India: company law reform moves a step closer - Companies Bill 2008 approved by Cabinet

In 2005 the Irani Report, on the reform of India's company law, was published. Legislation to replace the Companies Act 1956 has been expected for some time. Its introduction has moved a step closer: today it was announced that the Companies Bill 2008 has been approved by the Union Cabinet and will be introduced in Parliament in October. 

The Government's announcement contains an overview of the purpose of the Bill: to provide the principles for the internal governance of companies and a framework for their regulation, administered by Central Government, but with a much greater role for shareholders.  Specific proposals include:

• The introduction of a new entity, the "one-person company".
  
• The abolition of shares with differential voting rights.
  
• Provision for the duties and liabilities of directors, with every company to have at least one director resident in India.
  
• At least one third of board directors to be independent [it's not yet clear to which companies this rule will apply; the Irani Committee proposed that is should apply to public listed companies and those taking deposits from the public]. 
  
• Insider trading by directors to be recognised as a criminal offence.
  
• Auditors' rights and duties to be explained.
  
• Class action suits by shareholder associations to be permitted.
  

UK: England and Wales: auditors' liability and the ex turpi causa principle [a belated posting]

Several months ago the Court of Appeal gave judgment in Moore Stephens (a firm) v Stone & Rolls Ltd [2008] EWCA Civ 644 and it would appear from recent reports in the legal press that an appeal to the House of Lords will be made. The case required the Court of Appeal to consider the operation of the ex turpi causa non oritur actio principle (no cause of action may be founded on an illegal act) in the context of a negligence claim brought by the liquidators of a company (Stone & Rolls) against a company's auditors (Moore Stephens). 

The liquidators argued that the auditors had failed, during the course of several audits, to identify the fraud of Mr. Stojevic (the directing mind and will of the company). Mr. Stojevic fraudulently obtained, through the company, money from various banks. One of these banks sued the company and Mr. Stojevic and was awarded damages against Mr. Stojevic and the company. The company was unable to pay and entered liquidation. The auditors denied negligence and applied for the action to be struck out on the basis that the claim was barred by the ex turpi causa principle. The first instance judge declined to strike out the claim (see [2007] EWHC 1826 (Comm)). 

The Court of Appeal held that the liquidators' claim was barred by the ex turpi causa principle and struck out the claim. The court rejected the argument that the company was the victim of fraud and attributed Mr. Stojevic's actions to the company. There was not, the court unanimously agreed, any room for discretion in the application of the ex turpi causa principle because, as Lord Goff observed in Tinsley v Milligan [1994] AC 340 at 355B: "...the principle is not a principle of justice; it is a principle of policy, whose application is indiscriminate and so can lead to unfair consequences as between the parties to litigation. Moreover the principle allows no room for the exercise of any discretion by the court in favour of one party or the other".  The court also rejected the argument that the ex turpi causa principle did not apply where the claim was based on the commission of a fraud where the prevention of that fraud was "the very thing" that the defendants had undertaken to do. In this regard, Rimer LJ observed (at para. [109]):

There is ... no support in the authorities that we were shown for the proposition that if "the very thing" from which the defendant owed a duty to save the claimant harmless is, or includes, the commission of a criminal offence, the public policy defence based on the ex turpi causa principle will be overridden so as to enable the bringing of the claim that relies on the claimant's illegality".

Note: The case has been reported here in the Law Society Gazette.

Postscript (2 Sep 2008): The House of Lords Judicial Office informs me: "[the] petition for leave was presented on 18 July 2008 ... and we would hope to get a decision on leave before the end of November this year". 

UK: the Statutory Auditors and Third Country Auditors (Amendment) (No 2) Regulations 2008

The Department for Business, Enterprise and Regulatory Reform has published a draft of the Statutory Auditors and Third Country Auditors (Amendment) (No. 2) Regulations 2008 (available here in Word format). Further information, with background information, is available in the explanatory text accompanying the draft (available here in Word format) and from where the following text is taken:

The EU’s Statutory Audit Directive (2006/43/EC) introduces the regulation of auditors from outside the EEA (“Third Country Auditors”) who audit the accounts of companies who issue securities on regulated markets in the EEA. The Directive also allows these requirements to be disapplied where third country auditors are subject to a system of regulation in their home country which is determined to be equivalent to those in the EU.

