Tim Bush, head of governance and financial analysis, PIRC
The debate about director duties in the wake of problems with BHS and Sports Direct, has thrown up what, with apologies to Little Britain, might be best described as a “yeah, but no, but no, but yeah” approach from the Financial Reporting Council (FRC). Indeed, the FRC’s position on this and other matters begs the question of whether the regulator, which regularly calls for “principles rather than rules”, is able to follow principles unless there’s a rule to go with it.
The 2006 Companies Act requires directors to fulfill their duties to all shareholders by taking account of a broad group of stakeholders. This is set out in section 172 (s172) of the Act. The Strategic Report Regulations 2013 further state that the purpose of the strategic report is to set out how directors have fulfilled those duties.
The FRC told Parliament in November 2016 that there was not a requirement to report on these matters and that the law needed to be “reinvigorated”. The concept of “reinvigorating” law, especially given the law is relatively new, merely raises more questions. Either there is a requirement or there isn’t.
The regulator took issue with PIRC’s criticism of its assertions. But the recent BEIS Green Paper on Corporate Governance has confirmed there is a requirement, the method of delivering the requirement is not prescriptive and that the list of stakeholders in the legislation is non-exhaustive and includes a company’s pension fund. The legislation is structured as principles not rules.
Despite that clarity, the FRC response to the Green Paper side steps the issues to say there now needs to be “a requirement to report more effectively”. Given that “effectively” is an abstract term and merely means to get a result, these more weasel words pad things out and get us nowhere.
Similar problems can be seen with section 393 (s393) of the 2006 Act (the true and fair view), where problems occur in various FRC publications. The verbal gymnastics in this case involve missing out the subject to which the true and fair view applies, and replacing it with altogether different concepts. The wording of s393 states “a true and fair view of the assets, liabilities, financial position and profit or loss”, in other words the numbers. Despite the clarity of the legislation, the FRC’s versions of it are different.
One FRC publication states that the true and fair view test is about “stepping back and looking at the accounts as a whole at the end of the preparation process”. That description does not fit what the law says. The test in the law is the specified numbers in the accounts, not the pictures and the cover. It’s also a bit late to leave looking at the numbers until the end of the preparation process.
Problems aren’t just limited to these two examples. In responding to a letter from the House of Lords in December 2016, on the Companies Act requirements for making lawful distributions, the FRC – which according to senior Counsel has misread the law – replied saying that the wording of the legislation could be improved. Given that Parliament passes and judges interpret the legislation as written and case law develops around that, it’s odd to be criticising the words now. This is especially true given that, however clearly legislation is expressed, the FRC has a knack of writing the words down differently.
The FRC has spoken a lot recently about the importance of culture to corporate governance. That may be the case, but a good place to start first is the FRC itself, and that means it admitting when it is wrong.
Paul George, executive director of corporate governance and reporting, FRC
Endlessly arguing legal points that should be tested in court clouds the real issue, which is improving the quality of reporting. The FRC wants directors to provide clear explanations of how they have fulfilled their responsibilities, and we want financial statements that present a true and fair view as required by law, as well as disclosures on dividends that allow investors to assess management stewardship and the case for investment.
We have been clear on this to the Select Committee, our response to the Green Paper and, in respect of dividend disclosures, to company directors in our year-end letter. We have urged those who disagree to challenge the legal framework if they want clarity, rather than clouding the issue with ill-conceived disputes.
Where we have suggested the government consider making changes to the law it has been to achieve the above objectives and to provide greater clarity and remove sources of unnecessary dispute.
As to s172 and the strategic report content requirements, this sets out a duty for directors “to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (among other matters)” to a non-exhaustive list of other wide-ranging factors. In terms of reporting, the Act says, “The purpose of the strategic report is to inform members of the company and help them assess how the directors have performed their duty under s172”. It sets out requirements for the content of the strategic report.
We have expressed the view that the purpose of the strategic report could be better achieved if the explicitly required contents in the Act included a more direct explanation of how the directors have performed their s172 duties.
Strategic report content requirements, which are covered in Section 414C (s414C) of the Act are relevant, as there is overlap with the factors mentioned in s172, but the link to the s172 duty is not explicit.
In considering the purpose of the strategic report, the BEIS consultation comments that “there are no further details on how this should be done, which often leads to a lack of clear and transparent information about the steps that companies are taking”.
The FRC agrees with this and has consistently said that companies should be required to report more fully on how the directors have fulfilled their duty under s172. This is made clear in our response to the Green Paper, where we say that the Strategic Report Regulations should be amended to link the s172 duty and reporting under s414C.
In our June 2014 paper True and Fair, we make clear the fundamental and paramount importance of presenting a true and fair view in the preparation of financial statements. The paper stresses that “objective professional judgment must be applied to ensure that financial statements give a true and fair view” and that such judgment “applies at all stages of preparation”.
The FRC expects preparers, those charged with governance and auditors to always stand back and ensure the accounts as a whole give a true and fair view, but this does not replace the need to apply the true and fair concept throughout the financial statement preparation process. As our paper makes clear, the FRC also expects the presentation of a true and fair view to be the paramount objective in establishing accounting policies, in applying financial reporting standards, in determining if an override of a standard is required and in preparing disclosures.
On the disclosure of distributable profits, the FRC has, partly through the publication of a report by the Financial Reporting Lab, encouraged the provision of information on companies’ dividend policies and practices and the binding constraints they face in achieving these policies. Those constraints may be legal, such as the level of distributable reserves, regulatory, such as capital requirements, or operational. The development of that report and the willingness of the companies and investors listed in the report to participate shows the importance of such information.
The view that the disclosure of distributable profits is a legal requirement was not shared by the majority of participants in the Financial Reporting Lab project. But all participants listed in the report worked together constructively to identify and develop best practice disclosures.
The difference of opinion between groups of investors over whether the disclosure of distributable profits is a legal requirement led us in our response to the House of Lords letter to note that if the government chose to legislate to eliminate any diversity of views, then we would work with them on improvements.