CARDIFF UNIVERSITY
LAW
SCHOOL
LLM COMMERCIAL
LAW
2003/2004
«THE ROLE OF THE AUDITORS IN THE UK CORPORATE
GOVERNANCE»
BY
N'SEMY AUBIN
MABANZA
«THIS DISSERTATION IS SUBMITTED IN FULFILMENT OF
THE REQUIREMENTS FOR THE DEGREE OF LLM COMMERCIAL LAW »
SUPERVISOR: Dr TIM PRYCE-BROWN
ACKNOWLEDGEMENTS
I would like to thank my Supervisor Dr Tim Pryce-Brown for his
guidance and support during this research.
I would like to thank my wife Patricia for her love, care and
inspiration, without which this course would not have been possible.
TABLE OF CONTENTS
Chapter 1 Transparency in the UK Corporate
Governance
1 .1 Introduction
1.2 The Auditors and responsibilities
1.3 The Independence and Integrity of
Auditors
1.4 The Audit Committee in the UK
1.5 The Audit Committee in the USA
1.6 Current position under Common law: English
law and US law
1.7 Recent development of Auditors
liability
Chapter 2 Concept of «Good « Corporate
Governance in the UK
Chapter 3 Harmonisation of the European Company
law
Chapter 4 Conclusion
Bibliography
ABSTRACT
This paper traces the role of the Auditors in
the UK Corporate Governance.
It analyses the internal control and the
responsibilities of the auditors. The paper
identifies the importance of the audit committee under Common
law, particularly the
English law, and the US law.
The recent development of the auditors' s liability is
outlined. The concept of good
governance since the early period, as well as its
evolution within Europe is
illustrated. The implementation of the E C Directives in
the UK is also examined.
It is concluded that the role of the auditors need truth,
independence and objectivity
for the efficient functioning of UK corporate
governance. It is pointed that there
is not a single and perfect system of corporate
governance to monitor the audit.
It is also pointed that the current rules are
inadequate and unsatisfactory to protect
the interest of shareholders and others. It is
proposed that to avoid conflicts of
interest, individual rotation of auditors should be
absolute under new standards. It is
also proposed that the auditor should have a
permanent contact with all actors
who hold company information.
Chapter 1 Transparency in the UK Corporate
governance.
1.1 Introduction
The availability of accurate and up-to-date information on
company performance
1
is of fundamental importance. In the absence of reliable
accounting data, effective
shareholder supervision of management is impossible, as
the accurate pricing of
2
shares which is crucial to market modes of control. The
sudden collapse in recent
years of a number of well-known companies which, according
to their duly audited
accounts, were thriving, has focused attention on the
consideration scope for the
3
distorted presentation of financial information.
However, the modern English Company law contains
provisions to promote
transparency. S.384 of CA 1985 provides that every company
must appoint auditors
except companies which are exempt from the audit
requirement. An auditor is a
person appointed to examine the books of account and the
accounts of a registered
company and to report upon them to company members.
Normally, the auditor is
appointed by the director' s recommendation. However,
the relationship between
the auditor and the director's company is prone to
vulnerability. The close nature
of their relationship constitutes an important element
which has been implicit
in many debates of auditor independence. For many
years, external auditors
have contributed in a decisive way to the
development of welfare markets.
Moreover, the audit multidisciplinary links have put on
the market, on the edge of
the classic control, some worthy activities of
advising from non statutory
( lobbing for tax breaks, IT assistance,
representation of the internal audit).
1.J.E.Parkinson,'Corporate Power and Responsibility',p.161
2.ibid
3.ibid
This matter is very considerable. On the other hand, the
importance to fee income of
non- audit services has been identified as another factor for
criticism. For example,
in the Enron case, it has been widely reported that Andersen
received $25m in audit
fees and $27m for non audit services; there have been
many criticisms about the
potential conflict of interest faced by audit firms which
receive large consultancy
4
fees from their audit clients.
Concerns are expressed about how an auditor with a
statutory responsibility to
company shareholders can handle a commercial
relationship with the company's
5
management and remain impartial. In the UK, one of
the issues called by the
Cadbury Report was the establishment of the Audit Committee
and the development
6
of the effective accounting standards. Shaken by the
Andersen brutal scuttling,
the statutory dispositions of the profession has
strengthened quickly for a
7
better independence necessity, achieved in the USA by the
Sarbannes- Oxley Act.
On the other hand, the auditing firms themselves
have come up with the same
conclusion such as the rotation of auditors,
the splitting of their businesses
( non audit services and audit work), the
powers of the audit committees.
However, in the light of all these reports we have to note
that some problems remain
unsolved. This is not a unique issue. The auditors,
like solicitors, have to work
under rules adopted by the profession. However,
transparency by companies
management and auditors firms is important to
ensure impartiality in an audit
process, especially where auditors supply other
activities.
4.The Financial Times ,2001.
5.ibid
6.Cadbury Report ,1992 ,p.38 , para ,5.7
7.The Sarbannes- Oxley Act (SOA) is a US law passed in 2002 to
strengthen corporate governance and restore investor confidence. Act was
sponsored by US senator P. Sarbannes and US Representative M.Oxley (see http://
six signatutorial.com/Sox/Sarbannes-Oxley).
As in the case of directors, a company may by ordinary
resolution at any time remove
an auditor from office notwithstanding anything in any
agreement between it and him.
However, in accordance with the law, for the removal
of an auditor, special
safeguards are needed not only to protect him, but to protect
the company from being
deprived of an auditor whose fault in the eyes of
the directors may be that has
8
rightly not proved subservient to their wishes. In
other words, a company cannot
remove an auditor against his will without facing a
serious risk of a row at the
general meeting (and in the case of a listed
company, adverse press publicity)
9
and probably payment of compensation.
As a result of the encouragement from the Audit and
Accounting Issues Group and
the EC Commission professional guidance was changed to
require the rotation of
the audit engagement partner for listed firms at least
every five years and of other
10
key audit partners of listed firms every five years. Finally,
a breakdown in relations
between the auditor and the management may reveal
itself not in the removal,
11
but in the resignation of the auditor.
1.2 The Auditors and responsibilities.
Fundamental to Financial Statements, an audit is the
division of responsibility
between the management and the independent auditors.
Although the audit may
act as a deterrent, the auditor is not
responsible for preventing fraud or
12
errors. If the auditor identifies weaknesses
in the client's accounting
systems and internal controls which might result in
fraud not being detected, the
13
auditor should report these to management.
8.Gower and Davies , » Principles of Modern company law
» .
9.ibid
10.ibid
11.ibid
12.D.Walters and J . Dunn ,» Student ' s Manual of
Auditing the Guide to UK Auditing Practice ».
13.ibid
Under the Statement of Auditing Standards (SAS) 1101, it
is stated that 'Auditors
should plan and perform their audit procedures and
evaluate and report the results
thereof, recognising that fraud or error may materially
affect the financial statement'.
In practice, these provisions illustrate the limits of
the audit, also the division of
responsibility between the auditor and the audit clients. The
audit cannot be expected
14
to detect all errors or instances of
fraudulent or dishonest conduct.
The likelihood of detecting errors is higher than that
of detecting fraud, because
fraud is usually accompanied by acts specifically
designed to conceal its existence,
such as management introducing transactions without
substance, collusion between
15
employees or falsification of records.
One of the most important tasks of a total audit is
to report to the shareholders
significant matters that arise during an audit. The work of
the auditors carries out, and
the experience of the audit firm's partners,
managers and staff , is potentially a
source of greater value to clients; the
auditors should be positive and
constructive in conveying views and opinion to
clients; it is only through
16
effective reporting to management that
this value can be realised.
The audit report must include a statement of
the auditor's responsibility for
17
expressing an opinion on the financial statements,
this should be as follows:
«It is our responsibility to form an independent
opinion, based on our audit, on the financial statements and to report
our opinion to you».
14. D . Walters and J . Dunn ,' Student `s Manual of Auditing
: The Guide to UK Auditing Practice `.
15. D . Walters and J . Dunn , » Student ' s Manual of
Auditing the Guide to UK Auditing Practice ».
16. Gower and Davies , » Principles of Modern Company
law » .
