6 Some of the arguments that have been expressed for and
agai nst ext endi ng audi t or s’ dut y of car e t o i ndi vi dual
shareholders, purchasers of shares, and possibly b‘ther third
parties are as follows.
I
Arguments for extension
(a)
(b)
Cc)
Third parties, to the knowledge of all, in fact rely to a
consi derabl e ext ent on t he i nt egri t y of t he audi t ed
account s - if legal liability is not imposed there is an
allegedly justified expectation gap.
Professional men are paid - they should therefore be
accountable in a wide sense.
The auditors’ liability to the company may provide an
effective remedy where the auditors have negligently
failed to discover fraud or theft from the company -
THE CAPARO CASE
but in general not where, for example, the directors
have been overval ui ng asset s or ot herwi se i nfl at i ng
profi t s. In any case, the company’s loss may be less
than that suffered in aggregate by the shareholders.
(d) The case is bad publicity for the accounting profession
and has prompted the perception that, for example:
(i)
auditors are answerable to no-one;
(ii) the requirement for the auditors to exercise due
care and skill has been lessened;
(iii) having accounts audited is of little or no benefit.
Arguments against extension
(a)
(b)
(cl
Cd)
(e)
(0
(s)
To hold the auditors liable to all and sundry for any
purpose for whi ch t hey may choose t o rel y on t he
auditors’ statement would result, in the classic words
of Cardozo CJ, in ‘liability in an indeterminate amount
for an indeterminate time to an indeterminate class’.
Quite apart from the difficulty of defining the extent
of l i abi l i t y, t her e woul d be endlessproblems i n
det ermi ni ng where l i abi l i t y was due t o rel i ance on
audited accounts and where not.
The principal purpose of the statutory provisions for
audit and the publication of the accounts is to assist
shar ehol der s and debent ur e hol der s col l ect i vel y i n
monitoring the stewardship of the directors - there is
no bas i s f or as s umi ng t hat t he l egi s l at ur e had a
secondary purpose to provide protection for the public
at large and investors in particular.
The potential magnitude of the liability is out of all
proportion to the size of the audit fee.
The primary responsibility for producing true and fair
account s l i es wi t h t he di r ect or s - and i t woul d be
unfair if, in practice, the auditors (and their insurers)
had to foot the bill on their own, or substantially on
their own.
I t i s, i n pr act i ce, di f f i cul t f or audi t or s t o obt ai n
adequate insurance cover.
The third parties have themselves paid nothing to the
auditors - why should they be able to call the auditors
to account?
THE CAPARO CASE
( h) The s cope and cos t of audi t wor k mi ght r api dl y
become uneconomic if wide-scope liability to all users
of accounts were accepted.
The Committee’s view
7 The Commi t t e e r e c ogni s e s t ha t t he Hous e of Lor ds
j udgment i nvol ved a car ef ul and compl ex bal anci ng of
interests - not just those of users of accounts and auditors,
but more generally the interests of professional people and
t h o s e wh o s u f f e r l o s s a s a r e s u l t o f p r o f e s s i o n a l
negligence, and the public interest in having a viable and
fai r syst em. The pri nci pal pract i cal concerns whi ch l ay
behi nd t he concl usi ons reached by t he House of Lords
i ncl uded t he si ze of audi t or s’ pot ent i al l i abi l i t i es, t he
di f f i cul t i es i n def i ni ng wi der l i abi l i t y i n any f ai r yet
real i st i c way, and t he l i kel y di ffi cul t i es i n est abl i shi ng
whet her t hi rd part y l osses were due t o rel i ance on t he
account s. Bear i ng i n mi nd t he wi de r ange of user s of
accounts, the Committee is unable to see a practical and
equi t abl e way i n whi ch t he House of Lords coul d have
broadened the boundaries of auditors’ legal duty of care
without giving rise to a liability that was indeterminate in
scope, t i me and amount , nor does i t consi der t hat t he
decision should be altered by statutory intervention at the
present time.
