Modern company law - completing the structure
Comments from the Association of Chartered
Certified Accountants
February 2001
Executive Summary
The Association of Chartered Certified Accountants (ACCA) is pleased to submit its comments on the Company Law Review Steering Group's consultative document Completing the Structure.
We are concerned at the prospect of all the UK's 'small' companies being allowed to operate without either an auditor or a company secretary. Without the input of either or both, there is a serious risk that standards of financial management and levels of statutory compliance in small companies will deteriorate. We do not believe that the cost savings which flow from the abolition of the audit will be as great as the Steering Group believes and fear that stakeholders generally will suffer from the decline in the reliability of published information.
It is proposed to introduce a new Elective Regime for groups of companies whereby, in return for a guarantee of liabilities by the holding company, the group subsidiaries will be exempted from all requirements regarding the preparation, publication and audit of their accounts. We consider this to be misconceived. Few if any cost savings will result. By contrast, there will be a net loss to shareholders and other stakeholders because they cease to have access to subsidiaries' published accounts.
We welcome the proposals on large company reporting as being more practical and responsive to the needs of large companies than those which were envisaged in Developing the Framework. We support the recommendation that electronic media are recognised for the publication of financial statements as well as for other communications between companies and their members.
Specific Comments
1 In the following paragraphs, we address selected issues raised in the consultation document. We do not, for the most part, consider matters which, after consideration, have either resulted in a settled view or on which we have already expressed opinions.
CHAPTER 2: SMALL AND PRIVATE COMPANIES
The company secretary (paras 2.18–2.22)
2 The document proposes the abolition of the statutory requirement for all private companies to have a company secretary. It adds that private companies will still be able to appoint secretaries on a voluntary basis, as will also be the case with regard to auditors. Given the emphasis which the Steering Group places on reducing small companies' costs, the likelihood must be that, given the choice, many companies in this category will heed official encouragement and choose to operate without a secretary.
3 Allied with the proposed expansion of audit exemption, the abolition of the requirement to have a secretary will mean that the majority of companies on the register at Companies House will be entitled to operate without the two officers who – by express function in the case of the auditor and by custom in the case of the secretary – are concerned with the compliance by directors with their various responsibilities. With the planned increase of the audit exemption level to c£4.8 million, the range of companies operating without an auditor or secretary could include substantial trading companies.
4 Most small companies will continue to employ an accountant for specific tasks such as preparing their books, accounts and tax returns. Many small companies will also find that they are expected to have their accounts audited for non-statutory purposes such as applications for external finance. Under the Companies Act, however, the auditor and secretary are permanent officers of a company and have on-going duties and functions on its behalf. They are available to provide guidance and support to the directors throughout the period of their appointments. Without the availability of such support on a systematic basis, there must be an increased risk that the standard of management and compliance among small companies will decline.
5 At present, the great majority of small private companies have no in-house expertise to advise on the responsibilities of the company and its directors to comply with its various obligations under company law. It is widely accepted that there is a high level of ignorance among small company directors of their responsibilities under the law. Assuming the Review's proposals on directors' duties are enacted, directors will in the near future be subject to responsibilities which are significantly wider and more stringent than they are at present. The lack of financial management skills on the part of directors and entrepreneurs is repeatedly reported by insolvency practitioners as being a major factor in business failures. Directors of small companies tend therefore to rely heavily on their auditors and/or qualified secretaries for guidance on compliance and financial issues.
6 We question whether it is reasonable for the law to impose these extensive responsibilities on company directors to act in the interests of stakeholders and yet to play no direct role, on behalf of those stakeholders, in ensuring that directors comply with their responsibilities.
7 We accept that there is, currently, no requirement for the secretary in a private company to hold an appropriate qualification and that a great many small companies see no reason to appoint a qualified person to the position, largely because statute law does not specify the duties which the secretary has to perform. We do not suggest that it is feasible for the law to require that the secretary in a private company should at all times be qualified.
8 We believe, however, that in very many cases, the management of small companies benefits over a wide range of matters from the input of their auditors or their qualified secretaries or both. To encourage companies to believe that they can do without either could have serious adverse consequences for the standard of companies' financial management and for their levels of compliance with the law. We suggest that this must be borne in mind by the Government when making its decision on the future of audit exemption. Whether or not the decision is made to extend exemption to £4.8 million, the proposed Private Companies Committee should keep under review the position of small companies which operate without secretaries or auditors.
