13 Dec 2018 11:11am

Holding directors accountable for failure

When a business fails, it’s become common to focus on the role played by the auditor. But, asks ICAEW’s chief executive, what about the role played by the directors who hold the reins?

For companies to work effectively and efficiently, everyone from the executives through to investors must ensure that they play their part in upholding the governance and stewardship of the business.

For the vast majority of companies, this is a given but, as you will be only too well aware, a number of markets around the world have suffered corporate collapses or scandals in recent years, and these have brought into question the competence of management and the effectiveness of governance, not to mention the quality of audit.

In the UK, the collapse of companies such as retail chain BHS and construction company Carillion have led to a series of inquiries being launched, including, in April, Sir John King- man’s “root and branch” review of the governance, impact and powers of the UK’s audit regulator, the Financial Reporting Council (FRC). Kingman is due to report back soon.

When last July the FRC revealed its bucket list of additional new powers that it believed were fundamental to carry out its regulatory role properly, high on the list was a statutory power to be able to investigate and discipline non-accountant directors.

Not surprisingly, the FRC’s request was received with a certain amount of sympathy in the accountancy profession. Some accountants do feel that we are unfairly discriminated against when members are investigated and sanctioned by the FRC, with all the attendant media interest, while their fellow directors, equally culpable but non-regulated, apparently walk away scot-free.

It seems to me, however, that there are some perfectly good powers already in existence that could be used to bring non-professional directors to book. Some are already widely used: the UK’s Insolvency Service, for example, disqualified 1,231 directors and investigated 160 companies for various acts of misconduct in 2017/18, explaining that its work “helps protect the public from dishonest and misleading company directors who abuse their corporate position through fraud, scams or sharp practice”.

Most of the service’s disqualifications appear to involve directors of very small companies but from time to time it hits the headlines with more high-profile cases – like the collapsed charity, Kids Company, whose directors are currently fighting their case through the courts.

Other enforcement powers are less frequently used. In the case of the power under sections 431 and 432 of the 1985 Companies Act (for those of you who have better things to do than study UK company law, these allow the secretary of state to appoint an inspector to investigate a company), the provisions have only been used a few times in the last 18 years, possibly because in the past they have proved to be extremely costly and traumatic for the reputation of the company. They have also taken years to complete.

A particular bugbear of mine, though, is section 501 of the Companies Act 2006. This provision establishes the requirement for managers of businesses to disclose all the information the auditors ask them for and makes it clear that they must not “knowingly or recklessly” mislead them. It seems highly likely in some of the cases now playing out around the world that this provision has been breached.

So why does nobody take any action? In the UK, this is an offence potentially attracting a criminal sentence of up to two years in prison or a fine or both, but it is extremely rarely used – although auditors do use the threat of it once in a while to bring recalcitrant audit clients to heel. Indeed, the only recent case that springs to mind was SFO v Gyrus Group Ltd and Olympus Corporation in 2015, which was lost effectively on a technicality in the Court of Appeal.

So why is this provision in the statute book if those with the locus to bring an action – be they government, regulators or other enforcement authorities – do not use all the tools at their disposal? I believe it is time that the system worked in the way that those who designed it intended. I would be interested in your views.