UK: confidence in corporate reporting and governance - FRC warning continues

The UK's Financial Reporting Council held its Annual Open Meeting this week. The FRC's chief executive delivered a series of remarks concerning the on going work of the FRC and concluded with this warning:

In December of last year we issued a statement noting that the risks to confidence in corporate reporting and governance were higher than they had been for some years and that this needed to be matched by additional diligence on the part of preparers of accounts, audit committees and auditors. Eight months on our warning remains in place and the text of our statement and the key questions which we suggested that audit committees should consider is worth re-reading".

UK: the Data Sharing Review and corporate governance

The Data Sharing Review Report was published today. It contains many recommendations but the first two are of particular importance within the field of corporate governance:

Recommendation 1: As a matter of good practice, all organisations handling or sharing significant amounts of personal information should clarify in their corporate governance arrangements where ownership and accountability lie for the handling of personal information. This should normally be at senior executive level, giving a designated individual explicit responsibility for ensuring that the organisation handles personal information in a way that meets all legal and good-practice requirements. Audit committees should monitor the arrangements and their operation in practice.

Recommendation 2: As a matter of best practice, companies should review at least annually their systems of internal controls over using and sharing personal information; and they should report to shareholders that they have done so. The Combined Code on Corporate Governance requires all listed companies to review ‘all material controls, including financial, operational and compliance controls and risk management systems’ ... It would be surprising and worrying not to see information risks addressed explicitly in the Statements of Internal Control for such companies. We hope that bodies such as the Confederation of British Industry will develop guidance to help companies ensure their controls and disclosures are adequate. If approaches on these lines are not successful in improving high-level accountability for giving assurance on information risks, we would expect the Financial Reporting Council to intervene.

For background information click here.

UK: KPMG audit committee survey

KPMG has published the results of a survey of public company audit committee members. The views of just under 150 audit committee members were obtained and the following findings emerged:

• Risk management was seen as the top oversight priority for the year ahead.
• Nearly half of respondents said that the committee reported to the full board.
• One in four respondents said that their committee did not have a formal process in place to evaluate the external auditor.
• Over half of respondents expressed concern that the committee had been assigned (or had assumed) too much responsibility for risk oversight beyond financial reporting risk.

The results are available here (you may need to provide personal information in order to gain access).

UK: choice in the audit market - FRC progress report

The Financial Reporting Council has published its fifth progress report on the implementation of the recommendations of the Market Participants Group (here, pdf) on promoting choice in the UK audit market: see here (pdf).

The report summarises recent developments, including the publication of the audit firm governance code, and also describes the results of recent FRC research. It is noted that the revised Guidance to Audit committees has had a limited impact on disclosure and, with regard to market concentration, the FRC reports:

It is apparent that, despite previous increases in the number of FTSE 350 companies retaining a non‐Big Four auditor from 2006 – 2009, this trend has now ceased and may even have reversed. The February 2010 figures also show a slight drop in the number of smaller listed companies retaining a non‐Big Four auditor.

[Of] the thirteen FTSE 350 companies the [Professional Oversight Board] is aware have changed auditor since February 2008, none has switched from a Big Four to a non‐Big Four firm, and two which previously retained a non‐Big Four auditor have changed to a Big Four firm. There appears therefore to be little indication that concentration in the audit market is reducing or is likely to reduce in the near future".

UK: Institutional Shareholders' Committee statement on auditor liability limitation agreements

The Institutional Shareholders' Committee has published a statement concerning auditors' liability limitation agreements. The ISC notes:

• Agreements should be proportionate, and provide a limit for liability that is fair and reasonable.
  
• Companies should recognise that they are not obliged to enter into agreements if they are not suitable.
  
• Companies should justify to shareholders the benefits of concluding agreements in advance of putting them to a general meeting vote. 
  
• When audit committees discuss these agreements with auditors, they should seek to assure themselves that audit quality will be preserved and enhanced.
  
• Shareholders will not want to see their preference for proportionate liability agreed at holding company level undermined by other forms of agreement lower down the group structure.
  
• Companies should use the specimen principle terms for agreements which have been laid out by the FRC. 

For further information see:
FRC guidance on auditor liability limitation agreements | ISC | ISC statement | ISC press release |

UK: new version of the Combined Code published

The Financial Reporting Council has published an updated version of the Combined Code on Corporate Governance, which applies to financial reporting periods beginning on or after 29 June 2008. 

The revised Code includes the following changes, resulting from the FRC's 2007 review of the Code:

• The removal of the restriction on an individual chairing more than one FTSE 100 company
  
• For listed companies outside the FTSE 350, allowing the company chairman to sit on the audit committee where he or she was considered independent on appointment.
  

UK: changes to the Combined Code

The Financial Reporting Council has announced several changes to the UK's Combined Code on Corporate Governance:

• the removal of the restriction on an individual chairing more than one FTSE100 company.
  
