Examining The Effect Of The Proposed Governance Regime Across Europe A Presentation to The Securities Institute ISD Conference

by Gregory Pritchard of CPAAudit UK

London 26th September 2003

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Examining The Effect Of The Proposed Governance Regime Across Europe

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What is Corporate Governance The current debate Corporate Governance in the UK The European debate EC Transparency Directive and the Winter Group Reform of the FSAs Listing Rules on disclosure and other FSA requirements The impact of Sarbanes-Oxley on UK companies
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What is Corporate Governance Definition (OECD and Cadbury)

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Corporate governance is the system by which companies are directed and controlled. It is the way in which the affairs of corporations are handled by their Corporate Boards and officers. Although shareholders were the original focus of corporate governance, current thinking recognises a corporations obligations to society generally in the form of stakeholders. Corporate governance is therefore concerned with such issues as: u effectiveness and efficiency of operations u reliability of financial reporting u compliance with laws and regulations u safeguarding of assets

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What one can argue convincingly is that the UK has created a new and fast-growing industry of its own the Corporate Governance industry.
David Blundell, Chairman, UK Shareholders Association in a letter to Patricia Hewitt, Secretary of State, DTI (April 2003)
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What are some of the recent events and current issues in the field of Corporate Governance?

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Corporate Governance Recent Events and Current Issues Spectacular corporate failures eg Enron n Auditors conflicts of interest eg Andersen n Excessive executive remuneration n Ineffective non-executives n Previously hands-off investors becoming increasingly active n Legislation eg US Sarbanes-Oxley Act
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Complying with the major demands of Corporate Governance laws in the UK

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Comply or explain
Cadbury - internal financial control Greenburry - disclosure of directors remuneration Hampel - Combined Code, June 1998 Turnbull - internal controls, December 2000 Higgs reported in January of this year on the role and effectiveness of non-executive directors Smith also reported in January of this year on guidance for audit committees Revised Combined Code on Corporate Governance issued July 2003
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The Combined Code

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A2 There are two key tasks at the top of every public company the running of the board and the executive responsibility for the running of the companys business A3 The board should include a balance of executive and nonexecutive directors A5 There should be a formal and transparent procedure for the appointment of new directors to the board A6 All directors should be required to submit themselves for reelection at regular intervals B2 - Companies should establish a formal and transparent procedure for developing policy on executive remuneration B3 The companys annual report should contain a statement of remuneration policy and details of the remuneration of each director

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The Combined Code

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C1 Companies should be ready to enter into dialogue with institutional shareholders based on the mutual understanding of objectives C2 Boards should use the AGM to communicate with private investors and encourage their participation D1 The board should present a balanced and understandable assessment of the companys position and prospects D2 The board should maintain a sound system of internal control to safeguard shareholders investment and the companys assets D3 The board should establish formal and transparent arrangements for considering how they should apply the financial reporting and internal control principles and for maintaining an appropriate relationship with the companys auditors
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The Turnbull Report Key Provisions

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A companys system of internal control has a key role in the management of risks that are significant to the fulfilment of its business objectives Internal control facilitates the effectiveness and efficiency of operations, helps to ensure the reliability of internal and external reporting and assists compliance with laws and regulations

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The Turnbull Report Key Provisions

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The companys internal control system should: u Be embedded within its operations and not treated as a separate exercise u Be able to respond to changing risks within and outside the company u Enable each company to apply it in an appropriate manner related to its risks
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The Higgs Report

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Review of the role of the Non-Executive Director u Recommendations u Critics

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What is an Independent Director?

(Horwath 2002 Corporate Governance Report)
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Not just non-executive Not a substantial shareholder or associated with such Not a significant supplier or customer or associated with such Not an original founder Not a principal of a professional adviser to the company

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Not employed previously as an executive Has no significant contractual relationship with the company outside of directorship Free from any interest or relationship that could be perceived to interfere with the directors ability to act in the best interests of the company

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The Smith Report

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Roles and responsibilities of audit committees u To monitor the integrity of the financial statements of the company u To review the companys internal financial control system u To monitor and review the effectiveness of the companys internal audit function u To make recommendations on the appointment and remuneration of the external auditor u To monitor and review the external auditors independence, objectivity and effectiveness u To develop and implement policy on the engagement of the external auditor to supply non-audit services

