Directors, beware: corporate governance overhauls could end in personal liability

Corporate governance in the UK is about to undergo its biggest transformation in a generation. Next month, the government’s consultation on the powers held by the new Audit Regulatory and Governance Authority (ARGA), closes. Some of the proposals are seismic, driven by corporate scandals, and could mean directors of public companies, large AIM-listed companies and large private companies could be personally responsible for financial or audit failures.

The proposals set out the powers and duties of the new regulator in order to be effective. Some are both necessary and appropriate. Others, however, have a wide, menacing net.

The aim is to ensure the protection of investors, users of corporate reports and the public interest at large. But the proposals change what is expected of directors – and their accountability. These powers are far reaching and have the potential to cause real conflict for directors of companies that break the rules.

The directors will have to sign new annual declarations explaining the capital maintenance and dividend decisions, the measures taken to detect fraud and the adequacy of internal controls. The last of these has been described as “Sarbanes-Oxley Lite”, reflecting similar requirements in the United States. While this statement may sound laudable, there is a risk that the ticking of the boxes associated with the new rules will be expensive, time consuming and yet unlikely to lead to better judgments or expose wrongdoing.

To spice up these annual statements, the government plans to impose more duties on directors, as well as a code of ethics to govern financial audit matters. This will include the obligation to act with “due skill, care and diligence, and honesty and integrity”.

It is difficult to dispute that directors must comply with these obligations. But that depends, surely, on what it really means. If the annual declarations prove to be incorrect, the directors may be the subject of a personal investigation. They could, in other jobs, be fined or even temporarily disqualified for actions taken far below them in the chain of command.

Giving more and more responsibility to directors is the direction taken by other regulators. The Financial Conduct Authority and the Competition and Markets Authority have both taken steps to create individual accountability for business leaders. They are increasingly the target of regulators.

There can be unintended consequences to this. The white paper asks whether the regulator should be able to access legally privileged material shared with auditors. the FRC claims it needs it to assess audit quality. Such power is an unprecedented step. There is no guarantee that the material will not be obtained by third parties and used against the directors or the company in question. Companies would inevitably be less willing to share inside information with their auditors, making it more difficult for them.

A regulator with overburdened powers and dramatic increases in liability could also prove to be a costly decision: insurance rates for directors and officers will likely increase, along with compliance costs.

Directors will need to prepare for the multitude of new responsibilities. There is a pattern to follow, based on the similar pattern of FCA. The best preparation, however, will be to make their voices heard before the consultation period ends and they get stuck in the rules.

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