UK: FRC consultation - Guidance for Directors of Listed Companies on Going Concern and Financial Reporting

Listing Rule 9.8.6 requires listed companies incorporated in the UK to provide in their annual report "a statement made by the directors that the business is a going concern, together with supporting assumptions or qualifications as necessary, that has been prepared in accordance with Going Concern and Financial Reporting: Guidance for Directors of listed companies registered in the United Kingdom, published in November 1994".

The 1994 Guidance is now the subject of review: the Financial Reporting Council has published a consultation paper in which it states:

The Guidance for Directors was written by a Working Group formed under the auspices of the Cadbury Committee that reported on the Financial Aspects of Corporate Governance. The formation of the Working Group arose out of concerns that there had been several high‐profile company failures where there had been no apparent indication of the imminent problems in the previous year’s report and accounts.

The objective of the Guidance for Directors is to support good corporate reporting and, in particular, the requirements of the Listing Rules and Accounting Standards. When a company is not a going concern this does not necessarily mean that it is, or is likely to become, insolvent. The Guidance for Directors is not intended to address aspects of insolvency and, in particular, is not intended to support the requirements of the Insolvency Act 1986.

In the period since 1994 there have been substantial changes to the accounting standards applied by directors of listed companies. This is particularly the case for directors preparing consolidated accounts required to comply with International Financial Reporting Standards (IFRSs) as adopted by the EU.

The FRC observes that current economic conditions are creating particular challenges for companies. Recent developments in global debt markets have led banks to be cautious of lending to one another (the so‐called “credit crunch”). This has severely restricted liquidity which has created unexpected financial difficulties for banks and entities that depend on the availability of loans as a key source of capital. Many market commentators are now forecasting a period of reduced growth and in some cases recession, with the result that going concern questions are likely to need to be considered in more detail by Boards of Directors.

In view of these deteriorating economic conditions the FRC has concluded that this is an appropriate time to consider whether the existing Guidance for Directors is necessary and remains appropriate, or whether it can be improved.

Note: The UK's Combined Code on Corporate Governance (June 2008) provides in Section C ("Accountability and Audit") the following provision (C.1.2): "The directors should report that the business is a going concern, with supporting assumptions or qualifications as necessary".

Postscript (2 Sep 2008): For further comment see this short article in the Financial Times newspaper. 

UK: Rule 19.1 of the Takeover Code and public criticism for Kraft

The Takeover Panel Executive has publicly criticised Kraft Foods Inc for its failure to meet the standard required under Rule 19.1 of the Takeover Code in respect of statements made in the course of its takeover bid for Cadbury plc: see here (pdf). Public criticism is one of the disciplinary measures available to the Panel; a public criticism was last issued in 2007.

Rule 19.1 provides that "[e]ach document or advertisement published, or statement made, during the course of an offer must be prepared with the highest standards of care and accuracy and the information given must be adequately and fairly presented". During the course of its bid for Cadbury plc, Kraft had stated, on the basis of an honest and genuine belief, that it could keep operational one of Cadbury's factories (Somerdale).

In its statement, the Executive observed that Rule 19.1 was of "great importance" and "fundamental to ensuring the orderly conduct of takeovers" and that where a party to an offer makes a statement of belief of the kind made by Kraft, Rule 19.1 required "not only that the party concerned honestly and genuinely holds that belief (a subjective test) but also that it has a reasonable basis for so holding that belief (an objective test)".

The Executive accepted that Kraft held an honest and genuine belief that it could keep Somerdale operational. However, the Panel found that Kraft did not have a reasonable basis for holding this view because it did not know the details of Cadbury’s phased closure of Somerdale. Moreover, Kraft did not seek further information, or take the opportunity to take mitigating action in respect of its statements, when it learned, from Cadbury representatives, that the phased closure of Somerdale was well advanced.

UK: limiting the size of the company's board

The UK Companies Act (2006) does not impose an upper limit on the number of directors that can be appointed to a company board. Section 154 of the Act does, however, set a minimum number of directors: two for a public company and one for a private company. Moreover, Section 155 (which comes into force on 1 October 2008) provides that all companies must have at least one director who is a natural person.  

Companies can, if they wish, set a maximum number of directors in their articles of association. Marks and Spencer plc is planning to adopt such a provision. In the Notice for its forthcoming AGM, M&S explains its proposal to include in its articles a new term which will limit the size of its board to 20 directors. M&S says that this reflects "current best practice". What is this best practice to which M&S refers?  The Combined Code does not impose a limit on board size but it does state that "[the] board should not be so large as to be unwieldy" (A.3). Sir Adrian Cadbury has provided a further insight: in his book Corporate Governance and Chairmanship: A Personal View (Oxford: OUP, 2002) he observed that a limit of 10 was "an admirable starting point for any consideration of board size" (p. 51).

Postscript (8 June 2008): 

Interestingly, Tesco plc, at its forthcoming AGM, will be seeking shareholder approval for the removal of a cap on the number of directors in its articles. The company states that this will provide "more flexibility". Tesco's existing articles set a limit of 16.  See this Notice for further information.  

Another FTSE100 company - Centrica - has altered its articles this year and has included a cap of 20 directors on the board. The company has explained why in the Notice sent to shareholders: "Following guidance from the Association of British Insurers, published since the current Articles were brought into force, the Company has decided to insert a provision into the New Articles to allow for a maximum number of twenty Directors of the Company".

UK: BIS Committee calls for wide-ranging review of corporate governance

The Business, Innovation and Skills Committee yesterday published its report Mergers, acquisitions and takeovers: the takeover of Cadbury by Kraft. The report is available here (html) and here (pdf). The Committee concluded its report with this recommendation for its successor:

The takeover of Cadbury by Kraft has highlighted a number of important issues in respect of the way in which foreign takeovers of UK companies are conducted. It has been the catalyst for a wider debate, both in Government and in the City, about how takeovers are conducted. In highlighting the Kraft takeover of Cadbury, we have contributed to that debate which now needs to continue, and with urgency. Time does not allow us to consider the wider proposals for reform in detail but it is clear that the Companies Act 2006 has not resolved these major issues in corporate governance. We urge our successor Committee to consider this Report as a starting point from which to conduct a detailed inquiry into these important issues and into the role of shareholders and managers of companies more generally. Recent experience of the behaviour of boards and shareholders in situations ranging from the fall of RBS to the Kraft acquisition of Cadbury indicate that it is time to reconsider many aspects of corporate governance".

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.