Although the Commission has not yet made proposals for determinations of equivalence, the Commission and Member States have recently agreed a decision (2008/627/EC) on transitional measures which will allow Member States to treat auditors from specified countries largely as though the regulatory regimes were equivalent. This will allow the introduction of these provisions with the minimum disruption to EU markets. 

... because of the legal approach of the Commission’s decision, some amendments are needed to the existing provisions in SI 2007/3494 [The Statutory Auditors and Third Country Auditors Regulations 2007, and this is the purpose of the new Regulations]".

UK: POB annual report published

The Professional Oversight Board, part of the Financial Reporting Council, has published its annual report to the Secretary of State for Business, Innovation and Skills for the year to 31 March 2010: see here (pdf). This reports on the Board's responsibilities and activities and largely reproduces information already published. However, two items are worth noting.

First, the Board concludes that certain aspects of regulatory activity at some recognised bodies gives it "significant concerns". Second, with regard to audit choice, the Board notes that the majority of the Market Participants Group's recommendations have now been implemented but there is limited evidence that they have had a significant impact on market concentration and the risks thereby arising.

UK: auditors: market concentration and their role - enquiry begins

The House of Lords Economics Affairs Committee yesterday launched an enquiry which will explore the issues arising from the 'Big Four' accountancy firms' domination of the audit market. The Committee will also consider whether auditors should have done more ahead of the banking crisis to alert investors to the riskiness of banks' assets. Further information is available here and the Committee's call for evidence is available here (pdf).

UK: the provision of non-audit services by auditors

Last year the Auditing Practices Board published a consultation paper concerning audit firms' provision of non-audit services to the listed companies they audit. Feedback on this consultation has been published today and proposals published to change the APB's Ethical Standards for Auditors and the FRC's Guidance on Audit Committees: see here (pdf) and here (pdf). A prohibition on auditors providing non-audit services to the companies they audit is not being proposed.

UK: number of audits requiring significant improvement too high says AIU

The Professional Oversight Board, part of the Financial Reporting Council, yesterday published the Audit Inspection Unit’s Annual Report for 2009/10: see here (pdf).

The AIU reviews [a] the quality of the statutory audits of listed and other major public interest entities that fall within its scope and [b] firms’ policies and procedures supporting audit quality. The 2009/10 report provides an overview of the activities and findings of the AIU for the year ended 31 March 2010. With regard to the quality of audits by major firms the report finds:

... major firms have policies and procedures in place to support audit quality that are generally appropriate to the size of the firms and the nature of their client base. Nevertheless, improvements to these policies and procedures have been recommended at all firms. Notwithstanding the quality of firms’ policies and procedures, the number of audits assessed as requiring significant improvement at major firms (eight audits or 11% of audits reviewed at major firms excluding follow‐up reviews) is too high. Firms are therefore not always consistently applying their policies and procedures on all aspects of individual audits.

... a higher proportion of audits conducted by smaller firms require significant improvement. Six of the 11 smaller firm audits reviewed in 2009/10 (excluding follow–up reviews) were assessed as requiring significant improvement (2008/9: five of the 11 audits reviewed). Firms should not undertake audits unless they have the appropriate level of resources and expertise to ensure they are performed to an acceptable standard.

The AIU believes consideration should be given to establishing competency requirements specifically for auditors of listed and major public interest entities".

UK: auditors' contribution to prudential regulation - FRC and FSA issue joint discussion paper

The Financial Reporting Council and Financial Services Authority have today issued a joint discussion paper - available here (pdf) - the purpose of which is to start a debate on how the FSA, FRC and auditors can work together to enhance auditors' contribution to prudential regulation.

The paper makes clear the view of the FSA and FRC that auditors need to challenge management more. In chapter 3, for example, the paper notes (para. 3.9 and 3.10):

In some cases the FSA has seen concerning valuations, provisions and disclosures, the auditor’s approach seems to focus too much on gathering and accepting evidence to support managements’ assertions, and whether managements’ valuations and disclosures comply with the letter of accounting standards, rather than whether the standards’ requirements have been applied in a thoughtful way that would better meet the standards’ objectives. In some areas, it can be questioned whether auditors always exhibit sufficient professional scepticism".

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".

IOSCO publishes revised Objectives and Principles of Securities Regulation

The International Organization of Securities Commissions has published a revised edition of its Objectives and Principles of Securities Regulation: see here (pdf). Eight new principles have been added including a couple relating to auditing: auditors should be subject to adequate levels of oversight and should be independent of the entity that they audit. Further information is available here (pdf).