17. Statements of Auditing Standard (SAS 100).
According to the Auditing Practice Board, audit of
financial statements is an
exercise whose objective is to enable auditors to
express an opinion whether the
financial statements give a true and fair view...of the
entity's affairs at the period
end and of its profit or loss ... for the period then
ended and have been properly
prepared in accordance with the applicable reporting
framework or, where statutory
or other specific requirements prescribe the term,
whether the financial statements'
18
present fairly'.
In practice, the auditor's potential civil liability for
negligence arises in contract or
Tort. When acting for the client, an auditor performs his
duties under a contractual
relationship with his company; if he is negligent in the
performance of his contractual
19
duties he may be liable to the company for loss
arising from negligence. If the
company is in liquidation, proceedings may be brought
by way of misfeasance
20
summons under section 212 of the Insolvency Act 1986.
In the UK, the duties of
21
auditors depend on the terms of the articles as well
as on the statutory provisions.
Under English law, the earlier cases discussed
extensively the auditor' s duties.
22
In Leeds Estate Co. v Shepherd, Stirling J.
pointed that :
`The duty of the auditor ...[is]...not to confirm himself
merely to the task of verifying
the arithmetical accuracy of the balance sheet,
but to inquire into its substantial accuracy, and to ascertain that it...was
properly drawn up, so as to contain a true and correct representation of the
state of the company's affairs'.
18.APB was established in 1991 to advance Standards of
auditing and to provide a framework of practice for the exercise of the
auditor ' s role ( See D . Walters & J . Dunn ) .
19.Boyle & Birds ' Company Law , p . 450 , 4 t h edition
2000.
20.ibid
21. C .Worth and Morse Company Law.
22 . (1887) 36Ch.D.787 at p.802.
23
In the Kingston Cotton Mill Co, Lopes
LJ defined an auditor's duties as follows:
`It is the duty of an auditor to bring to bear on the
work he has to perform that skill,
care and caution which a reasonably competent, careful
and cautions auditor would
use. What is reasonable skill, care and caution must
depend on the circumstances of
each case. An auditor is not bound to be a detective, or
as was said, to approach his
work with suspicion. He is watchdog, but not a
bloodhound. He is justified in
believing tried servants of the company in whom
confidence is place by the
company. He is entitled to assume that they are
honest, and to rely upon their
representations, provided he takes reasonable care. If
there is anything calculated to
excite suspicion, he should probe it to the bottom, but
in the absence of anything of
that kind he is only bound to be reasonably cautions and
careful.'
Moreover, an auditor may be liable for negligence to persons
relying on his report and
with whom he does not stand in a contractual or fiduciary
relationship. The Court of
Appeal in Candler v Crane Christmas had
held that a firm of accountants was not
liable in negligence to someone who had relied on a
report negligently prepared
by them and which they had known would be acted on by him,
and suffered loss as
24
a result, because there was no contractual
relationship between the parties.
However, more recently there is a tendency to
restrict the liability. In Caparo
Industries plc v Dickman, the House of Lords
considered the auditor's duty of care
25
to shareholders and potential shareholders. It held that the
purpose of the audit report
was to enable shareholders to exercise their property powers
as shareholders by giving
them reliable intelligence on the company' s affairs,
sufficient to allow them to
scrutinise the management' s conduct and to exercise
their collective powers to
26
control the management through general meetings.
23 .[1896]2 Ch279 ,also Re Equitable Fire Insurance Co
[1925]Ch 407.
24. [1951]2 K.b.164,CA
25. [1990]1 All ER 568.
26. R . Wareham , ' Tolley ' s Company Law'.
27
However, the Deloitte Haskins & Sells v National
Mutual life Nominees judgement
instead, the House of Lords confined the Common law
duty of care within the
statutory framework set by the Companies Act for company
accounts and their audit,
28
which by itself is a policy which has much to commend it.
In Electra Private Equity Partners v KPMG Peat
Marwick,a crucial initial issue is
that the special relationship does not require that the
auditor should consciously have
29
assumed responsibility. The Barings PLC v Coopers
& Lybrand case illustrate that
30
a number of different situations have been considered
in this light in the case law.
First, within groups of companies, the Courts have accepted
that it is arguable that the
auditors of a subsidiary company owe a duty of care to
the parent company, since
the auditors will be aware that the parent will rely
on the audit of the subsidiary
31
to provide accounts which reflect a true and fair
view of the group as a whole.
A second area of tortuous duty to
«third» parties involves the directors of the
32
Company by which the auditors have been engaged.
Although the Act presents the
compilation of the accounts by the directors and
their audit as consecutive and
separate events, in practice the two overlap, with the
directors finalising the accounts
33
at the same time as the audit is in progress
on the basis of draft accounts.
27.[1993]A.C.774,PC.
28.Gower and Davies , ' Principles of Modern Company law ' , p
. 584.
29.[2001]1 B.C.L.C.589,CA.
30.[1997]2 B.C.L.C.427,CA.
31.Gower and Davies , ' Principles of Modern Company
law'.
32.ibid
33.ibid
In addition, auditors who come into possession of
information about wrongdoing
during the course of their audit may be
obliged to report it to the relevant
authorities; auditing standards require auditors to
consider whether the public
34
interest requires such action. On the other
hand, the Court of Appeal,
in Sasea Finance Ltd v KPMG held that
on the basis of this professional
guidance, the auditor' s duties to the company
could embrace, as last resort,
35
a duty to inform relevant third parties of suspected
wrongdoing. For example,
where the auditors discovered fraud on the part
of those in control of the
company so that simply warning the company was
likely to be ineffective.
In practice, the test of the public interest
is used in order to give auditors
in such cases a defence to an action at Common
law by the company for
36
breach of confidence. However, the concern about the
independence and integrity
of auditors is based on the influence of non audit
services principally to the recent
corporate collapses.
1.3 The Independence and Integrity of Auditors.
The external auditor plays a critical role in
lending independent credibility to
published Financial Statements used by investors, creditors
and other shareholders as
37
a basis for making capital allocation decisions. Indeed, the
public's perception of the
credibility of financial reporting by listed entities is
influenced significantly by the
perceived effectiveness of external auditors in examining
and reporting on financial
Statements; while any consideration of the effectiveness of
external auditors involves
a wide variety of issues, it is fundamental to public
confidence in the reliability of
34 . A P B , Statement of Auditing Standards No.110.
35. [2000]1 All ER 676,CA.
36. Gower and Davies , ' Principles of Modern Company law
' .
37. '.Principle of Auditor Independence and the Role of
Corporate Governance in
Monitoring an Auditor' Independence'. International
Organisation of Securities
Commissions (IOSC),) October 2002.
financial statements that external auditors operate, and
are seen to operate, in an
environment that supports objective decision-making on key
issues fraying a material
38
effect on financial statements. In other words, the
auditors must be independent in
39
both fact and appearance.
The current English law for securing the independence of
auditors from management
have focussed to date mainly on placing the appointment,
remuneration and removal
40
of auditors in the hand of the shareholders. Everyone
concerned accepts the principle
that auditors must be objective and thus remain
independent from company
management. The regulatory framework in the UK in respect
of non-audit services
requires listed companies and other large companies to
disclose in the annual report
the amount of non audit services fees paid
to their incumbent auditor.
On the other hand, The Eighth Directive requires that
Company Auditors should
conduct audits with professional integrity and
independence. Moreover, the recent
Recommendation on Statutory Auditors' Independence
suggests that non audit
services disclosure should be further broken down into
assurance, tax advisory and
41
other, with details being provided as to the
composition of `other'. When acting,
auditors should comply with the ethical
guidance issued by their relevant
professional Bodies; each professional body has
published detailed guidance on
maintaining professional independence.
38 .'.Principle of Auditor Independence and the Role of
Corporate Governance in
Monitoring an Auditor' Independence'. International
Organisation of Securities
Commissions (IOSC),) October 2002.
39 .ibid
40 .ibid
41 .European Commission , 2002.