Possible ways of extending duty of care without creating open-ended
liability
8
If, not wi t hst andi ng t he Commi t t ee’s recommendat i on, i t
wer e deci ded t o change t he pr i nci pl es laid‘down by
Caparo, it would be necessary to amend the law by statute
to impose a liability on auditors to compensate accounts
user s i n gener al , or speci f i ed cl asses of user such as
investors, who suffer loss by relying on negligently audited
accounts. Those proposing such a change have suggested as
a q u i d p r o q u o t h a t a u d i t o r s ’ l i a b i l i t y s h o u l d b e
proportionate only, or that it should be limited. There are,
however, serious objections in both cases:
(a) Proport i onat e l i abi l i t y onl y: it is proposed that the
l aw shoul d be changed so t hat t hose who t oget her
cause damage should not, as at present, each be liable
for the whole of the loss, but should each only assume
a reasonable proportion of the loss. However, there are
considerable technical difficulties in this proposition,
THECAPAROCASE
not least because not all the potential defendants may
be before the court. The proposition would also need
to be considered in relation to the law as a whole, and
t her e i s no par t i cul ar r eason f or si ngl i ng out t he
auditors for special treatment. It should in any event
be recogni sed t hat even wi t h l i abi l i t y l i mi t ed t o a
proportion of the claimant’s loss, the amount payable
by the auditors could still put them out of business.
( b) Li mi t ed l i abi l i t y: it is proposed that the law should
be changed to permit auditors to limit their liabilities
by contract with the relevant company. Apart from any
pr act i cal pr obl ems i n r eachi ng agr eement wi t h t he
company, t her e i s a f undament al l egal pr obl em i n
establishing a basis on which an auditor might found a
limitation of his liability to those with whom he has no
contractual tie. Another possibility would be to impose
a statutory ‘cap’ on an auditor’s liability, either fixed
for all auditors or related to variables such as the size
of audit fee or the size of audit firm. However this
suggest i on woul d be an unsat i sfact ory compromi se.
When the cap operated it would prevent plaintiffs from
recovering the full loss suffered, whilst if the auditors
faced more claims in relation to one year than their
insurance provided cover for, they might still be put
out of busi ness and not al l t he successful pl ai nt i ffs
would be able to recover the amount of the cap.
APPENDIX 7
The Committee is nrateful to the following for submitting comments on
- its draft report:
Mr R J Alexander
Mr Gary Allen
Managing Director and Group
Chief Executi\le. IMI plc
Alliance & Leicester Building Society
Alliance of Independent Retailers and
Businesses
Mr Michael Arnold
Arthur Andersen & Co
Association of Authorised Public
Accountants
Association of British Chambers of
Commerce
Association of British Insurers
.Association of Investment Trust
Companies
Auditing Practices Board
Mr H S Axton
Chairman, Brixton Estate plc
BDO Binder Hamlyn
Mr Neville Bain
Group Chief Executive, Coats
Viyella plc
Barratt Developments plc
Mr Nicholas Beale
Scifeh
Mr V W Benjamin
Mr A G Biggart
Mr D A V Boyle
University of Excler
Mr E A Bradman
Mr C B Brayshaw
British Bankers Association
British Merchant Banking and
Securities Houses Association
British Petroleum Company plc
British Rail Pension Trustee
Company Ltd
Mr Robin Broadley
Deputy Chairman, Baring Brothers
& co L&i
Mr C R E Brooke
Chairman, Candover Investments
plc
Mr Derek Broome
Mr A C Bryant
Chairman, Bryant Group plc
Mr Donald Brydon
Building Societies Association
Building Societies Commission
Mr Gavin Burnett
Burson-Marsteller
Centre for Business and Public Sector
Ethics
Chartered Association of Certified
Accountants
Chartered Institute of Management
A c c o u n t a n t s
Chartered Institute of Marketing
Mr Jonathan Chaytor
City Capital Markets Committee
Mr J R Clark
English & Overseas Properties plc
Clark Whitehill & Co
Dr K Cleaver
University of Liverpool