The model constitution (Q2.2)
9 We support the suggestion that new companies which wish to diverge from the model constitution should be required to file 'complete' copies of their chosen constitutions. This will be convenient for stakeholders and will present no significant costs for the companies concerned.
Filing of report and accounts (Q2.4)
10 We support the retention of a single deadline for the delivery of private company annual accounts and the holding of an Annual General Meeting (where private companies opt to hold them). The principal purpose of aligning the date must be to allow shareholders the opportunity to consider the company's accounts at the General Meeting before they are filed with the Registrar. We believe there are good governance reasons for requiring this to be done in that order. In the light of this, we do not see the logic of allowing companies to convene meetings by the expiry of the deadline but to actually hold the meeting at some later date. We do not believe that it will cause private companies serious problems if they are required to both prepare their accounts and convene any General Meetings within the proposed seven month deadline.
Independent Professional Review (IPR) (Q2.7)
11 ACCA continues to believe strongly in the benefit of the independent audit for the efficient financial management of companies. Recent research which we have undertaken has re-affirmed our view that, not only does the audit add value for management control purposes, but it is a vital check for company stakeholders on financial irregularities within the company. In late 2000, ACCA consulted 1250 audit firms about their experiences of the nature and causes of fraud among small and medium sized companies. Each audit firm consulted had an average client base of 215, meaning that the survey encompassed more than 260,000 companies.
12 The survey found that the principal motivation for fraud was personal gain by management. Other motivations were a desire to disguise cash flow problems, to suppress profits and to reduce the tax liability of sub-contractors. Where fraud was discovered, in 45% of cases it was the auditor who located it. In only 18% of cases was it discovered by the Inland Revenue. In 42% of cases, management overrode financial controls in order to allow the fraud to take place. A copy of the full report of this survey is attached for information.
13 The findings of the survey bear out the concerns we have previously expressed on the Steering Group's recommendation (already partly endorsed by the Government) that the audit exemption level should be raised in due course to £4.8 million, whether or not the IPR is found to have value. We believe that, by dispensing with the statutory audit, the law deprives stakeholders of a tool which, directly in the case of members and indirectly in the case of creditors and other stakeholders, acts as a monitor for their financial interests. The Steering Group places great emphasis on the importance within the company law framework of accountability. We suspect, however, that the abolition of the small company audit may have a significant adverse effect on the reliability of published financial information. The Steering Group and in due course the DTI need to consider carefully whether this outcome will be a price worth paying for the achievement of cost savings for small companies (the extent of which we in any case dispute).
14 The consultative document reports that no clear consensus on the IPR emerged from the responses to Developing the Framework. It reports also that a similar response was forthcoming when the Auditing Practices Board issued its own discussion paper on the IPR in May 2000. Given the substantial scepticism which clearly already exists about the value of the IPR, both in terms of its ability to achieve cost savings and its usefulness as an assurance report, we find it surprising that the Steering Group can remain so committed to the abolition of the small company audit.
15 While we have doubts about the ability of the proposed IPR to act as an adequate replacement for the audit in terms of its ability to provide a credible level of assurance, we nevertheless take the view that a statutory requirement for a worthwhile intermediate level of assurance will be preferable to no form of assurance at all. ACCA is, therefore, happy to co-operate with the project of the Auditing Practices Board (APB) to assess the likely practical impact of the IPR. If, on the strength of the project, there is evidence that the IPR can offer positive benefits to companies and their stakeholders, we shall support its introduction.
16 With regard to the appropriate mode of regulation for the IPR, we believe that the proper performance of an IPR will depend on the possession by the reviewer of appropriate assurance skills. We suggest that eligibility to act as a reviewer should be restricted to those practising members of approved professional accountancy bodies who can demonstrate that they possess appropriate skills. These could be assessed by accreditation following training or by some other form of professional scrutiny of their suitability to perform IPRs.
17 We agree that accountants carrying out IPR work will need to be subject to some form of additional regulatory control. There is a clear public interest in ensuring that persons who provide a form of statutory assurance on financial statements, even in the limited form envisaged for the IPR, are subject to initial and continuing assessments of their suitablity to perform the function. Whatever form of regulation is adopted should be capable of meeting public expectations as to its ability to ensure the quality of work carried out by IPR accountants.