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The Evolving Role of Audit Committees

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Review of communication between auditors and audit committees, John Collier, September 2003 Research conducted with 10 large UK listed companies, mainly from the FTSE100 Challenged the principle that the unitary board is at the centre of the UK Corporate Governance model Found that audit committees are increasingly taking on some of the wider functions expected of supervisory boards elsewhere in Europe
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The European Debate EC Transparency Directive

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Transparency about publicly traded companies is essential for the functioning of capital markets, enhancing their overall efficiency and liquidity u Annual financial reporting within three months u More detailed half yearly financial reports u Less demanding quarterly financial information u More frequent disclosure of changes to important shareholdings with stricter deadlines u Update of Community law with regard to information provided at general meetings
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The European Debate The Winter Group

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Winter Group report on Corporate Governance issued 4th November 2002 recommends improving the EU framework for: u Disclosure of the companys remuneration policy and individual directors remuneration, as well as prior shareholder approval of share and share option schemes in which directors participate, and accounting for the costs of those schemes u Confirming as a matter of EU law the collective responsibility of directors for financial and key non-financial statements of the company u Creating an integrated legal framework to facilitate efficient shareholder information, communication and decision-making on a cross-border basis, using where possible modern technology, in particular the companys web site

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Reform of the FSAs Listing Rules on Disclosure and Possible Future Developments in the UK
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The Winter Group recommended that listed companies in the EU should be required to make a coherent, descriptive statement in their annual accounts covering the key elements of their Corporate Governance structures and practices They should refer to a national code on Corporate Governance or company law with which they comply or in relation to which they explain any deviations The response to the Winter Group recommendations from some member states has been a demand for a framework directive on Corporate Governance so the outcome may be more rules based
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FSA Expectations with regard to Corporate Governance

Apportionment and oversight n Risk Assessment prospect of a separate risk assessment function n Audit Committee to examine the appropriateness and effectiveness of systems and controls n Internal Audit independence, access to records n The sourcebook rules or guidance?
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The Impact of Sarbanes-Oxley on UK Companies

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The most far reaching reforms of American Business Practice since the time of Franklin Delano Roosevelt (President Bush) Applies to all SEC reporting companies, regardless of where incorporated Companies with more than 300 shareholders in the US are subject to SEC reporting

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Sarbanes-Oxley Core Elements

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CEO and CFO Certification u CEOs and CFOs must personally certify public company financial and other disclosures, subject to harsh penalties of up to 20 years imprisonment and US$5m fine u Disclosure fairly presents, in all material respects, the financial condition and results of operations of the company (S302) and fully complies with SEC requirements (S906) Corporate Governance reforms u Enhanced role of the audit committee composed of independent directors with tough definition of independence (US-listed companies only) u Appointment, oversight and remuneration of auditors u Pre-approval of audit and non-audit services u Shareholder approval of all equity compensation and stock option plans (NYSE/Nasdaq)
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Sarbanes-Oxley Core Elements

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Auditors/financial disclosure u Auditor independence not considered independent if a former partner or principal are employed by the company u Prohibition on a wide variety of non-audit services including bookkeeping, MIS design, internal audit outsourcing and other expert services u Limitations on use of non-GAAP financial measures must include a reconciliation to the most directly comparable GAAP financial measure and cannot be materially misleading u Enhanced management discussion and analysis disclosure (MD&A) separately captioned section disclosing material offbalance sheet arrangements including nature and purpose of arrangements, nature and amounts of interests retained and known events or trends
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Sarbanes-Oxley Core Elements

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White collar crime/liability u Increased penalties, liability and SEC enforcement powers u Shredding documents equivalent to attempted murder! u Prohibition on retaliation against whistleblowers u Attorney regulation up-the-ladder reporting to CLO and/or CEO required if material violations of securities laws, fiduciary duties or other similar material violations have occurred no client/attorney privilege Analysts conflicts of interest
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If anyone thinks that the rise and rise of Corporate Governance claptrap will save any investor from anything, theyre living in a dream world.
Terry Smith, CEO, Collins Stewart following public criticism of their bundled resolution at the EGM on 17th February 2003

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