UK: culture and corporate governance - recommendations from the Future of Banking Commission

The Future of Banking Commission published its report yesterday: see here (pdf). This sets out wide ranging recommendations concerning the regulation of banks. Chapter 4 - titled "Culture and Corporate Governance" - contains recommendations under the following headings: boards and directors, remuneration, accounting and auditing, shareholder oversight, credit rating agencies and the adoption of a code of conduct for banking. Some of the specific recommendations include:

• The duties of directors under the Companies Act (2006) should require them to consider the effect of the company's activities on the stability of the financial system as a whole.
• Fundamental questions should be asked about the purpose of the audit.
• Auditors should be asked to attest that banks' accounts represent a "true, fair and comprehensive statement" of the affairs of the company.
• The Stewardship Code for Institutional Investors should be mandatory for those fund managers which own bank shares.
• Non-executive directors should be charged with particular tasks and particular areas where their "challenge" is expected.

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".

Europe: the governance of financial institutions - Commission publishes green paper

The European Commission has published a green paper titled Corporate governance in financial institutions and remuneration policies: see here (pdf). The paper contains a large number of questions for consultation and sets out possible ways to:

• improve the functioning and composition of boards of financial institutions in order to enhance their supervision of senior management;
• establish a risk culture at all levels of a financial institution in order to ensure that long-term interests of the business are taken into account;
• enhance the involvement of shareholders, financial supervisors and external auditors in corporate governance matters;
• change remuneration policies in companies in order to discourage excessive risk taking.

Amongst the questions on which views are sought are:

• Should the number of boards on which a director may sit be limited?
• Should combining the functions of chairman of the board of directors and chief executive officer be prohibited in financial institutions?
• Should a specific duty be established for the board of directors to take into account the interests of depositors and other stakeholders during the decision-making procedure?
• Should cooperation between external auditors and supervisory authorities be deepened?
• Should supervisory authorities be given the power and duty to check the correct functioning of the board of directors and the risk management function?
• What could be the content and form, binding or non binding, of possible additional measures at EU level on remuneration for directors of listed companies?
• Should disclosure of institutional investors' voting practices and policies be compulsory? How often?

The paper makes clear (at p. 11) the Commission's view that there is a role for financial regulators to play:

The main challenge in seeking to improve existing corporate governance practices will be to ensure real change in the behaviour of the relevant actors. This cannot be achieved through new regulatory and non-regulatory requirements alone. It must also be backed up by effective financial supervision".

Interestingly, whilst the paper is concerned with financial institutions, it is noted (at p. 3):

... the Commission will soon launch a broader review on corporate governance within listed companies in general and, in particular, on the place and role of shareholders, the distribution of duties between shareholders and boards of directors with regard to supervising senior management teams, the composition of boards of directors, and corporate social responsibility".

For further information see: press release | press conference video | faqs | Commission consultation page | Commission staff working document: lessons from the financial crisis | other proposals announced: credit rating agencies : remuneration : financial services regulation |

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: FRC guidance on auditor liability limitation agreements

Sections 532 to 538 of the Companies Act (2006) provide the framework governing provisions exempting auditors from liability. Companies are permitted to enter into auditor limitation liability agreements, subject to gaining shareholder approval. Guidance on these agreements, and the framework introduced by the Act, has today been published by the Financial Reporting Council.  The guidance explains:

• What is and is not allowed under the Act.
  
• Several factors to consider when considering the case for an agreement.
  
• What should be included in the agreement and provides example clauses.
  
• The shareholder approval process and provides example wording for including in shareholder resolutions. 

For further information see:

FRC guidance | FRC | Companies Act (2006) - auditor liability provisions | Statement by the Institutional Shareholders' Committee |

Europe: Commission Recommendation on limiting auditors' liability

The European Commission has issued a Recommendation concerning the limitation of auditors' liability in respect of the statutory audit of the accounts of a company which is registered in a Member State and the securities of which are admitted to trading on a regulated market in a Member State. The Recommendation provides:

• The civil liability of statutory auditors and of audit firms arising from a breach of their professional duties should be limited except in cases of intentional breach of duties by the auditor. 
  
• The limitation of liability should apply against the company audited and any third party entitled under national law to bring a claim for compensation. 
  