• for listed companies outside of the FTSE350, permitting the chairman to sit on the audit committee where he/she was considered independent on appointment.
  

These changes follow a consultation earlier this year.  The revised Code will be published at the end of June and it will apply to accounting periods beginning on or after 29 June 2008.  Click here for further information.  The FRC has also published a regulatory impact assessment and a summary of consultees' responses.

NB: The revised Code will come into force on the same day as new FSA rules implementing European Directive 2006/46/EC which will require a corporate governance statement to be published in the annual reports of companies who have their registered office in the Community and whose securities are admitted to trading on a regulated market.  For further information, see here.

Postscript (27 June 2008): Further information about the new FSA rules is available here and information about the revised Combined Code is available here.

India: voluntary corporate governance and social responsibility guidelines published

The Ministry of Corporate Affairs has, for the first time, published voluntary corporate governance guidelines: see here (pdf). Based on 'comply or explain', the guidelines are directed at public companies and are divided into six sections: the board of directors; responsibilities of the board; audit committee of the board; auditors; secretarial audit; and whistle blowing. 

The Ministry has also published voluntary corporate social responsibility guidelines: see here (pdf). 

UK: FRC consults on its priorities for 2010/11

The Financial Reporting Council has published, for consultation, its priorities for 2010/11: see its draft plan (pdf). Major activities include implementing changes to the Combined Code (to become known as the the UK Corporate Governance Code); supporting the introduction of a Stewardship Code for institutional investors; considering whether the need remains for updated guidance for directors and audit committees arising from the financial crisis; and continuing work to improve narrative reporting, including disclosures concerning business models.

UK: current economic conditions - challenges for audit committees

Yesterday the Financial Reporting Council published a document highlighting the challenges for audit committes arising from current economic conditions. The document contains questions which are designed to identify issues of relevance to the work of audit committees over the coming months. It also contains the following assessment:

The current economic outlook appears to be less depressed than this time last year. However, significant economic risks remain and will present challenges for many audit committees during the 2009/10 reporting season. Past experience shows that insolvencies have increased after the technical end of recessions as companies run out of working capital. Such conditions mean that the next twelve months are likely to be particularly difficult for management and may increase the risk that annual reports and accounts misreport facts and circumstances and contain uncorrected errors and omissions".

Australia: audit quality consultation paper published by FRC

Australia's Financial Reporting Council has published a consultation paper titled Audit Quality in Australia - A Strategic Review: see here (pdf) or here (rtf). The report concludes that the audit framework is robust and stable and that fundamental change is not required. It nevertheless identifies possible areas for reform including, for example, key finding 23:

... having regard to the important role that the audit committee plays in the good governance of a company, Treasury considers that it would be appropriate to examine whether the requirement for a company listed on the S&P/ASX All Ordinaries Index to establish an audit committee should be included in the Corporations Act rather than the Listing Rules, and whether the existing requirement should be extended to all listed companies.

Another related issue that Treasury considers should be examined is whether the mandatory requirement for the top 300 listed companies to comply with the recommendations of the ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations on the composition, operation and responsibility of the audit committee should be applied to all 500 companies listed on the S&P/ASX All Ordinaries Index. Treasury proposes to explore these issues with relevant stakeholders including ASIC, the Australian Institute of Company Directors (AICD) and the ASX".

Ireland: Combined Code principles to be placed on statutory footing

A Renewed Programme for Government has been agreed by the Government partners (Fianna Fáil and the Green Party). It contains measures concerning corporate governance, most notably the following objective (at p. 13):

We will put the principles of the 'Combined Code' of [sic] Corporate Governance on a legislative footing for all banks, public companies and state-sponsored bodies to deal with the following key areas of governance of institutions: board composition and independence; segregation of CEO and Chair; clear definition of executive and non executive responsibilities; audit committee composition, independence, role and function; responsibilities and composition of board committees; segregation of committee chairs; risk management; selection of non-executive directors; and sanctions for non-compliance".

UK: Grant Thornton's FTSE350 Corporate Governance Review

Grant Thornton has published its FTSE350 Corporate Governance Review 2009: see here (pdf).

The Review examines companies' compliance with the Combined Code and disclosure in this regard. It notes that 47% of companies reported that they were fully compliant with the Code. The quality of disclosure remains, nevertheless, an issue according to the Review, with only 29% of those companies claiming full compliance providing the disclosures needed to support their claim. Amongst the other finding reported are:

• The average FTSE 350 board has 5.2 non-executive directors compared to 3.3 executive directors, although 80 companies did not have at least half the board made up of independent non-executive directors for the entire year.
• 31 companies, including eight in the FTSE 100, did not disclose who on the audit committee had recent and relevant financial experience.
• Three FTSE 100 and 13 Mid 250 companies changed their auditors during the year.

