BEIS publishes audit reforms and corporate governance proposals – considerations for D&Os and their insurers
This article was co-authored by Maya Rubinstein, Trainee Solicitor, London.
Following our article earlier this month (Directors & officers and their insurers await detail of UK audit reforms), the Department for Business, Energy and Industrial Strategy (BEIS) has recently published its white paper “Restoring trust in audit and corporate governance” which sets out proposals aimed at strengthening and improving the UK’s framework for audit, corporate reporting and corporate governance systems. The proposals are open for consultation until 8 July 2021.
Key proposals for D&Os
As the title of the white paper suggests, rebuilding trust is a key focus of the proposals, with emphasis placed on the importance of investors and financial markets being able to depend upon information published by UK companies. This aim is understandable in view of recent corporate failures of high profile organisations such as BHS, Carillion, Patisserie Valerie and Thomas Cook.
The white paper includes a number of proposals which, if implemented, could significantly impact the potential exposure of D&Os and their insurers. Key proposals from a D&O perspective include:
- New reporting and attestation requirements covering internal controls, dividend and capital maintenance decisions, and resilience planning, designed to sharpen directors’ accountability in these key management areas.
- The replacement of the Financial Reporting Council (which the white paper notes does not have any powers to enforce directors’ duties other than when a director is a member of a professional accountancy body) with a new regulator, the Audit Reporting and Governance Authority (ARGA).
- Ensuring the regulator has effective investigation and civil enforcement powers to hold to account directors of large businesses which are of public importance for breaches of their duties in relation to corporate reporting and audit.
Expanded definition of Public Interest Entities
It is apparent that BEIS is particularly focussed on the operations of Public Interest Entities (PIEs). Currently, PIEs are predominantly publicly listed companies in respect of which audits and auditors are subject to a number of additional regulatory measures. Consideration is being given to broadening the kinds of companies that would qualify as PIEs, for example by including large private companies and third sector (not for profit) entities.
For D&Os of PIEs, it is proposed ARGA will have broad enforcement and investigatory powers to hold individuals responsible where there have been breaches of directors’ duties in relation to corporate reporting and audit. In addition, consideration is being given to whether D&Os of PIEs ought to be required to meet certain behavioural standards in the way they carry out their duties relating to corporate reporting and audit.
Internal company controls
With a view to strengthening internal company controls, the white paper includes the following proposals:
- A directors’ responsibility statement, pursuant to which D&Os would be required to acknowledge their responsibility for establishing and maintaining adequate internal controls and procedures for financial reporting.
- An annual review of internal control effectiveness and new disclosures, whereby D&Os would be required to:
- Review the effectiveness of the company’s internal controls and financial reporting
- Disclose the benchmark used to make such an assessment
- Disclose any identified deficiencies and proposed remedial action.
- A directors’ statement about the legality of proposed dividends and the effects on the future solvency of the company. This would address the legality and affordability of dividends, including confirmation that they would not threaten the company’s solvency over the next two years.
These proposals suggest the conduct of D&Os will be under ever greater scrutiny, whether via claims by relevant stakeholders or investigations brought by a new regulator with a broader remit. Depending on the outcome of the consultation, if the proposals are implemented, it is hard to see anything but an escalation in D&O exposures.
Picking up on our earlier article, for D&O insurers, consideration will need to be given to the breadth of cover that can be provided whilst seeking to ensure the product is viable.
A careful eye should be kept on any expanded definition of PIEs, given the heightened focus such categorisation could impose on its D&Os via ARGA. We anticipate insurers will consider the imposition and scope of exclusions, such as of the kind seen in the US regarding Sarbanes-Oxley Act of 2002 (where D&Os are required to report on the adequacy of the company’s internal controls on financial reporting) and in relation to insolvency. It is foreseeable that ‘per director’ sub-limits may become more common place to provide comfort to individuals whilst also managing the exposure of insurers. Other possible changes could include more limited cover for defence costs and/or investigation costs and insurers having greater control over the handling of any insured events.
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