18 Of the alternative approaches put forward for the future framework of IPR regulation, we suggest that the most straightforward and effective option would be to integrate the arrangements for regulating IPR accountants into the machinery which already exists for the monitoring of registered auditors. We accept that the approach which is likely to be appropriate for monitoring the work of IPR accountants will be different from that currently adopted with respect to the monitoring of auditors. Given the different scope and level of assurance of the IPR, regulation will be less thorough and compliance-orientated. It will still, however, need to be sufficient to satisfy public interest concerns. By incorporating IPR work into the present structure, advantage can be taken of the resources, experience and expertise which already exist. We have reservations as to whether bodies which have no experience of monitoring assurance work under the Companies Act 1989 will be in a position to perform the regulatory function to an equivalent standard. If the existing machinery is adopted, as we suggest, and at the same time eligibility to carry out the IPR is opened up to persons other than members of the existing RSBs, these other persons can be regulated and monitored within this framework.
CHAPTER 3: DIRECTORS' DUTIES AND THE OPERATING AND FINANCIAL REVIEW (OFR)
Ratification of breach of duty (Q3.4)
19 Where a company is insolvent the directors owe their duties to the company's creditors. It would therefore be inappropriate for the shareholders of a company which is currently insolvent, or which would become insolvent as a result of the breach, to ratify the director's breach.
Guidance for the OFR (Q3.5)
20 We agree that the relevant standards body should be allowed to issue guidance on the preparation of the OFR.
Proper preparation of the OFR (Q3.6)
21 The OFR is going to be as important a component statement as any other in companies' annual reports. It is important, therefore, that directors should be obliged to prepare it properly and that it comes within the scope of the enforcement process, currently administered by the FRRP. With respect to the audit of the FRRP, we re-iterate the concern which we expressed previously that an expectation gap could easily arise in relation to the assurances provided by auditors on the OFR. We suggest, therefore, that research is undertaken into the expectations of stakeholders.
Standards for the OFR (Q3.7)
22 We see no reason why the relevant standards bodies should not, in due course, have the power to issue standards governing the process for preparation of the OFR and, if appropriate, its audit. We consider it appropriate that the OFR is subject to both company law and appropriate standards so as to ensure that the regime is flexible enough to respond to rapid developments in reporting. It would not be reasonable, in our view, to preclude the standard setting bodies from establishing a framework of rules if that were considered necessary or desirable.
Exemption for smaller companies (Q3.8)
23 According to the Steering Group, the purpose of the OFR is to provide an opportunity for directors to discuss their company’s performance in a broad, qualitative sense. The OFR will analyse the various factors, financial and non-financial, which contribute to the company's performance. Given that the new statement is intended to be 'inclusive' in nature, we do not accept the logic of exempting some public companies from the requirement to produce an OFR by reference only to the size of their annual turnover. If it is considered in principle that public companies should fall within the OFR regime, it follows that all such companies should be targeted and there should be no exemption on the basis of turnover.
24 With respect to private companies, we would prefer to see the requirement to prepare an OFR linked to a "two out of three" test involving the figures for turnover, net assets and employees. This would be similar to the test which is applied for the purposes of deciding small company accounting exemptions. There are cases of companies which have a high turnover, but which are relatively small in other ways – for example commodity dealers and property development companies in the year of sale of one large building. On its own, the limit of £500 million appears rather high.
CHAPTER 4: UNLISTED AND SMALLER COMPANIES
Shadow directors (Q 4.1)
25 In our view, a person who effectively dictates the actions of any single director, whether or not that director in turn exercises any dominant influence over the board's decision-making, should be treated as if he were a director. It is arguable that a person in that position satisfies the definition of 'director' in s741(1) of the Companies Act anyway. We agree with the proposal that the statement of directors' duties and the rules on conflicts should extend also to shadow directors.
Directors' training (paras 4.42–4.43)
26 The document proposes that the new standards body should have the power to issue guidance on biographical details to be provided to members prior to board elections. We agree that such information is useful. Many companies already in fact provide details of the training and experience of candidates for election.
27 We believe that training is an issue which affects private company as well as public company directors. If all directors recorded in some way their training and experience, the relevant details could be useful for the purposes of investigating matters such as wrongful trading.