• Any limitation of civil liability should not prevent injured parties from being fairly compensated. 
  

The Recommendation provides that any of the following methods can be used by Member States:

• establishing a maximum financial amount (or a formula for the calculation of such an amount).
  
• establishing principles by virtue of which the auditor is not liable beyond its actual contribution to the loss suffered and is accordingly not jointly and severally liable with other wrongdoers.
  
• permitting the auditor and company being audited to determine a limitation on liability through agreement.

For further information see the following documents published by the Commission: executive summary, impact assessment, press release and frequently asked questions. 

NB: In the UK, Section 534 of the Companies Act (2006) permits auditors to enter into a "liability limitation agreement".  This is an agreement "that purports to limit the liability owed to a company by its auditor in respect of any negligence, default, breach of duty or breach of trust, occurring in the course of the audit of accounts, of which the auditor may be guilty in relation to the company".  To be valid, such agreements must comply with Section 535 and must be authorised by the company's shareholders under Section 536. 

England and Wales: the auditor's role and financial assistance

Section 151 of the Companies Act (1985) makes it is unlawful for a company to provide financial assistance for the purchase of its own shares.  Private companies can, however, provide financial assistance by complying with the so-called "whitewash" procedure.  This requires directors to make a solvency declaration (or statement) in accordance with Section 156. Atttached to this must be a report by the company's auditors stating that they have enquired into the company's affairs and that they are not aware of anything to indicate that the directors' opinion is unreasonable in all the circumstances.

The nature of the auditor's role in respect of this report has recently been considered in M&S Tarpaulins Ltd. v Green (Ch.D., Manchester, 2 May) (not yet available on BAILII). The trial judge: (a) held an auditor negligent in the preparation of the report (the auditor had failed, inter alia, to analyse the company's cash flow position) and (b) rejected the claim that the questions to be asked and the techniques to be used in preparing the report would vary depending on the size of the transaction.

The decision is, however, of wider interest because of the endorsement given to the Auditor's Code within the ICAEW's Audit Quality document and the way in which the Code was used by the trial judge to consider the auditor's role and responsibilities. The trial judge cited several Code provisions including:

Rigour

Auditors approach their work with thoroughness and with an attitude of professional scepticism. They assess critically the information and explanations obtained in the course of their work and such additional evidence as they consider necessary for the purposes of their audit

NB: Change is afoot: Part 18 of the Companies Act (2006) introduces a new regime, effective from 1 October 2008, under which it will no longer be unlawful for private companies to provide financial assistance. For further information, see here.

Australia: Large cap companies' corporate governance compliance

The 2008 BDO Kendalls large-cap corporate governance survey has been published. Amongst the findings are the following (to quote from BDO Kendalls' press release):

Australia’s largest publicly listed companies generally meet all aspects of best practice guidelines for corporate governance; however full independence still remains a key issue for some major companies.

Areas highlighted included some companies having audit, remuneration or nomination committees that were either not made up of all independent directors or the chair was not independent. The survey findings are based on the 2007 annual report disclosures of the 20 largest Australian listed companies by market capitalisation as at 13 March, 2008.

Several companies (15%) were also found to be paying a high proportion of non-audit fees to their statutory auditors. News Corporation and Newmont Mining were the only companies not to have a formal Share Trade Policy. Also, 40% of the top 20 companies did not have a dedicated Risk Management Committee.

However, despite some of the largest caps needing to improve in certain areas, the broad finding for Australia’s biggest listed companies is that their corporate governance structures are robust and in most areas meet best practice guidelines.

For further information click here. For further information about corporate governance in Australia, see here. For BDO Kendalls 2007 mid-cap corporate governance report, see here.

New Zealand: new 'super regulator' for financial markets

The Government has announced that a new 'super regulator' will be created - the Financial Markets Authority (FMA) - and that it will consolidate various functions currently carried out by the Securities Commission, the Ministry of Economic Development and the New Zealand Stock Exchange.

In a press release published yesterday, Commerce Minister Simon Power stated that the FMA will "enforce securities, financial reporting, and company law as they apply to financial services and securities markets. It will also regulate and oversee, trustees, auditors, financial advisers and financial service providers including people who offer investments". The Reserve Bank will retain responsibility for prudential regulation.

The Government's intention is that legislation establishing the FMA will be passed this year and that the FMA will begin operating early in 2011. For further information see here (and, in respect of auditor oversight, here).