Solomon argued that the desire for auditors to compete on
price in offering a number
of services, as well as their desire to satisfy
their client's wishes, can lead to
42
shareholders interests being sidelined. Auditing
companies offer consultancy
43
services and IT services to the companies
that they audit . However,
as the Cadbury Report comments, such a prohibition
could increase corporate
costs significantly, as their freedom of choice in the
market would be restricted.
Consequently, the Cadbury Report stated that
companies should disclose full
details of fees paid to audit firms for non- audit
work, such as consultancy.
In 2003, the Smith Report was reluctant to deal with the
issue in a proactive manner,
44
the report stated that:
`... we do not believe it would be right to seek to impose
specific restrictions on the
auditors' s supply of non services through the vehicle of
Code guidance. We are
sceptical of a prescriptive approach, since we believe
that there are no clear-cut,
universal answers ... there may be genuine benefits to
efficiency and effectiveness
from auditors doing non-audit work'.
In the light of the Smith Recommendations, responsibility
for auditor independence
and objectivity is transferred on to the audit committee.
The audit committee plays a
key role in the financial reporting process in modern
company. The recent scandal
frauds in the UK and in the USA illustrated that
there are some common points
between the two systems.
42. J. Solomon and A . Solomon ,' Corporate Governance and
Accountability',2004.
43. ibid
44 . Smith Report,2003,p.27,para.3.5
1.4 The Audit Committee in the UK.
The Audit Committee is a committee of directors of a
company responsible for
facilitating and improving audits of its financial
statements and for dealings
with matters raised by auditors. It is an essential safeguard
of auditor independence
and objectivity. In particular, the audit committee should
have a key role where the
auditors also supply a substantial volume of non-
services to the client. An audit
committee also usually supervises internal auditing.
In modern company, the
information given in the directors' report relating
to the financial year must
be verified. Usually, to provide such third- party
control is the role of audit.
Companies Act 1981 introduced a three-tier size classification
of companies (Small,
Medium, and Large) and the option for small companies to
file `modified accounts'.
The size of small company that should be exempt from the
audit was an important
issue in the debate in the UK. In 1994 the EC fourth
Directive permitted national
Governments to dispense with the requirement for small
companies to undergo a
statutory audit.
The importance of audit committee was increased with the
major reports of 1990s
which had an impact on UK listed companies. The Code
of Best Practice of the
45
the Cadbury Committee stated that:
`The board should establish an audit committee of at
least three NEDs with written
of reference which deal clear with its authority and
duties'.
In 1992 only approximately two thirds of the top UK
listed companies had audit
46
committees. The Cadbury Code Provision had the indirect
`hidden agenda' impact
of virtually ensuring that the boards of listed
companies became balanced
47
through having a significant number of non
- executive directors.
45. Cadbury Code , provision 4.3.
46. Price Waterhouse Corporate Register , published by
Hamilton Scott .
47 . ibid
In 1998, the Hampel Committee on the financial aspects of
corporate governance
and directors' remuneration published its report and
the Combined Code which
replaced the Cadbury Code. The recommendations of
Hampel were along
similar lines and on similar issues to Cadbury; an
important contribution made by
the Hampel Report was the emphasis attributed to avoiding a
prescriptive approach to
48
corporate governance improvements and recommendations.
In 2003 a new version of the Combined Code was published,
so - called because it
combined the Cadbury (1992) and Greenbury (1995)Codes with the
modifications and
additions that the Hampel Committee had decided upon,
all of which the Stock
49
Exchange then adopted. The main principle of the
Combined Code regarding the
audit committee and auditors is that 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
the company' s auditors (C . 3).
The audit committee is responsible to the board, it
exists to assist the board to
discharge certain of its responsibilities, it should
satisfy that at least one member of
50
the audit committee has recent and relevant financial
experience. The main role and
responsibilities of the audit committee should be set out in
written terms of reference
51
and should include:
* to monitor the integrity of the financial statements of
the company and any formal
announcements relating to the company's financial
performance, to review the
company 's internal control and, risk management
systems ( para 3.2.);
* to monitor and review the effectiveness of the
company's internal audit function
(para 3.2.3);
48 . J . Solomon and A . Solomon , ' Corporate Governance
and Accountability ' , 2004.
49 . A . Chambers , ' Tolley ' s Corporate Governance'.
50.ibid
51.The 2003 Combined Code.
*to make recommendations to the board, for it to put
the shareholders for their
approval in general meeting, in relation to the
appointment, reappointment and
removal of the external auditor and to approve the
remuneration and terms of
engagement of the external auditor (para 3.2.4);
*to develop and implement policy on the engagement of
the external auditor to
supply non audit services, taking into account relevant
ethical guidance regarding
the provision of non-audit services by the external firm
(para 3.2.5).
On the other hand, the establishment of relations between the
audit committee and the
shareholders is essential for good corporate
governance. The Combined Code
provides that there should be a dialogue with
shareholders based on the mutual
understanding of objectives. The board as a whole has
responsibility for ensuring that
a satisfactory dialogue with shareholders takes
place (para. D.1).
However, the shareholder's contact is mostly with the
chief executive and finance
director, the chairman should maintain sufficient contact
with major shareholders
to understand their issues and concerns; the
board should keep in touch with
shareholder opinion in whatever ways are most practical and
efficient (para. D. 1).
Many UK companies already have an audit committee.
J . Charkham argued that in 1994, 53 % of the
top 250 industrial firms in
52
The Times 1000 have an established audit committee. In
addition, the impact of
the Combined Code on UK companies' directors and
industrial investors has
been far- reaching, especially in the area of investor
relations and shareholders'
53
activity. In a decade, corporate attitudes toward
their core investors have been
54
transformed from relative secrecy to
greater transparency. Similarly,
the attitudes of institutional investors have
been transformed from relative
55
apathy toward their investor companies
activities to an active interest.
52 .J . Chakham , ' Keeping Good Company'.
53.J.Solomon and A . Solomon, ' Corporate Governance and
Accountability'.
54.ibid
55.ibid
Even if the UK corporate governance does not provide a
requirement for a report
from the audit committee to appear in the annual
report of the company, the
Chairman of the audit committee should be available to
answer questions at the
56
annual general meeting of the company.
In addition to regular reporting through to the board
following each audit committee
meeting, it is good practice for the audit committee to
provide a special annual report
57
to the board. Some boards may consider this annual
report to be a satisfactory
alternative to regular reporting through to the board
following each audit committee
meeting, although there is an obvious need for the audit
committee to report to the
board on its scrutiny of interim and final financial results;
the annual report will cover
58
the committee's activities over the year.
Regarding the meeting of the audit committee, the
agenda plays an essential role.
Errors in minutes are usually errors of omission
rather than mistaken minutes;
it is important that the Chairman of the audit
committee is effectively in control
59
of both the agendas and the minutes of the committee.
On the other hand, the US Public Oversight Board's new
recommendation provides
that the committee should develop a formal calendar of
activities related to those
areas of responsibility prescribed in the committee
charter, including a meeting plan
60
that is reviewed and agreed to by the entire board. The
meeting plan should include
communications between the committee chair or full
committee and the auditors
61
before the release of interim or year end financial
data .
56 . J. Solomon and A . Solomon ,' Corporate Governance and
Accountability `.
57 . A . Chambers , ' Tolley 's Corporate Governance'.
58 .J .Baden ,'The Developing Role of Audit Committee ' ,
Internal Control(July 1998),
pp.3-6.ICAEW,London.
59.A.Chambers,'Tolley's Corporate Governance'.
60.J.Baden,'The Developing Role of Audit Committee ' ,
Internal Control (July 1998),
pp.3-6.ICAEW,London.
61.A.Chambers ,'Tolley `s ,Corporate Governance `.
However, the committee's relationship with internal audit is
quite crucial. One of
the responsibilities of the audit committee is to advise the
board on the effectiveness
of risk management and internal control and so the
committee needs to be able
62
to place reliance upon internal audit. A. Chambers
argued that it is best practice
that the appointment or removal of the head of
internal audit should have
the prior approval of the audit committee; the head of
internal audit should have
unrestricted access to the chair of the audit committee at all
times and the right to ask
63
for items to be placed on the agenda
of audit committee meetings.
