Large companies with insufficient cash reserves are to be barred from paying shareholder dividends and executive bonuses in a major overhaul of the UK’s audit and corporate governance regime.
Under government proposals to be unveiled on Thursday, company directors will also face fines, suspensions and the claw back of bonuses if their businesses make significant errors with accounts or leave the door open to fraud.
The much-delayed reforms are contained in a white paper drawn up after accounting scandals at UK companies including Carillion, BHS and Patisserie Valerie.
Directors would be required to take much greater responsibility for the accuracy of company accounts, in an overhaul similar to the US Sarbanes-Oxley legislation passed after the Enron scandal.
The government said large companies will be required to restrict dividends and bonuses if the businesses cannot cover the payments from reserves or there is a risk of insolvency.
The white paper referred to “high-profile examples of paying out significant dividends shortly before profit warnings and, in some cases, insolvency”.
Carillion paid a record dividend and bonuses just weeks before a profit warning that preceded its collapse in 2018, with MPs later criticising the outsourcing company’s directors for seeking to increase payouts as cash ran low.
Carillion and other accounting scandals raised questions about the quality of auditing by the Big Four accounting firms: Deloitte, EY, KPMG and PwC.
Business secretary Kwasi Kwarteng said: "When big companies go bust, the effects are felt far and wide with job losses and the British taxpayer picking up the tab. It's clear from large-scale collapses like Thomas Cook, Carillion and BHS that Britain's audit regime needs to be modernised."
New obligations
The white paper, which will go out to public consultation until July, said companies and their auditors would face new obligations around detecting and preventing fraud.
Directors would need to review their company’s internal controls each year and attest to their effectiveness in the annual report.
If directors were found to have engaged in serious misconduct, which includes inaccurate accounts or a company suffering reputational damage, the white paper said they could have two years worth of bonuses clawed back.
A new regulator called the Audit, Reporting and Governance Authority is set to have the power to investigate wrongdoing by directors as well as oversee accounting firms.
The government is aiming to end the Big Four firms’ dominance of auditing of FTSE 350 companies.
The white paper would implement most of the recommendations of three reports into the audit profession by Sir John Kingman, Sir Donald Brydon and the UK competition regulator.
However, the government has rejected calls for a joint audit approach under which every large listed company would have its accounts checked by one of the Big Four and another small accounting firm.
Instead, the white paper has backed the more modest proposal of “managed shared audits” where companies will be required to use a small accounting firm to do a “meaningful portion” of scrutinising their accounts.
The government said the Big Four could still face a cap on their market share of auditing FTSE 350 companies if competition in the sector did not improve.
The new regulator is due to have the power to impose an operational split between accounting firms’ audit and consulting arms, although the Big Four are already pushing through voluntary separations.
Ministers will also hold consultations on giving the regulator the power to appoint an auditor where serious problems exist with a company’s accounts.
Business lobby groups have warned of the extra cost on listed and private companies that are due to fall within the scope of the new audit and corporate governance regime.
Public sector bodies
The government is proposing to expand the definition of a “public interest entity” to cover large private groups, Aim-listed businesses and, potentially, public sector bodies.
However, ministers are to consider exempting newly listed companies to help the UK stay competitive on initial public offerings.
The government said it would bring forward primary legislation to take forward the reforms “when parliamentary time allows” after the public consultation.
Michael Izza, chief executive of the Institute of Chartered Accountants in England and Wales, said the accounting profession would welcome the certainty from finally seeing the white paper but questioned why it had taken so long.
“Recent corporate collapses have caused questions to be asked about financial reporting, audit and governance,” he added.
Suren Thiru, head of economics at the British Chambers of Commerce, said the government and regulators had to tread carefully to avoid unintended consequences, "including adding to the already onerous cost burden on firms and undermining the UK's global reputation as great place to do business".
Matthew Fell, CBI UK chief policy director, said “many businesses are still to be convinced that mandating shared audits will get to the heart of the issues around rigour and quality”. – Copyright The Financial Times Limited 2021