CHAPTER 5: SHARES AND SHAREHOLDERS
Rights of beneficial shareholders (Q 5.1)
28 We support, in principle, the extension of governance-related rights within a company to beneficial shareholders, and agree that individual companies should be entitled, although not obliged, to allow beneficial members to exercise their rights. Given the danger that this might lead to double voting, however, the proposed standards committee should address the issue of the mechanisms which companies should put in place in order to avoid that outcome. For the sake of clarity, we believe that the rights which may be extended to beneficial shareholders should be specified in statute. Beneficial shareholders should always have the right to be involved in any decision by a public company to dispense with its AGM.
Enforcement of personal rights (Q5.2)
29 The proposal to empower individual members to enforce all rights owed to them under the company's constitution appears reasonable in theory, although we fear that it may cause problems in practice. The Steering Group proposes to deal with the potential problem of frequent challenges by making them subject to a 'trivia' test. Even if actions which are clearly trivial are ruled to be so by the courts, the fact that the action was brought in the first place would still result in time and expense being incurred. We believe that, in the interests of minimising the potential for disputes and disruption, there needs to be a clear benchmark for the circumstances in which a member may not bring enforcement action.
Refusal to register a transfer (Q 5.5)
30 We believe that directors of all companies should be required to give reasons for why they are refusing to register transfers. If a transferee has executed a valid contract for the purchase of a shareholding, he or she is entitled to know why the application to be registered as a member has been rejected.
Unfair prejudice (paras 5.75–5.81)
31 We query whether it will be possible to disapply s459 if there is an adequate escape route built into a company's constitution. This would enable a shareholder to insist on the purchase of his shares at a fair valuation. It should be subject to the right of any shareholder to use the s459 mechanism to bring proceedings on the strength of a breach of duty on the part of a director.
CHAPTER 6: REPORTING, ACCOUNTING AND AUDITING
Proposals for listed companies (Q 6.1)
32 We agree with the proposals set out under question 6.1.
Timescales for reporting (Q 6.2)
33 We agree with proposals (i) (ii) and (iv). Given the preparation limit of 90 days and the filing deadline of 150 days, it seems to us unnecessary to provide for proposal (iii). As long as listed companies are required to hold AGMs, they will be subject to a separate requirement to distribute their accounts in good time before the dates of the meetings.
Summary Financial Statement (SFS) (Q 6.3)
34 We do not believe that it will be desirable to make the SFS mandatory. ASB's Statement of Principles for developing financial statements includes understandability as one of the qualitative characteristics which financial statements should aim to achieve. In our view, this provision is sufficient.
Quoted but unlisted companies (Q6.4–6.5)
35 We believe that listed and quoted companies should be covered by the same reporting regime. With respect to Q 6.5, we respond 'yes' to (a) and 'no' to 'b'. The preliminary announcement has reverted to being non-statutory for listed companies under these proposals. It would not be consistent to make it a legal requirement for other quoted companies.
Unquoted companies (Q6.7–6.8)
36 We do not agree that unquoted public companies should be required to lay and file their accounts within 150 days. Such companies should be subject to the same reporting rules as those which apply to private companies.
Delegation of consolidated accounts requirement (Q 6.9)
37 We agree that the rules requiring the publication of consolidated accounts should remain in the Companies Act, as long as any legal requirements are framed in such a way as to avoid inflexibility. We do mention, however, that this might entail changes from the current situation: there is no requirement in accounting standards, for example, for the preparation of a company-only balance sheet.
Duty of care (Q6.10)
38 If the range of the duty of care of auditors is to be extended by statute, we would support the introduction of a matching extension to the duty of care of the company and its directors. Indeed, we question whether it would be acceptable in equity to do otherwise.
Duty of claimants (Q6.11)
39 We consider that the Courts have not placed sufficient emphasis on the need for claimants to prove that they have taken all reasonable steps to protect themselves from loss. Accordingly, we would support the introduction of a requirement for claimants to prove that they have taken such steps.
Other protections against abuse of the extended liability (Q6.12)
40 If liability is to be extended, the ability of parties who have suffered loss to pursue claims should not, in principle, be fettered. Although there are cost constraints which, in practice, limit the ability of small creditors to pursue claims, we believe that the Courts should be open to all those who seek redress.
Civil liability of directors and officers (Q6.13)
41 In principle, we believe that breach of duty ought to be a matter for civil liability. We are, however, concerned with the position of employees who may be placed in a difficult situation by their employers. There is also the public policy issue of whether the potential liability may dissuade people with substantial personal assets from becoming employees. The provision of misleading information or explanation by an employee without reasonable excuse and with a motive of personal gain should fall to be dealt with as a criminal offence. Other circumstances are less important and we consider, accordingly, that it will not be appropriate to extend civil liability to employees.