In 1999 The Turnbull Committee was set up specifically
to address the issue of
internal control and to respond to those Provisions in
the Combined Code. The
Report provided an overview of the systems of internal
control in existence in
UK companies and made clear recommendations for improvements,
without taking
prescriptive approach. In addition, the Turnbull
Report represented an attempt to
64
formalize an explicit framework for internal control in
companies. Even though many
other countries are now focusing attention on the
systems of internal control and
65
corporate risk disclosure within their listed companies.
Even before Turnbull there
66
was a trend in this direction, as J. Baden reported :
`We believe that internal audit, as a separate discipline,
is no longer cost-effective or efficient. It is, instead, an essential element
of the overall corporate risk management system. Good internal auditors must be
risk and control consultants. Their job, in part ,is to help the business
make more accurate assessment as a basis for commercial
decisions'.
Moreover, the Turnbull Report requires that the board at
least annually reviews the
adequacy of the internal audit function or, whether there is
no internal audit, considers
67
whether internal audit should be set up.
62.A.Chambers,'Tolley's Corporate Governance'.
63. ibid
64.ibid
65. J. Solomon and A. Solomon ,'Corporate Governance and
Accountability `.
66.A. Chambers ,'Tolley `s Corporate governance `.
67.ibid
It is generally admitted that the effectiveness of
internal control is essential for
communication between the audit committees and the boards, the
audit committee's
68
responsibilities is to review the quality of information that
the board receives:
`One of the major requirements for good corporate governance
is that the board of the company receives the information it needs to take the
decisions it has to take; that this information is reported in a digestible
form and that it is accurate. This is something
the audit committee looks at on a regular basis, though it is
equally a concern of the whole board who take great interest in this
matter'.
The board should certainly be `in the know 'about this
whether or not the directors
intend to publish their opinion about it; some organisations
are establishing additional
committees of the board, for example, many UK hospital
boards of directors now
have clinical governance committees reporting to the
board on clinical risk and
69
control which, by and large, is their
equivalent of operational control.
1.5 Audit Committee in the USA
Traditionally, directorate audit committees were first
proposed in 1939 as a direct
result of the Mckesson & Robbins
scandal and in 1940 by the New York Stock
Exchange ( NYSE) and the Securities and Exchange
Commission (SEC), were not
70
widely used for many years. Revived interest in audit
committees began with a
recommendation for their use by the executive committee
of the AICPA in 1967
which stated: 'that publicly owned corporations
appoint committees composed
of out side directors (those who are not officers or
employees) to nominate the
independent auditors of the corporation' s financial
statements and to discuss the
71
auditor's work with them.
68 . A .Chambers , ' Tolley ' s Corporate governance'.
69 . The Turnbull Report is guidance to directors on
implementing the section on
Internal control within the Combined Code.
70 .J . Baden , ' The Developing role of Audit Committees
'internal control'.
71. A . Chambers , ' Tolley ' s corporate governance'.
Moreover, the audit committee' s members shall meet
the requirements of the
72
NYSE, the SEC and any other applicable law or
regulation. The audit committee
shall be independent non executive directors and
shall meet at least four times
73
annually or more frequently as circumstances dictate. In
2002,the Sarbanes-Oxley
Act (SOA) operated an important reform
on the Accounting Industry. On the other
hand, the New York Exchange ( NYSE ) submitted a rule
filing to the SEC which
includes new proposed corporate governance Standards
intended to be codified in a
74
new section 303A of the Exchange's Listed Company Manual.
The SOA established a new law against executives who commit
corporate fraud and
increase the Securities and Exchange Commission ( SEC)
budget for auditors and
investigators; the law is also intended to restore
investor confidences in US market
75
after the 2001' s scandals. This reform was a land mark
event, representing the most
76
important changes in the Federal Securities laws since
the 1930s. However, even if
there are some common points between the new US corporate
governance standards
and the Combined Code, the new proposed US Standards do not
distinguish between
77
'Principles' and `Provisions'. The scope of these new
proposed US Standards is thus
much narrower than the scope of the UK's Combined Code
which gives much more
comprehensive coverage of essential elements of
corporate governance; the
proposed US Standards appear to be a focussed `fix'
designed to address almost
exclusively the corporate governance weakness revealed by
the recent US corporate
78
debate. Section 303 A of the new proposed US
Standards requires that listed US
companies must have a majority of independent directors not
merely non-executive.
72.Norman E . Auebach, ' Audit Committees New Corporate
Institution'
73.A.Chambers,'Tolley's Corporate governance'.p.1145
74.ibid
75.A.Chambers,'Tolley's corporate governance'.
76.ibid
77. ibid
78. ibid
The proposed new US Standards elaborate upon
the criteria to assess
`independence' whereas in the UK independence is
expressed simply as:
... independence of management and free from any business
or other relationship
79
which could materially interfere with the exercise of their
independent judgement.
Non - executive directors considered by the board to be
independent in this sense
80
should be identified in the annual report. A. Chambers points
out another element of
comparison between the new proposed US Standards and the
UK Combined Code.
In the UK it is for the board to decide whether a
director is independent, indeed the
guidance to the US proposed Standards also states that the
concern is `independence
81
from management' and a proposal Standards reads:
`No director qualifies as «independent «unless the
board of directors affirmatively determines that the directors has no
material relationship with the listed company
(either directly or as a partner, shareholder or
officer of an organization that has a
relationship with the company).
82
Regarding the specific criteria, the new proposed US
Standards provides as follows:
`No director who is a former employee of the listed company
can be «independent»
until five years after the employment has ended.
No director who is, or in the past five years has been,
affiliated with or employed by
a (present or former) auditor of the company (or of an
affiliate) can be independent
until five years after the end of either the
affiliation or the auditing relationship.
No director can be» independent» if he or she is, or
in the past five years has been, part of an interlocking directorate in which
an executive officer of the listed company
serves on the compensation committees of another company that
concurrently employs the director.
Director with immediate family members in the foregoing
categories are likewise subject to the five years «cooling-off»
provisions for purposes of determining
«independence».
79 . A. Chambers , ' Tolley ' s corporate governance'.
80. Combined Code `Provision A 3.2.
81 A . Chambers , ' Tolley ' s corporate governance'.
82.New Proposed US Standards 2.(a),(i) to (iv).
In practice, there are many other possible impediments
to independence; notable
amongst the above four given criteria is the introduction of a
past audit relationship as
an impediment to independence; it is also notable
that, in the third independence
83
tests, interlocking directorships are seen as an
impediment to independence.
Under the new proposed Standards, all members of the
audit committee should be
independent directors. According to this section, the audit
committee is sole authority
to hire independent auditors, and to approve any
significant non-audit relationship
with the independent auditors and it must set clear
hiring policies for employees or
84
former employees of the independent auditors'. In
addition, the new proposed
Standards prescribes that the audit committee must receive at
least annually a report
on the independent auditor's quality control and
information about certain inquiries
85
and investigations of the independent auditor
within the last five years.
1.6 Current position under Common law :English Law and
USA.
The CA 1900 provided that in an attempt to ensure the auditors
from the management,
the auditor should not be an officer of the company.
In addition to the classic
provisions, there is the influence of the European Company
Law. The implementation
of the EEC Council Directive of 1984 in the CA1989 is
considered as the result of the
legislation on the qualification of auditors. Under s.25 of
CA 1989, to be eligible for
appointment as a company auditor, persons must be
members of a recognised
supervisory body, and be eligible under its rules to be
appointed as company auditor
which in turn requires that they be independent of the
company concerned and hold
appropriate qualifications. This is important for the
objectivity and the integrity of
the audit.
83.A.Chambers,'Tolley's corporate governance'.
84.ibid
85.ibid
On the other hand, section 53 of CA 1989 stated that
where a firm is appointed,
company auditor it is the firm which must be a member of a
recognised supervisory
body and be eligible for appointment as company auditor
under the rules of the
relevant body. In addition under CA1989, a person whose
function is to report to the
members and who originally was frequently also member,
the auditor has always
been appointed by the members. One of the most important
tasks of the auditors is to
communicate effectively with the shareholders.