Cleveland County Council
Mr Paul Collier
University of Exeter
Confederation of British Industry
CONTRIBUTORS TO THE COMMITTEE
Mr P D Cooper
Coopers & Lybrand
Sir Colin Corness
Chairman, Redland plc
Courtaulds plc
Sir Michael Craig-Cooper
Mr David Craine
Mr Paul Dare
Mr P A Davis
Deputy Chairman, Sturge Holdings
plc
Mr Nicholas Dimsdale
The Queen’s College Oxford
Dr J P Dobrowolski
Chief of Internal Auditing, Argos
Ptc
Mr Eric Dodson
Mr Stewart Douglas-Mann
Guinness Mahon & Co Ltd
Mr J C Dwek
Chairman, Bodycote
International plc
Dr Christopher Eaglen
English China Clays plc
Ernst & Young
Mr Noel Falconer
Federation of Small Businesses
Mr David Fifield
Foreign Banks and Securities Houses
Association
Mr John Franks
Mr Gavin Fryer
GKN plc
Mr Matthew Gaved
The Social Market Foundation
The General Electric Company plc
Mr Mark Gifford-Gifford
University of Exeter
Sir Paul Girolami
Chairman, Glaxo Holdings plc
Mr Dermot Glynn
National Economic Research
Associates
Catherine Gowthorpe
Lancashire Business School
Mr Nigel Graham Maw
Grand Metropolitan plc
Grant Thornton
Mr Donald Green
Sir Owen Green
Chairman, BTR plc
Sir Richard Greenbury
Chairman, Marks and Spencer plc
Mr T J Grove
Mr Anthony Habgood
Chief Executive, Bunzl plc
Mr Charles Hambro
Chairman, Hambros plc
Mr R W D Hanson
Chairman and Managing Director,
Hardys and Hansons plc
Hay Management Consultants Ltd
Mr R M Heard
Company Secretary, BPB
Industries plc
Mr A L Hempstead
Professor Brian Houlden
Warwick Business School
Gerard Howe
Howe Associates
Mr D J Hughes
Humberside County Council
The Hundred Group of Finance
Directors
Mr A Hyslop
Group Chief Internal Auditor,
Crown Agents
CONTRIBUTORS TO THE COMMITTEE
IBM United Kingdom Ltd
Institute of Business Ethics
Institute of Chartered Accountants in
England and Wales
Institute of Chartered Accountants in
Ireland
Institute of Chartered Accountants of
Scotland
Institute of Chartered Secretaries &
Administrators
Institute of Directors
Institute of Internal Auditors
Institute of Investment Management
and Research
Institute of Personnel Management
Institutional Fund Managers
Association
Investor Relations Society
Mr Michael Jackaman
Chairman, Allied-Lyons plc
Mr Edmond Jackson
Mr J B H Jackson
Mr J N C James
Executive Deputy Chairman,
Grosvenor Estate Holdings
Mr David Jefferies
Chairman, The National Grid
Company plc
Mr J Jeffreys
Mr David Jinks
Group Finance Director, Cadbury
Schweppes plc
KPMC Peat Marwick
Mr Stanley Kalms
Chairman. Dixons Group plc
MrJCKay
Mr Noel Kelleway
Kidsons Impey
Mr Christopher King
Director, BP Europe
Mr G W King
Mr Tim Knowles
Mr Adam Kounine
Lord Lane of Horse11
Mr John Lavery
Newcastle Business School
Law Society (Company Law
Committee)
Law Society of Scotland
Legal and General Group plc
Mr J L Leonard
Chairman, Eurotherm plc
The Liberal Democrats
Mr L E Linaker
Deputy Chairman & Managing
Director, M&G Group plc ~. ‘.
Mr Norman Lindsay
Mr Martin Lipton
Sir Richard Lloyd
Chairman, Vickers plc
Lloyds Bank plc
London Stock Exchange
London Stock Exchange Listed
Companies Advisory Committee
Sir Desmond Lorimer
Dr A D McCann
McCann Research
McKenna & Co
Mr Colin McLean
Managing Director, Scottish Value
Management Ltd
Mr D S McMullen
Managing Director, McMullen &
Sons Ltd
Mr Ewan Macpherson
Chief Executive, 3i Group plc
Mr D F Macquaker
CONTRIBUTORS TO THE COMMITTEE
Mr Donald Main
Mr Geoffrey Maitland Smith,
Chairman, Sears plc
Christine Mallin
University of Nottingham
Management Consultancies
Association Ltd
Mr W H Melly
Mr Paul Meredith
Chief Executive, Phillips & Drew
Fund Management Ltd
Mr Tony Merrett
Mr Ian Michell
Mr D E Midgley
The Midlands Industry Group of
Finance Directors
Rowena Mills
Rowena Mills Associates Ltd
Sir Nigel Mobbs
Chairman and Chief Executive,
Slough Estates plc
Morgan Grenfell Group plc
Mr James Morton
Mr Roger Morton
Mr Tony Morton
Mr Geoffrey Mulcahy
Chair-man and Group Chief
Executive, Kingfisher plc
Mr Michael Mumford
Lancaster- Univer%ty
Mr Paul Myners
Chairman Audit Committee,
PowerGen plc
National Association of Pension Funds
Nationalised Industries Finance Panel