CHAPTER 8: REGISTRATION AND INFORMATION
Controls over Company Names (paras 8.29–8.30)
42 The Steering Group has not addressed the lack of co-ordination between the rules on company names and business names. We believe that this warrants attention. Under s32 of the Companies Act, a company may be directed to change its adopted name if that name gives such a misleading impression of its activities as to be likely to cause harm to the public. Clearly, this provision assumes that the corporate name is the name by which the company carries on its business.
43 In practice, a company name may be precluded under s32 but the company may still carry on business using the 'offending' name as its trading name. Given that a s32 order is made in order to protect the perceived public interest, it is anomalous that a corporate body can continue to present itself to the public under a name which has been ruled unacceptable.
44 We accept that the Business Names Act may be beyond the scope of the current Review. We consider, however, that it should be possible for the Companies Act to provide that a company incorporated under the Companies Act may not carry on business under a name which has been the subject of a s32 direction. While such directions are rare, the fact that they are issued in order to protect the public from harm means that it should not be as easy as it currently is for companies to evade their consequences.
Restoration to the Register (paras 8.31–8.35)
45 We do not believe that it will be reasonable to impose an unconditional five-year limit on applications for restoration. Cases occasionally emerge which require companies which have been dissolved for decades to be restored, primarily in order to settle non-injury compensation claims. If a five-year period is in the event imposed, we urge that the court is given the discretion to allow late applications in exceptional circumstances where the court considers it reasonable to allow them.
CHAPTER 10: COMPANY LAW AND GROUPS OF COMPANIES
Groups of Companies (Q10.1)
46 We have strong reservations about the proposal to exempt subsidiaries from all requirements regarding the preparation, audit and publication of their accounts if their group's holding company guarantees the subsidiaries' liabilities. We do not believe that the proposal will achieve the cost benefits for groups which the Steering Group assumes. It will, on the other hand, result in a significant reduction in published information available to stakeholders.
47 We have a number of specific technical objections to the proposal.
(i) We do not agree that the proposal will in fact result in cost savings for the group. The preparation of the accounts of the parent company will still require that the financial information relating to the subsidiaries has been properly prepared. The auditor of the group accounts will need to be assured that the information relating to the subsidiary companies has been audited. It is also the case that, regardless of any blanket exemption for subsidiaries, banks will, invariably, require audited accounts from applicants for finance. Accordingly, there will, in practice, be no reduction in the work that which will need to be done and therefore no cost savings.
(ii) Under current rules, individual companies may only make distributions on the basis of their most recent statutory accounts or by reference to interim accounts prepared in accordance with the statutory rules. Without radical change to the rules on distributable profits, therefore, the elective regime proposals will have the effect of making it impossible for any subsidiary company to distribute its profits.
(iii) Unless and until the Inland Revenue agrees to deal with corporate taxation on a group basis, subsidiary companies will still be required to prepare individual accounts on a basis which is acceptable to the Inland Revenue, as set out in issue 38 of Tax Bulletin.
(iv) Enforcement of guarantees against a parent (possibly in a foreign and unfamiliar jurisdiction) may be more time consuming and troublesome than action against the subsidiary directly involved in the contract.
(v) Q10.1(xii) refers to the parent retaining responsibility for liabilities incurred during the elective period. It does not seem clear how this would work on, for example, the disposal of a subsidiary.
48 The principal effect of the proposal will, therefore, be to reduce the amount of information which is made available to stakeholders via the public record. We find the proposal to do this inconsistent with the Steering Group's emphasis, in some of its other proposals, on strengthening companies' duties of accountability to stakeholders. The ASB Statement of Principles recognises employees, customers, government agencies and the public as 'users' of company accounts.
49 We believe that the proposed Elective Regime should not be proceeded with. Whatever cost savings the proposal might possibly offer to groups themselves, we believe that the plan is technically unworkable and will result in an undesirable reduction in information available on the public record.
Restriction to small companies (Q10.2)
50 Given that it would not be difficult to divide a business into a sufficient number of limited companies to achieve the benefits, there seems little point in suggesting a limitation of the Elective Regime to small companies.
Inland Revenue requirements (Q10.3)
51 As already indicated, we believe that the tax implications could well undermine the whole proposal to establish the Elective Regime.