In Re London and General Bank it was
held that the Standard of care and skill
auditors must exhibit in carrying out their tasks is
that of the ordinary reasonable
86
auditor. In view of the professional qualifications now
required, and the increased
rights to inspect records and demand information and
explanations, it may be doubted
87
whether a Standard based on the nineteenth century case
law is still appropriate.
As to the specific issues of the case, Justice
Lindley had the following to say:
`It is a mere truism to say that the value of
loans and securities depends upon
their realisation. We are told that a statement
to that effect is so unusual that
the mere presence of those words is enough to excite
suspicion.But,as already stated,
the duty of an auditor is to convey information, not to
arouse enquiry ,and although
an auditor might infer from an unusual statement
that something was seriously
wrong ,it by no means follows that ordinary people
would have their suspicions
aroused by a similar statement if ,as in this case, its
language expresses no more than an ordinary person would infer without
it.'
88
Under English law, the Kingston Cotton Mill
Co. case and the Re London and
General Bank case have formed the basis
for all subsequent decisions as to the
89
determine of auditor's negligence. Also, the crucial
importance in both instances is
the recognition of auditing as a profession. Finally, we may
consider that auditors do
not guarantee that the financial statements a true
and fair view any more than
86.[1895]2 Ch 673 at 682-3,CA.
87.Farrar's Company Law.
88.[1896]2 Ch 279
89.[1895]2 Ch 673 CA.
solicitors guarantee to win a case; the auditors
warrant to bring to bear the highest
degree of work in the performance of their duties. The
reform of the joint and several
liability rule not in favour, attention has concentrated
instead on the rules governing
whether and in which circumstances auditors owe a duty
of a care to persons other
90
than the company which has engaged them. Under the
present rules, each party is
liable for 100% of the loss through dishonest or unauthorised
dealing or concealment
of matters from the auditors, with a right of contribution
against the others who are
910
92
also liable. In practice, it is the auditors who are
sued because of their insurance
cover.
On the other hand, s. 310 of CA has prevented auditors
limiting or excluding their
liability, or being indemnified against liability, by
contract with the company.
Moreover, there is the work of the Courts which have
operated not on any special
rules applicable to auditors but on the application in
the auditing context of the
general Common law rules governing liability for
economic loss caused by
93
negligent misstatement.
Under the English law, before the Hedley Byrne v
Heller, there was no liability for a
negligent misrepresentation made by one person to another
even where the person
acted upon the representation to his or her detriment;
Hedley Byrne has proved to be
94
of crucial relevance to claims against accountants and
auditors. Here, it was held
that in certain circumstances, liability could be incurred
for a negligent misstatement
where there was a special relationship between
the parties.
90.Gower and Davies , ' Principles of Modern Company law
.'
91.Farrar's company law'.
92.ibid
93.Gower and Davies , ' Principles of Modern Company law
' .
94.[1963]2 All ER 575.
In the Hedley Byrne case, the test for
liability is:
*Whether the plaintiff is a person, or within a class of
persons, who the defendant in preparing, or reporting on the accounts knew,
or ought to have known would rely
upon the accounts for a purpose which the defendant knew,
or ought to have known.
In general, the liability of the auditors to third
parties is more likely to arise if the
audited accounts are shown to the third party either
by or in the presence of the
auditor.The scope of the auditors's duties to the company and
to shareholders was set
95
out in Caparo Industries Plc v Dickman. Here
,the plaintiffs (Caparo Industries plc),
which had purchased the shares of another (Fidelity
plc), brought a lawsuit against
the directors of Fidelity plc and against the auditors.
The plaintiffs claimed that the
auditors were negligent in carrying out their audit. As the
auditors owed both current
shareholders and potential shareholders a duty of care
regarding the audit of Fidelity's
financial statements; that the auditors should have known
that Fidelity's profits were
not as high as reported; that Fidelity' s share price
had fallen significantly; that
Fidelity required financial assistance; that it was
susceptible to a take - over bid;
and that reliance would be placed on the accuracy of the
financial statements by any
potential bidder.
It was held that the auditors do not owe a `duty of care' to
those third parties who may
place trust in their work or for decisions as to whether or
not to extend credit to the
company. Lord Bridge of Harwich cited the CA1985 and referred
to the decision of
Bingham J of the Court of Appeal. In his opinion, Bingham J
discussed the role of the
statutory auditor under CA1985, stated that the role of
statutory derives from the
nature of the public limited liability company.
95.[1990]AC 605 HL.
The shareholders of the plc are its owners, but
they are too numerous and too
unskilled to undertake the day-to-day management of the
company. Consequently,
the responsibility for the day-to-day management is
delegated to the directors of the
company; there is a potential for abuse if the
shareholders only receive information
from the directors of the company. On the other hand,
section 384 of CA1985
provides that the shareholders of the company should
an appoint auditor whose
duty it is to investigate and form an opinion on
the adequacy of the company's
financial statements.
The statutory of the framework for company accounts and
audits led them to the
following conclusions; the statutory provisions establish a
relationship between those
responsible for the accounts(directors) or for the report (the
auditors) and some other
96
classes of persons and this relationship imposes a duty of
care owed to those persons.
Among these »persons» is the company itself, to
which apart altogether from the
statutory provisions, the directors are in a fiduciary
relationship and the auditors in a
97
contractual relationship by virtue of their employment by the
company as its auditors.
Under Common law once the duty of care is established, for
liability to imposed on
the auditor, the auditor's breach of the duty
(negligence) must have caused the loss
or damage suffered by the third party; the Courts have
relied on the «but for» test
98
for proving causation. However, in recent cases some judges
have taken a «common
99
sense» approach to the causation issue. In the
Australian case of Alexander v
Cambridge Credit Corporation Limited the
New South Wales Court of Appeal
95.Gower and Davies , 'Principles of Modern Company Law'.
96 .ibid
97.ibid
98.ibid
99.ibid
approved the common sense approach to the issue of causation
in a case involving
100
auditors. Here, in 1971 the auditors of Cambridge Credit
failed to note in the annual
certificate that the accounts did not show provisions
which should have been made.
The company claimed damages for negligent breach of
contract against the auditors
claiming that « but for» the breach by the auditors
the company would have gone into
receivership in 1971. It was held that there was no
causal connection between the
1971 breach and the losses suffered later on. In reaching
this decision, all the judges
considered that « but for» test was
not enough to determine the causation
requirement; McHugh J stated:
«In general, the application of the «but
for» test will be sufficient to prove the necessary cause or connection.
But that test is only a guide. The ultimate question is whether, as a matter
of common sense, the relevant act or omission was the cause».
In the UK, the Galoo v Bright Grahame Murray
case follows the Cambridge Credit
as it concerned a claim against auditors and the decision is
important for its finding on
101
the causation issue. Here, the auditors of Galoo and its
parent company were claimed
to have negligently performed their duties over a five year
period by failing to detect
the Court of Appeal argued that although the auditors'
negligence gave Galoo the
opportunity to continue to incur trading losses, it
did not cause those losses.
The plaintiffs claimed for the losses resulting
from the continuation of trading
after the date on which, had the auditors not been
negligent, the company' s true
position would have been discovered. The Court of Appeal
argued that although the
auditors' negligence gave Galoo the opportunity to continue
to incur trading losses, it
did not cause those losses.
100.[ 1987 ] 9 nswlr 310 /credy
101.[1994] BCC 319
According to Glidewell L J, a plaintiff is entitled
to claim damages for breach of
contract by the defendant where the breach is the effective
or dominant cause of his
loss and does not merely provide him with the opportunity to
sustain loss. Further,
in considering whether a breach of duty by the defendant is
the effective cause of loss
or merely the occasion for the loss, the Court has to
reach a decision by applying
common sense to the facts of the case. It was held
that on the facts the auditors'
breach of duty clearly provided the plaintiff with the
opportunity to incur and to
continue to incur trading losses, but it could not be said to
have caused those losses.
On the other hand, the study of Company Law in the USA shows
that the laws differ
among the various States. In addition, the Federal
Government law constitutes a
separate system of law. The two most important Federal
statutes affecting auditors
are the Securities Act of 1933 and the Securities
Exchange Act of 1934,which are
administered by the SEC. The 1933 Act requires audited
financial statements to be
included in registration statements filed with the SEC
when non-exempt entities
initially offer securities for sale to the public. On the
other hand, The 1934 Act
requires public companies with assets in excess of $ 5
million and more than 500
stockholders to file annual reports with the SEC,
including audited financial
statements.