Note: For earlier reviews see (in pdf): 2008 | 2007 | 2006 | 2005 |

UK: Audit Committees: Smith Guidance: Proposed Changes

The FRC has issued a consultation paper which proposes changes to the Combined Code and Smith Guidance on Audit Committees. The recommendations include:

(a) Company boards to provide information to shareholders relevant to their auditor selection decision.
(b) Company boards to disclose any contractual obligations (such as loan agreements) to appoint certain types of audit firms.
(c) Large companies to consider the need to include the risk of the withdrawal of their auditor from the market in their risk evaluation and planning.
(d) Sections of the Smith Guidance dealing with auditor independence to be reviewed for consistency with the relevant ethical standards for auditors.

The FRC's press release is available here.

Some useful background information on the role of audit committees can be found in a guide published by Deloitte titled "Catch the Current".

UK: long association with the audit engagement - APB issues revised Ethical Standard 3

The Auditing Practices Board has published a revised version of Ethical Standard 3 - Long Association with the Audit Engagement. The revised standard increases the audit engagement partner's maximum period of association with the audit engagement from five to seven years in circumstances where (to quote directly from the standard):

... the audit committee (or equivalent) of the audited entity decide that a degree of flexibility over the timing of rotation is necessary to safeguard the quality of the audit and the audit firm agrees, the audit engagement partner may continue in this position for an additional period of up to two years, so that no longer than seven years in total is spent in the position of audit engagement partner. An audit committee and the audit firm may consider that such flexibility safeguards the quality of the audit, for example, where:

• substantial change has recently been made or will soon be made to the nature or structure of the audited entity’s business; or
• there are unexpected changes in the senior management of the audited entity. 
  

In these circumstances alternative safeguards are applied to reduce any threats to an acceptable level. Such safeguards may include ensuring that an expanded review of the audit work is undertaken by the engagement quality control reviewer or an audit partner, who is not involved in the audit engagement".

UK: ICAS Working Group rejects ban on auditors providing non-audit services to their listed company audit clients

The Working Group established by the Institute of Chartered Accountants of Scotland to consider the issues raised by audit firms providing non-audit services to their listed company audit clients, following the publication of the Auditing Practices Board's consultation paper, has published its final report: see here (pdf).

The Working Group concluded that no benefits would be gained by banning auditors from providing non-audit services to their listed clients. The Group instead recommended greater disclosure and transparency with regard to the policy and procedures in place where the auditor provides non-audit services. The Group also proposed changes to the way in which auditor remuneration is disclosed because, in its view, the current regime has not resulted in useful information being provided.

UK: Combined Code: Proposed Changes

In December 2007, the FRC began a consultation with regard to two changes to the Combined Code on Corporate Governance:

(1) the removal of the restriction preventing an individual from chairing more than one FTSE100 company

(2) for listed companies outside of the FTSE350, to allow the chairman to be a member of, but not chair, of the audit committee providing he or she was considered independent on appointment.

For further information click here.

UK: FTSE350 companies' compliance with the Combined Code

Earlier this year, Grant Thornton published research exploring FTSE350 companies' compliance with the UK's Combined Code on Corporate Governance. The research revealed (to quote directly from the relevant press release):

(a) 66% of FTSE 350 companies still do not claim to be in full compliance with the provisions of the Combined Code.

(b) The most common areas where companies chose to depart from the Code's provisions were the terms and conditions of the appointment of non-executives, aspects of internal controls and audit committee independence and financial experience.

(c) 80% of businesses had attempted a Business Review in accordance with the new Companies Act, although the majority would not have been required to do so.

For further information, click here.

UK: should auditors undertake non-audit work for their audit clients?

Yesterday's Sunday Times newspaper reported that Pensions Investment Research Consultants (PIRC) is calling for a ban on auditors performing non-audit work for their audit clients. The report cites "fears that it compromises auditors' independence and discourages them from confronting directors on difficult issues" as reasons for PIRC's position. Research by proxy voting agency Manifest is also cited:

The FRC said the level of fees paid to auditors in the FTSE 100 for non-audit work dropped from 191% of audit fees in 2002 — almost double their traditional income — to 71% last year. However, research by Manifest, the voting advisory service, for The Sunday Times shows a significant number of blue-chip companies last year shelled out more in non-audit fees to their auditors than for the cost of core audit work. The firms included Pennon, Experian and SAB Miller. PIRC research found that many smaller companies in the FTSE All-Share paid hefty multiples of auditors’ fees for their non-audit work. The biggest spenders in the 2008-9 financial year included Salamander Energy, Ashmore Group, Berkeley Group, William Hill and Premier Foods, as well as Land Securities, the FTSE 100 property company".

We've been here before: the Cadbury Committee considered whether auditors should be prohibited from providing non-audit services to clients and concluded in its 1992 report (at para. 5.11):

Such a prohibition would limit the freedom of companies to choose their sources of advice and could increase their 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".

These arguments will be considered again very soon: the report notes that in a few weeks' time the  Auditing Practices Board will begin a consultation on the issue of non-audit work performed by auditors.