Regulated sectors (Q10.4)
52 We agree.
Emoluments of subsidiary companies' directors (Q10.5)
53 To exempt wholly-owned subsidiary companies from the requirement to disclose their directors' emoluments will bring no cost savings to the preparer of accounts. Accordingly, we see no economic argument for such an exemption.
Directors' Interests (Q10.6)
54 We do not find any of the arguments quoted for making change to the current rules to be persuasive. We therefore support the continuation of the present requirements.
Shareholdings in parent company (Q10.8)
55 We support the principle that all entities over which the parent has control should be prohibited from holding its shares. A total prohibition would, however, apply to ESOPs and nominee holdings. We do not believe that such holdings should be prohibited, and suggest that the scope of any change is restricted to beneficial interests.
CHAPTER 12: A REGULATORY AND INSTITUTIONAL FRAMEWORK FOR COMPANY LAW
General criteria (Q12.1–12.2)
56 We agree with the general approach adopted with regard to legislation. We have, however, some concerns over the extent to which reliance will be placed on "soft" law. Recommended practice in the area of financial reporting has not always been fully applied in spirit and letter. Non-mandatory guidance should be employed only where clear rules cannot be framed. It is ultimately more satisfactory for there to be clear rules as to what needs to disclosed than a requirement to disclose whether there has been compliance or not. If this is what is meant by 'soft law', the approach proposed should be viewed generally as an intermediate step before mandatory compliance is introduced.
The Companies Commission (Q 12.3)
57 We endorse the proposed establishment of a new body, the Companies Commission, to keep company law under review. Developments in technology, globalisation, trends in reporting methods and the introduction of new forms of business operation (the LLP, the reformed partnership and the European Company) all make it desirable that there is some forum for monitoring the continuing relevance of UK company law.
58 In setting up the proposed Commission, two principles need to be observed. First, the Commission and its sub-committees need to have operational independence from government and from each other. This will be essential for the credibilty of the financial reporting standards body in particular. In appointing members to the various committees, the Commission must ensure that the committees are representative and that they have the freedom to address and pronounce on issues as they see fit. Secondly, care must be taken to ensure that the Commission and the other committees do not duplicate functions exercised by other bodies, for example the Accounting Foundation.
59 The new structure should also take account of the fact that International Accounting Standards (IAS) are increasingly becoming the acknowledged international benchmark for financial reporting. It is likely that the importance of IAS will grow and that domestic standard-setting bodies will adopt a subsidiary role in relation to them. The replacement body for ASB should, consequently, be seen in this context.
Specific responsibilities (Q12.4)
60 We agree with the individual responsibilities suggested for the Companies Commission with the exception of item (iv): setting guidelines on auditors' liability. We believe that this matter should be outside the scope of the Commission's operations.
Standards Committee responsibilities (Q12.5–12.7)
61 We agree with the proposals set out under these questions.
Standards Committee structure (Q12.8)
62 We consider that there should be a single body. Developing the requirements and/or guidance for the OFR is going to be a key area of activity and it is important that this is integrated into accounting standards, as the OFR will be a key component of the overall company report.
63 In connection with the Standards Committee, the document does not address the issue of whether the responsibility for implementing the EU directives should be devolved to the new body. In our response to Developing the Framework, we expressed some concerns that delegation of responsibility in this regard could constrain the Committee. In the past, ASB and ASC have both felt able to specify accounting treatments which entailed invoking the true and fair override. If it has direct responsibility for implementing the Directives, it might not be possible for the new Committee to do likewise.
Additional areas of responsibility (Q12.9)
64 We have reservations about allowing the Secretary of State to delegate additional areas of responsibility to a rule-making body. Such matters should ideally remain the subject of full Parliamentary scrutiny and consultation with interested parties. If authority were to be delegated to the Secretary of State, there should be appropriate notice and opportunity to make representations.
Private Companies Committee (Q12.10)
65 We welcome the proposal to establish a Private Companies Committee.
Reporting Tribunal (Q12.11)
66 The rationale for the proposed tribunal does not seem clear. The Financial Reporting Review Panel (FRRP) currently comprises a group of people who are experts themselves. The FRRP has not, so far, ever had to go to court, or been taken to court. Given this experience, the proposed tribunal would not, in all likelihood, be very busy. We consider that a High Court judge should be able to master any technical problems which he may be called upon to resolve.