In general, the liability of the auditors to third parties
under Federal Securities law is
102
greater than under the Common Laws of the various States.
However, in most cases
the auditor can defend against suits brought by third
parties under Federal Securities
Law by establishing either that the auditor performed his
or her professional duties
103
with «due diligence» or that there was no intent
on the part of the auditor to deceive.
102. A . Chambers , ' Tolley ' s Corporate Governance'.
103.ibid
However, under common law there have been several ways of
viewing (see USA)
auditors' duty of care to third parties; the first
view is consistent with the Caparo
decision and argues that the auditor does not owe a
specific duty of care to third
104
parties. This is referred to as the strict
privy of contract doctrine;
this doctrine was first introduced into the area of
auditor' s legal liability by the
105
Ultramares Corp.v Touches case in the early
1930s. Here, the Court found the
auditors guilty of negligence but ruled that
accountants should not be liable to
any third party for negligence. The Ultramares case
also introduced the concept
of foreseability, which suggests that if the auditor
foresaw or could be expected to
foresee that certain persons would use the auditor's
report then the auditor might
be held liable for ordinary negligence by the
group of persons.
Even though Ultramares introduced the concepts of
foreseability and gross
negligence which may constitutes fraud into the
discussion of auditors' s liability,
the privy of contract was established as matter of policy
via now famous quote from
Chief Justice Cardozo:
`If liability for negligence exists ,a thoughtless slip
or blunder, the failure to detect
forgery beneath the cover of deceptive entries, may
expose accountants to a liability
in an indeterminate amount for an indeterminate time to
an indeterminate class. The
hazards of a business conducted on these terms are so
extreme as to enkindle doubt
whether a flaw may not exist in the implication of a duty
that exposes to these consequences'.
In addition, Courts in the USA have not found auditors
liable under Common law for
ordinary negligence to third parties; to be held liable,the
auditor must not only foresee
the use of the audit report by the parties, the auditor
must also acknowledge the use
106
of the audit report by the third parties. However,
the Caparo case is similar to
Ultramares in its lack of extension of an auditor duty of care
to third parties;
104 . ibid
105. (1939) 255 NY.
106. A. Chambers , ' Tolley ' s Corporate Governance'
it can also be compared with the Credit Alliance
Corporation v. Arthur Anderson
107
& Co. decision. Here, the New York Court
of Appeal reaffirmed the basis rational of
Ultramares and specific three following additional
prerequisites before an auditor may
be held liable for ordinary negligence to third parties:
1) the auditor must have been aware that financial
statements were to be used for a
particular purpose or purposes by a known
party or parties;
2) in furtherance of the particular purpose, the known parties
were intended to rely on
the financial statements; and
3) there must be some conduct on the part of the
auditor linking the auditor to the
known party or parties that demonstrates the
auditor' s understanding of the
reliance.
More recently, the California Supreme Court in Bily
v. Arthur Young & Co. ended
108
the foreseeability standard in that stated:
`We conclude that an auditor owes no general duty of care
regarding the conduct of an audit to persons other than the client. An auditor
may, however, be held liable for negligent misrepresentations in an audit
report to those persons who act in reliance upon those misrepresentations in a
transaction which the auditor intended to influence...Finally, an auditor may
also be held liable to reasonable foreseeable third persons for intentional
fraud in the preparation and dissemination of an audit report.'
As G .Quillen pointed out, Bily 's decision has had a profound
impact on professional
liability litigation; there has been a well recognized
«expectations gap» between
auditors own understanding of their role and the
expectations that clients, third
parties, judges and juries often have; Courts, clients,
and third parties often seemed
to expect auditors to be able to detect any type of
financial statement misstatement,
and assumed that if the auditor 's report did not disclose
a misstatement it must be a
109
result of fraud or negligence. Bily has elevated the level
of discussion of subsequent
110
accountant liability cases; recent judicial decisions
confirm Bily's influence.
107.1985.483 NE 2d 110.
108.3 Cal.4th 370 (1992).
109.G.Quillen,'The Profound Influence of Bily vs. Arthur
Young', published in ABTL Report
Volume XXIII No.3,June 2001.
110.ibid
For example, In Marini v . Pricewaterhouse
case, the Court applied the essential
teachings of Bily, and it demonstrates that Bily
changed the landscape of auditor
111
liability litigation. Here, plaintiffs were
individuals including Mr. Marini, the
Chairman of the board of directors of a corporate audit
client of Pricewaterhouse
( « PW » ). The individual was also a
guarantor of some of the corporation's debt
obligations. Plaintiff sued PW for negligence, negligent
misrepresentation, intentional
misrepresentation and breach of contract. It was
held that claims for auditor
negligence can be asserted by the auditor 's client only,
and not by third parties.
As we can see, under the Federal decisions, Bily impact is
still important. It was also
applied in at least three significant decisions, one decided
under the federal securities
laws, and two in Securities and Exchange Commission (
« SEC » ) enforcement
112
proceedings against auditors. In Reiger v .
Pricewaterhouse Coopers LLP, the
plaintiffs alleged that the defendant («PW»)
violated Section 10b and Rule 10b-5 of
the Securities Exchange Act of 1934 in a case in which
PW's audit client restated
113
financial numbers which had been previously reported on by
PW. Here, the Court
ruled that plaintiffs failed to allege scienter on the
part of PW and granted PW's
motion to dismiss without leave to amend; it cited several
federal cases stating that
auditors will rarely, if ever, have a rational motive for
participating in a client's fraud.
In addition, the Court cited Bily as follows:
« Second, because an independent accountant often
depends on its client to provide
the information base for the audit, it is almost always
more difficult to establish
scienter on the part of the accountant than on the part of
its client...»
111 . 70,Cal.App.4th 685 (1999)
112. G. Quillen,' The Profound Influence of Bily vs. Arthur
Young'; ABTL Report.
113. Reiger , F.Supp.2d.1003 (S.D .Cal. 2000)
1.7 Recent development of Audit liability
The most common on the corporate governance debate are
the duties of care which
are in relation to conduct and supervision of the
company's affairs, and in particular
the preparation of the company's accounts. The auditors can
be held liable in relation
to their audit of the company 's accounts,
if they conduct their business
negligently. On the other hand, there is now a
fair amount of case law which
recognises that common sense and logic an important role
to play when it comes to
114
determining the cause of a plaintiff's loss.
In South Australia Asset Management Corporation
v York Montague Ltd, a
valuer had provided a lender with a negligent over-valuation
of a property offered as
115
security for a mortgage advance. The lender gave evidence
that the loan would never
have been entered into in the first place if the lender had
been aware of the true value
of the property. The House of Lords had to determine the
lender's loss, which had
been increased by a drop in property values throughout
the market. It was held that
the valuer was not liable for the loss due to the drop in the
market.
The House of Lords stated that generally a wrong-doer
would only be liable for the
foreseeable consequences of the action being taken in
reliance on that information.
The decision makes it clear that a negligent
valuer will only be liable for the
consequences of a lender's bad investment which are
within the scope of the duty
which the valuer owes to the lender.
The damages awarded against the auditors can be far in
excess of their ability to pay,
either from their own resources through their professional
cover; the liability system
116
is regarded as a risk transfer mechanism and the auditors
are the prime transferees.
114.M.Robertson and K . Burkhart , ' Liability of Auditors to
third Parties'.
115.[1996] All ER 365.
116. G.W. Cosserat ,' Modern Auditing '.
On the other hand, the Supreme Court of Canada, in
Hercules Management Ltd
stated that accountants can be held responsible in
delict or tort to non- clients
117
for the negligent acts they commit in exercising their
protection. In an attempt
to determine class or classes of plaintiffs to whom
auditors owe duty of care, a
duty of care the Court held that auditors are liable to
plaintiffs who are members of a
limited class whose use of and reliance on financial
statements are known to them.
Here the Court recognised that in many cases a duty of
care exists when it is proved
that the accountant ought to have reasonably foreseen that
shareholders, as a class,
will rely on his representations and that the reliance by
shareholders was reasonable
(such as in the Caparo Industries plc case).