Neville Russell
New Bridge Street Consultants
Mr B T O’Driscoll
Group Chief Internal Auditor, ICI
plc
Mr J F O’Mahoney
Vice Chairman, Ladhroke Group
Plc
Mr P Ormrod
University of Lil*erpool
Mr G J Osborn
General Auditor. Europe. Eli Lilly
& Company Ltd
Mr Simon Pallett
Newcastle Business School
Pannell Kerr Forster
Mr Bruce Pattullo
Cover-nor & Group Chief
Executive, Bank of Scotland
Pensions Investment Research
Consultants Ltd
Professor J P Percy
Mr D E Philpot
Sir David Plastow
Chairman, Inchcape plc
Portsmouth and Sunderland
Newspapers plc
Price Waterhouse
ProShare
Public Interest Research Centre Ltd
Dr Derek Purdy
University of Reading
Sir Alick Rankin
Chairman, Scottish &
Newcastle plc
Reads & Co
Professor William Rees
City of London Polytechnic
Mr D E Reid
Director-, Tesco plc
Mr Andrew Robb
Director, Pilkington plc
TO THE COMMITTEE CONTRI BUTORS
Sir Lewis Robertson
Sir George Russell
Chairman, Marley plc
Mr David Sainsbury
Deputy Chairman, .I Sainsbury plc
Mr Saleem Sheikh
City of London Polytechnic:
Mr John Salter
Demon Hall Burgin & Warren,
Mr John Sclater
Chairman, Foreign and Colonial
Investment Trust plc
Mr John Scott-Oldfield
The Corporate Consutting Group
Securities and Investments Board
Serious Fraud Office
Shareholder Monitor Ltd
Sir Patrick Sheehy
Chairman, BAT Industries plc
Mr J J L G Sheffield
Chairman, Norcros plc
Mr Peter Small
Crescent Management Selection
Society of Labour Lawyers
South Western Electricity plc
Stoy Hayward
Mr C M Stuart
Swiss Bank Corporation
Mr Allen Sykes
TSB Group plc
Thames Valley Commercial Group
Mr A R Threadgold
Chief Executive, Pastel Investment
Management Ltd
Lord Tombs of Brailes
Chairman, Rolls-Royce plc
Mr R C Tomkinson
Top Pay Research Group
Mr P G Totty
Touche Ross.& Co
Mr J D Traynor
Chairman, CRH plc
Unilever plc
Union of Independent Companies
Unit Trust Association
United Kingdom Shareholders
Association
Professor Gerald Vinten
Luton University College of Higher
Education
Lord Watkinson
Lord Weir
Chairman, The Weir Group plc
Mr F Williams
The Hon Geoffrey Wilson
Chairman, Delta plc
Mr N S Wilson
Mr Ralph Windle
The Committee is also grateful to all those who provided assistance at earlier
stages of its work. A full list of names was published in the Committee’s draft
report.
RELEVANT PUBLISHED STATEMENTS
Relevant published statements
The following published documents were among those drawn to the Committee’s
attention:
Chartered Institute of Management Accountants: ‘Corporate Reporting -The
Management Interface’ (1990); ‘Non-Executive Directors -Their Value to
Management’ (1992); ‘A Framework for Internal Control’ (1992)
Financial Reporting Council: ‘The State of Financial Reporting -a Review’
(November 199 I)
Institute of Business Ethics: ‘Business Ethics and Company Codes -Current Best
Practice in the United Kingdom’ (1992)
Institute of Chartered Accountants in England and Wales: ‘The Changing Role of
the Non-Executive Director’ (May 1991); ‘Audit Committees’ (April 1992)
Institute of Chartered Accountants in England and Wales and Institute of
Chartered Accountants of Scotland: ‘The Future Shape of Company Reports’
(1991)
Institute of Chartered Accountants in Ireland: Report of the Financial Reporting
Commission (January 1992)
Institute of Chartered Accountants of Scotland: ‘Corporate Governance -
Directors’ Responsibilities for Financial Statements’ (February 1992)
Institute of Chartered Secretaries & Administrators: ‘Duties of the Company
Secretary’ (1992)
Institute of Directors: ‘Guidelines for Directors’ (1990)
Institutional Shareholders Committee: ‘The Role and Duties of Directors - A
Statement of Best Practice’ (April 1991); ‘The Role and Responsibilities of
Institutional Shareholders in the UK’ (December 1991)
PRO NED: ‘Code of Recommended Practice on Non-Executive Directors’ (April
1987); ‘Remuneration Committees’ (January 1992); ‘Research into the Role
of the Non-Executive Director’ (sponsored jointly with the London Stock
Exchange, published July 1992); ‘ 10th Annual Review’ (September 1992).
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