Sanctions (Q12.12)
67 We agree with the proposals set out under this question.
Mode of Recognition of the new Structure (Q12.14)
68 Direct establishment by statute will, we suggest, risk rendering the structure inflexible. In our view, it will be preferable to delegate responsibility for this area to the Secretary of State. We think, however, that this should be subject to public consultation on the detailed statutory criteria to be used for the recognition of bodies. For example, the draft criteria include "adequate public consultation" and "due process". What will be judged "adequate" in this regard? It is arguable, for example, that Financial Reporting Council and the Accounting Standards Board currently fall short of best practice with regard to, for example, providing information to the public and opening their processes to public scrutiny.
Criteria for authorisation (Q12.15)
69 The proposed criteria set out in paragraph 12.99 should also include some appropriate recognition of the public interest.
The framework of audit regulation (Q12.18)
70 The existing framework for the regulation of auditors under Part II of the Companies Act 1989 has proved itself to be successful in terms of protecting the public interest and raising standards of audit work. The arrangements of regulatory bodies are subject to regular assessments by the DTI and a comprehensive assessment of the machinery's effectiveness in achieving its aims was carried out in 1994 by an expert consultant appointed by that Department. With regard to the suggestion that responsibility for regulating auditors might be transferred to the Accountancy Foundation, it needs to be remembered that the object of the Foundation is not to play a direct regulatory role but to exercise a public oversight function. We believe that, in this capacity, the Foundation can make a valuable contribution to the reinforcement of public confidence in the integrity and high standards of the accountancy profession. The combination of this new oversight function and the existing regulatory machinery supervised by the DTI should be given time to prove itself before alternative arrangements are considered.
CHAPTER 13: SANCTIONS
Specific proposal on sanctions
71 We agree with the specific proposals made in Q13.5 (failure to disclose an interest in a contract), Q13.6 (failure to keep accounting records), Q13.7 (false statements to auditors), 13.10 (dishonest approval of defective accounts) and 13.11 (regime of technical criminal offences to maximise compliance levels). In the light, however, of the Steering Group's proposal to abolish the statutory audit for small companies, we make the point that, whether it is wilful or otherwise, non-compliance with requirements relating to the keeping of records and preparation of accounts is likely to be encouraged if directors and employees are aware that no audit will take place. In relation to Q13.8 (false statement by an employee), we consider that, given the difference in status, responsibility and right of access to information, the position of the employee should be treated somewhat differently from that of the officer. False statements should be subject to penalty, but these should not be the same, as a rule, as those which apply to directors.
Phoenix companies (Q 13.21–23)
72 The term 'phoenix company' is misleading. In keeping with the concept of separate legal personality, there is nothing, in principle, amiss in the directors of a company which is going or has gone into liquidation starting up a new company, even one which carries on the same line of business as the directors' other company. The new company can, legitimately, remain apart from the troubles and liabilities of the failed or failing company.
73 What, of course, is wrong is for directors to abuse the principle of separate legal personality by seeking to mislead customers as to the connection between the new company and the old or by retaining within their control valuable assets which would otherwise have been made available to compensate creditors who have suffered loss. Misconduct by directors in these respects should be discouraged and penalised.
74 With regard to the various options for strengthening the current statutory rules set out in Q13.23, any new provision should have, as its main focus, the compensation of creditors for any asset transferred by a company in liquidation within a specified period before the commencement of the winding up, whether or not the transfer or sale was approved by shareholders. s238 and s239 of the Insolvency Act 1986 already allow a liquidator to take recovery action where the failed company has entered into a sale at an undervalue or given a preference. The ability of these provisions to address 'phoenix' transactions could be enhanced through a widening of the sections' application beyond the current restriction to cases where the transfer or preference was made at a time when the company was unable to pay its debts or became unable to pay its debts as a result of the transaction. Liquidators could be allowed to query, under s238 or s239, any transaction at an undervalue or preference within the periods specified in those sections, regardless of whether the company was unable to pay its debts at the time.
75 Potentially the most effective weapon in dealing with misconduct by directors in the 'phoenix' situation remains, in our view, disqualification action by the liquidator and the Insolvency Service. We believe though that more needs to be done to increase the effectiveness of this sanction as a deterrent. While improvements have been made in recent years, in terms of resources and procedural rules, which have led to an increasing number of disqualifications for unfitness, the speed with which disqualification cases are processed and brought could still be increased. The Steering Group should consider whether the current periods allowed for reporting by liquidators and for bringing proceedings before a court could be reduced.