According to the Court, the normal
purpose for which auditors' reports are used, in order
to give rise to a duty of care
on their part, is to guide the shareholders as a group
in supervising or overseeing
management and not to assist them in making personal
investment decision, the
auditors should not, as a matter or policy, be
exposed to indeterminate liability.
More recently, in Price Waterhouse v Kwan
the Court of Appeal held that the
auditors owe a duty of care in tort to the Solicitors 's
clients who invested through the
118
Solicitors `nominee company. Here, the Court found that there
was a clear prima facie
case for imposing the duty of care which should be
confirmed at trial unless there
emerged some evidence providing policy reasons
sufficient to lead to the opposite
conclusion.
117. (1997) D.L.R. (4th ) 577 (S.C.C.).
118 . (2000) 6 NZBLC 102,945
Chapter 2 Concept of `Good `Corporate Governance in the
UK
2.1 Introduction
Traditionally, the early work of Berle and Means is
recognised as the origin under
119
modern Common law. Corporate governance has been
practiced for as long there
have been corporate entities, yet the study of
the subject is less than half a
century; indeed, the phrase 'Corporate Governance' was
scarcely used until the
120
121
1980s,and the whole topic was overlooked until recently. The
expression'....is concerned with the way corporate entities are governed
,as distinct from the way business within those companies are mange. Corporate
governance addresses the issues facing boards of directors, such as the
interaction with top management , and
relationships with the owners and others interested in the
affairs of the company...'
In 1978 Clifford C. Nelson, wrote that' corporate
governance is a fancy term for the
various influences that determine what a company does and does
not do or should and
122
should not do'. Even if the practice of corporate governance
is ancient, the theoretical
123
exploration of the subject is relatively new. All business
enterprises need funding in
order to grow, and it is the ways in which companies are
financed which determines
their ownership structure; it became clear centuries ago
that individual entrepreneurs
and their families could not provide the finance necessary to
undertake developments
required to fuel economic and industrial growth; the sale
of company shares in order
to raise the necessary capital was an innovation that has
proved a cornerstone in the
124
development of economies worldwide.
119. A. A. Berle Jr and G. C. Means, 'The Modern Corporation
and Private Property'.
120. R .I. Tricker,' Corporate Governance : History of
Management thought'.
121 .R .I. Tricker, 'The Independent Director-A Study of the
Non- executive director and
the Audit Committee'.
122 .cited in Dill.1978.
123. R .I .Tricker, 'Corporate Governance'.
124. J. Solomon and A. Solomon,' Corporate Governance and
Accountability'.
Solomon argued that the rise of the global
institutional investor as a powerful and
dominant force in corporate governance has transformed
the relationship between
companies and their shareholders and has created a
completely different system of
corporate governance; ownership structure is no longer
widely dispersed ,as in the
model presented by Berle and Means, but is now
concentred in the hands of a few
125
major institutional investors. Under Common law, since the
early period, the House
of Lords' s decision in Solomon v Solomon
& Co. Ltd established the separate
126
identity of the company. Here, Lord Halsbury LC said:
`I must pause here, to point out that the statute enacts
nothing as to the extent or degree of interest which may be held each of the
seven (subscribers ) or as to the
proportion of influence possessed by one or the
majority of the shareholder over
the others. One share is enough. Still less is it
possible to content that the motive
of becoming shareholders or of making them shareholders is
a field of enquiry which the statute itself recognises as legitimate, if there
are shareholders, they are shareholders for all purposes; and even if the
statute was silent as to the recognition of trust, I should be prepared to hold
that if six of them were the cestuis que trust of the seventh, whatever might
be their rights inter se, the statute would have made them shareholders to all
intents and purposes with their respective rights and liability, and dealing
with them in their relation to the company ,the only relations which I believe
the law would sanction would be that they were corporators of the body
corporate'.
127
The House of Lords 'decision in Solomon has been
criticised as going too far.
The contemporary comment of the Law Quarterly Review
was that the House
of Lords had recognised that one trader and six dummies would
suffice and that the
128
statutory conditions were mere machinery. Farrar points
that all legal personality
129
is in a sense fiction the creation of legal artifice.
Corporate personality is essentially
a metaphorical use of language clothing the formal group
with a single separate legal
130
identity by analogy with a natural person. Metaphors in
fact abound in this area of
131
law, both to support and to reject the separate
legal personality of the company.
125. J. Solomon and A. Solomon ,'Corporate Governance and
Accountability `.
126 . [1897] AC 22 at 49,HL.
127. J. Solomon and A .Solomon, 'Corporate governance and
Accountability'.
128. ibid
129. Farrar's company law'.
130. ibid
131.ibid
It is interesting to note that this case thus established one
of the basis articles of faith
of British company law, indeed of company law of all Common
law systems, that
company is a legal person independent and distinct
from its shareholders and its
managers.
The principle of separate identity has been consistently
applied as the New Zealand
case of Lee v Lee's Air Farming Ltd, which
went to the Privy Council, Lee owned
132
all the shares but one in the company that he founded. His
wife held the other share.
Lee was governing director of the company whose
business was spraying crops
from the air. When he was killed in a flying accident
while on company business,
his widow was held to be entitled to recover
compensation from the company
for his estate as the company was quite separate and
distinct from her husband its
employee.
More recently, the European Community's 12th
Directive on Company Law (89/667),
was enacted in the UK in the form of the Companies (Single
Member Private Limited
Company) Regulations 1992, provision has been made for the
establishment of true
one man companies. This Regulations permits the
incorporation of private limited
companies by one person and with only one member. In
the UK, the debate on
corporate governance was greatly influenced by the 1992
Report of the Committee
chaired by Sir Adrian Cadbury on the Financial Aspects
of corporate governance.
The Cadbury Report described corporate governance as
the system by which
companies are directed and controlled. Boards of
directors are responsible for the
governance of their companies. The shareholder's role in
governance is to appoint the
directors and the auditors and to satisfy themselves
that an appropriate governance
structure is in place.
132.[1961] AC 12
The responsibilities of the board include setting
the company's strategic aims,
providing the leadership to put them into effect,
supervising the management
133
of the business and reporting to shareholders on
their stewardship. The board's
actions are subject to laws, regulations and the
shareholders in general meeting. The
importance of corporate governance for corporate success as
well as far social welfare
cannot be overstated; recent examples of massive corporate
collapses resulting from
weak systems of corporate governance have highlighted
the need to improve and
134
reform corporate governance at an intentional level.
2.2 The Boards and Functioning.
A modern British company is based on its constitution, and
in particular ,its articles
of association. One of the important matters which are
regulated mainly by the articles
is the division of power between the shareholders and the
board of directors and the
composition, structure and operation of the board of
directors. The board's task is to
approve appropriate policies and to monitor the
performance of management in
implementing them. It is the board's responsibility to
ensure good governance and to
account to shareholders for their record in this regard.
In Rayfield v Hands, Vaisey J. was
prepared to make an order in effect for specific
135
performance. Under s. 282 of CA1985, all companies must have
directors. However,
the Act leaves the determination of the functions of
the board very largely to the
company's constitution's affairs, so a separation will
develop between those own the
133.J.Solomon and A . Solomon , ' Corporate governance and
Accountability'.
134.ibid
135.[1958]All ER 194
company (shareholders) and those who manage it (directors).If
we look at the Table A
we can see that it supposes that the board will be
allocated a very significant role.
According to its article 70, »...the business of the
company shall be managed by the
directors who may exercise all the powers of the
company...»The Bullock Committee
described that `the role of a board varies from company to
company and is constantly
changing with the requirements of business. It may be related
to the size, complexity
and nature of the company' s operation and therefore to the
organizational structure
which has been developed over many years, it may
depend on the philosophy of
136
management in the company or on the personality
of the chief executive'.
Parkinson suggests the responsibility of the board
which is for long-term strategic
planning, for example, concerning investment in new
production facilities and
products, merging or making a bid for another company, closing
down existing plants
137
or pulling out of unprofitable markets. Parkinson added, at
least in theory, another
important function is to monitor the performance of senior
executives, and also the
138
performance of the company's operating divisions and
subsidiaries. The main board
will normally be made up of a chief executive, who will hold
the office of managing
director, or possibly Chairman, or both, and will
include a number of `heads of
139
Department', for example, the finance director, personnel
director, technical director.
