Written by Noona Barlow and Francis Kean from McGill and Partners
Can more board regulation bring out the best in the boardroom?
In March 2021 the UK government published a consultation paper called “Restoring trust in audit and corporate governance.” Among other things it proposes “new reporting and attestation requirements covering resilience planning, designed to sharpen directors’ accountability in (…) key management areas within the largest companies.”
The consultation is predicated on a belief that there are weaknesses in corporate reporting and accountability in three areas:
1) internal controls over financial reporting,
2) dividend and capital maintenance decisions and
3) the steps directors are taking to consider and ensure a company’s “future resilience”.
An obvious challenge for boards is to identify what constitutes “key management areas” for this purpose. The penalty for directors who get this wrong and fail to implement appropriate resilience planning is potential personal liability, since courts and regulators have consistently emphasised that company directors cannot delegate or outsource their supervisory functions. For directors of the UK’s biggest companies there is the additional prospect of fines or bans when there are serious failings such as misleading accounts or hiding information from the auditors.
Examples of “key management areas” for many companies are likely to include matters in respect of which mature and sophisticated legal, compliance and enforcement regimes already exist such as health and safety and anti-corruption. Moreover, sound corporate governance and risk management systems and procedures have been baked into to well-run companies for decades. Many if not all of these “key management areas” will fall into the list of key stakeholders and interests to which directors have had to pay regard in company decision-making ever since the enactment of section 172 of the Companies Act 2006. By way of reminder these are:
- the likely consequences of any decision in the long term,
- the interests of the company’s employees,
- the need to foster the company’s business relationships with suppliers, customers and others,
- the impact of the company’s operations on the community and the environment,
- the desirability of the company maintaining a reputation for high standards of business conduct, and
- the need to act fairly as between members of the company.
Moreover, the UK Corporate Governance Code has been encouraging large companies to issue Section 172 statements since 2018.
Just a case of doing the right thing?
It is impossible for boards always to do the right thing. They do not possess crystal balls and it is for this reason that in judging whether directors have discharged their duties to exercise reasonable skill and care and to abide by Section 172, courts are scrupulous in not seeking to apply the benefit of hindsight. Part of the difficulty here is that there is often more than one “right thing” or more accurately perhaps any one “right thing” contains the germ of many “wrong things”. Unfortunately, disgruntled investors, pressure groups and, to an extent, regulators tend to focus on bad outcomes and can be less forgiving when it comes to making judgments on actions and statements made by boards in good faith.
Despite the enormous resources being poured into risk measurement and reporting both by regulators and companies across the developed world, there are often no clear guidelines, measurements or “tick boxes” that directors can follow. Does this ultimately matter? After all, the whole theory behind measurement and reporting is precisely to encourage companies down the implementation route. Adherence to good governance should lead to better outcomes in the form of strong investor support for the right companies doing the right thing.
But are there hidden perils here for directors? By committing a company to goals which (with the benefit of hindsight) prove to be unrealistic and unachievable, do they risk creating a dangerous expectation gap which investors and their lawyers will be only too keen to exploit?
The status quo?
Yet doing nothing is not really an option either. The momentum generated by and the support from governments, regulators, analysts and the public at large for well-articulated and sophisticated reporting on key management issues means no company dependent on its reputation can afford to sit on its hands.
This is particularly true when a company is seeking effective D&O cover. D&O insurers constantly “scan the horizon” for new and emerging risks, and then place the onus on insureds to explain how they are addressing or mitigating both the risks they are being asked to underwrite but also these potential future risks. Effective insurance cover ensures that a company can attract top talent to its board by ensuring personal protection for directors in the event of a claim. Depending on the nature of the cover purchased, the insurance may also provide significant balance sheet protection for the company. We are currently in the midst of a “hard market” for D&O insurance, so the added burden of being able to demonstrate good risk management for known and emerging risks makes the challenge of purchasing adequate insurance even more onerous.
In this very challenging environment, maintaining the status quo is not enough. Boards must be nimble enough to keep up to date with the ever-evolving demands made on them to demonstrate that they are addressing both existing and emerging risks in order to ensure not only company resilience but also the ability to secure adequate insurance.
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