UK: directors, accountants and the financial crisis

A couple of articles from today's newspapers deal with two inevitable consequences of the financial crisis: the prospect of litigation and a reassessment of governance structures. The Financial Times newspaper reports the following comments of former Attorney-General Lord Goldsmith: "There will be an avalanche of litigation arising from the credit crisis". Elsewhere, Richard Aitken-Davies, the president of the Association of Chartered Certified Accountants, writing here in the Guardian newspaper, questions the role of directors but has the humility to question the role played by accountants: 

The roles of the chairman and chief executive are ultimately ones of accountability - to shareholders, to customers, to staff and, whether they like it or not, to government, the taxpayer and society at large. But our increasingly well-defined principles of corporate governance have not prevented this crisis. We therefore need to open our thinking to alternative models and, in particular, to the role and effectiveness of independent non-executive directors. If directors ignored bad habits, if they accepted complacency after a prolonged bull market then they should be held accountable. If they have overseen failure, and allowed greed to flourish then they are accountable for this, too. Naivety has also played its part, with well-meaning people succumbing to the seductions of advanced risk management techniques at the expense of common sense. And perhaps we accountants haven't said no enough, either"

USA: "The Race for the Bottom in Corporate Law" - Frank Easterbrook

The Virginia Law Review recently held a symposium to mark the 75th anniversary of the Securities and Exchange Commission (SEC). The keynote address, titled "The Race for the Bottom in Corporate Law", was delivered by Chief Judge Frank H. Easterbrook of the United States Court of Appeals for the Seventh Circuit. Within corporate law scholarship, Judge Easterbrook is perhaps most well known for his book The Economic Structure of Corporate Law, co-authored with Daniel Fischel (considered here).  The following outline of Judge Easterbrook's speech is taken from Virginia Law Weekly (the Virginia Law School newspaper):

The primary focus of Easterbrook’s talk was the application of Judge Ralph Winter’s hypothesis regarding broad state regulation of corporations, particularly of corporate governance. Winter had argued that increased discretion in the hands of corporate managers would, in the end, enable them to design the governance measures that investors want the most. Easterbrook pointed out that economic event studies in the last 20 years or so had confirmed this: securities prices would rise and fall depending on different structures of governance, and investors could indeed move to those forms which they found most attractive.

The national government, however, has been “hampering the market of corporate control” in recent years. Easterbrook singled out the Sarbanes-Oxley Act passed in the wake of the Enron and WorldCom scandals as the major culprit, although he also targeted the recently imposed limits on short sales and changes to the tax code. Sarbanes-Oxley, Easterbrook argued, mandated corporate governance structures that often set up an “adversarial mode of corporate governance” that made little sense for the companies forced to adopt them and were, ironically, not at all what investors wanted.

Worse, Easterbrook argued, the “national government could win a race to the bottom in a way that the states cannot,” since in “moving toward a national system of corporate governance,” corporations could not simply change to another jurisdiction’s corporate law if dissatisfied with federal requirements. Easterbrook argued that in theory there are four basic models of corporate governance, and that any one could be appropriate for a corporation at a given time. “A reduction in [this] opportunity set,” the judge concluded forcefully, “makes everyone worse off, all the time—and that’s what the Sarbannes-Oxley Act has done.” As further evidence, he noted that event studies indicated that the Act actually depressed stock prices, and that Enron was, in fact, a model corporation under the governance terms of the Act.

Easterbrook had some suggestions on what might happen as a result of the “Race to the Bottom.” He noted that many firms are “opting out” of the system by becoming private and thereby removing themselves from regulation. He also argued that the international market could supply a response to Sarbanes-Oxley, the ultimate result of which may be the flow of capital to other countries with more desirable governance regulations.

Europe: exempting "micro-entities" from the Accounting Directives - McCreevy recommendation

Internal Market Commissioner Charlie McCreevy has stated that he will recommend to the European Commission that Member States should be given the option to exempt "micro-entities" from the Accounting Directives (Fourth Council Directive 78/660/EEC (annual accounts of companies with limited liability) and the Seventh Council Directive 89/349/EEC (consolidated accounts of companies with limited liability). Mr McCreevy also announced that the time has come to overhaul the Accounting Directives and in this regard he stated that his review would be guided by the "think small first" principle. 

UK: Companies Act (2006) implementation - directors' duties and financial assistance

Amongst the provisions of the Companies Act (2006) which came into force on 1 October are those concerning directors' duties and financial assistance. It is no longer unlawful for private companies to provide financial assistance for the purchase of their own shares (see here for further information and note this post). With regard to directors and directors' duties, the following provisions are now in force:

[a] The duty of directors to avoid conflicts of interest (Section 175) and not to accept benefits from third parties (Section 176). 

[b] The duty of directors to declare interests in proposed transactions or arrangements (Section 177) and the duty to declare interests in existing transactions or arrangements (Sections 182-187).

[c] The requirement for all companies to have at least one director being a natural person (Section 155).  There is, however, a period of grace for certain companies - see here.

[d] The minimum age requirement for directors: 16 years (Section 157). 

Notes: 

[a] Section 170 provides, inter alia, that directors' general duties within Sections 171 to 177 are owed to the company and that they replace the common law rules and equitable principles upon which they are based.  This said, Section 170 also provides that the general duties "shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties".

[b] Companies House has published information on the provisions coming into force on 1 October 2008 - see here. 

UK: market conditions and the challenges for corporate reporting - FRRP annual report

The Financial Reporting Review Panel has published its annual report with regard to its reviews of reports and accounts for the year to 31 March 2008. The main purpose of the report is to provide guidance for those preparing accounts in the future. It therefore includes comments from the Panel on the challenges for corporate reporting presented by the so-called "credit crunch".  In this regard, the report identifies several issues which are of particular relevance:

• Selection of accounting policies.
  
• Disclosure of management judgments and estimation uncertainties.
  
• Sufficiency of descriptions of revenue recognition policies.
  
• Consolidation.
  
• Principal risk and uncertainty disclosure in the business review. 
  

With regard to its review of accounts and reports, the Panel noted in its report:

... the current standard of corporate reporting in the UK is good. The areas of reporting that prompted most questions were those dealing with more complex accounting issues or where the exercise of judgement by management is most critical. The Panel did not identify any systemic issues requiring immediate remedial action.

The Panel published two press notices in the year in respect of companies that had failed to comply with the requirements of the Act. These companies restated comparative amounts in their next set of annual and half-yearly financial statements ... 88 companies undertook to make future changes to their reporting. Several of these were asked to refer to the Panel’s intervention when explaining the changes in their accounts".