136. Report of the Committees of Inquiry on Industrial
Democracy,1976.
137. J . E . Parkinson , ' Corporate Power and
Responsibility : Issues in the Theory of
Company law'.
138. ibid
139. ibid
In general, if for some reason the board cannot or will not
exercise the powers vested
in them, the general meeting may do so. In Baron v
Potter, action by the general
140
meeting has been held effective where there was a
deadlock on the board.
In addition, although the general meeting cannot
normally abort legal proceedings
141
commenced by the board in the name of the company.Normally the
board of directors
142
is an important element of modern company. In practice,
some of them are full-time
directors. Their function is in general to supplement
the skills and experience of
143
management team, often by bringing a more dispassionate;
understanding to bear on
strategic and optional matters; it is also said that they are
able to exercise an element
144
of independent supervision over inside management. Solomon
argued that for a
company to be successful it must be well governed; as
well-functioning and effective
board of directors is the holy grail sought by every
ambitious company; a company's
board is its heart and as a heart it needs to be healthy, fit
and carefully nurtured for the
145
company to run effectively.
« Good » corporate governance is viewed as
essential in terms of safeguarding
company assets and maintaining investors confidence thus
providing greater access to
funds and reducing the potential risks associated with fraud
as there was an important
debate about corporate governance in the UK, the Financial
Reporting Council and
The Stock Exchange co-sponsored a Committee chaired by Sir
Adrian Cadbury. The
Committee's draft Report Financial Aspects of Corporate
governance published in
1992 had as its remit: the control and reporting functions of
boards, and the role of
shareholders and the role of auditors ( a
strengthening of their independence).
140. [1914] 1 Ch 895.
141. J. E .Parkinson, 'Corporate governance and
Responsibility'.
142. ibid
143.ibid
144. ibid
145. J. Solomon and A. Solomon ,'Corporate Governance and
Accountability `.
The Cadbury Committee's definition of corporate governance as
the system by which
companies are directed and controlled'
(Report,para.2.5).That definition puts the
directors of a company at the centre of any discussion
on corporate governance,
linked to the role of shareholders, since they
appoint the directors. One of the
Cadbury Committee' s recommendations was based on the
need for boards of the
Directors within listed companies to be effective. The
Cadbury report reviewed the
structure of the board and the responsibilities of
company directors, the report
recommended that company boards should meet frequently
and should monitor
executive management .
According to J . Charkham, in 1995 ICI had sixteen
directors, British Telecom
146
fifteen, Grand Met. Eight, Sainsbury twenty- two, BP
sixteen. The average for the
147
Top ten companies was sixteen. Smaller companies
sensibly tend to have smaller
boards, for example, the Bank of England Quarterly Bulletin
in May showed that
of 549 companies in The Times 1,000,39 per cent had
between six and eight and
29 per cent between nine and eleven; the 3i
Survey shows that 172 of the 215
companies in it had boards of six or fewer, and that
this was of companies with a
148
turnover of less than £ 100 million. If we look
at the classical board, we can see
that it is the of number of directors who
entrusted with the day-to-day
management of the company. The effect of the
Cadbury Code is to make non-
executive directors mandatory in quoted companies, since
they must have an audit
committee (para.4.3). In addition, the main characteristic
of a non-executive director
is that he must not only be independent
but be seen to be independent.
149
Sir Cadbury stating that the essential attribute of effective
NED is their independence.
146.J.Charkham,'Keeping Good Company'.
147.ibid
148.ibid
149.ibid
The non- executive director (NED) should bring an
independent judgement on
issues of strategy, performance, including key
appointments, and standards of
conduct (para. 2.1 of Cadbury Best Practice also
the Pro-NED). They should be
appointed for specific terms and re-appointment should
not be automatic; NEDs
should be selected through a formal process and both
this process and their
150
appointment should be a matter for the board as a whole.
However, in practice there is no distinction
between the roles of executive and
non- executive directors as both owe exactly the same
legal duties and bear equal
responsibility for decisions taken by the board
as whole. Their roles are not
formally separated as in other European systems.
In the German model, for
example, there is a formal division of duties
between the management and
supervisory board. Moreover, in the UK system
there are some factors which
exacerbate the problem which prevent NED from
being effective monitors of
management; his appointment is still largely in the hands
of executives and most of
them are former executives, which mean they are more
inclined to be sympathetic
rather than assertive and dynamic in their capacity
as NEDs. In the USA, the
proposed new section 303 A requires that listed
US companies must have a
majority of independent directors and this
clearly may take time to effect.
However, the new proposed US requirement is
that the majority of the board
should be `independent' not merely `NED'. Moreover,
the movement towards a
greater proportion of outside directors was given a
great fillip in the late 1970s as
a result of some cases of extensive
misfeasance by executive directors
consequently, in 1978 the NYSE made it a listing
requirement that companies
151
should have audit committees of outside directors.
150. J. Charkham ,'Keeping Good Company'.
151. ibid
The outside director's remuneration is founded on an
annual retainer which nearly
all companies pay, plus a `per meeting'; US
companies are obliged to report
quarterly, most boards, smaller and younger and
more independent than they
152
were, meet about six or seven times a year. The
board elects a non-executive
director as its Chairman. Contrary to the UK, the practice
in the USA is to call that
person the «President»: in the UK,
this title does not imply any executive
responsibilities, sometimes conferred as an honorary
title. Under CA1985, article
153
of Table A recognises this function. On the other hand,
the collapse of Enron, the
former US energy giant focussed attention on
the effectiveness of the NED
function. The scandal shook corporate America to
the core, and resulted in
reforms to company law.
Enron went bankrupt in December
2001 after it emerged that the company had
Concealed millions of dollars in debts . In light of the
Enron scandal, US lawmarkers
154
passed the Sarbannes- Oxley Act (SOA), compelling chief
executives to submit a
pledge that they fully understand and take
responsibility for their firm's accounts.
Cadbury and Greenbury both recommended that the
boards of listed companies
should establish a remuneration committee to
develop a policy on the
remuneration of executive directors and, as appropriate,
other senior executives; and
to set remuneration packages for the individuals
concerned. However, S.12.43 (X)
of the Listing Rules implements most of the disclosure
provisions in section B of
the Greenbury Code by requiring companies to include in
their annual report:
· a report by the remuneration committee on behalf of the
board, covering both
the company's remuneration policy for executive
directors; and
· details of the remuneration package of each
director.
152. Dorchester Finance Co .Limited v Stebbing [1989] BCLC
498
153. J . Charkham, ' Keeping Good Company ' .
154. The SOA of 2002 is a US law passed to strengthen
corporate governance and restore investor
confidence ( see
http://six signatutorial.
Com/Sox/Sarbannes-Oxley).
In 1995, the Hampel Committee was set up. Its remit
was to promote high
standards of corporate governance both to protect
investors and preserve the
standing of companies listed on the Stock Exchange
(para.1.7). The requirement
was to review the Cadbury Code and its implementation to
ensure that the original
purpose is being achieved; to pursue any
relevant matters arising from the
Greenbury Report; to look afresh at the roles of
directors, shareholders and
auditors in corporate governance. The Hampel Committee
produced a report in
1998. It noted that good corporate governance is not
just a matter of prescribing
particular corporate structure and complying with
a number of hard and fast
rules (para.1.11- 1.14). Instead there is a need
for board principles which, the
Committee hoped, will command general agreement
and which can be
applied flexibly and with common sense to
the varying circumstances of
individual companies(para.1.11-1.20).
As Solomon argued, in some ways (such the role
of institutional investors in
corporate governance) Hampel could be interpreted as
being less demanding than
Cadbury; indeed, there is a widely held perception that
the report represented the
interest of company directors more than those of
shareholders and that much of
155
the positive impact from the Cadbury Report was diluted
by the Hampel Report.
Certainly, in the area of corporate social
responsibility and corporate
accountability to broad range of shareholders, there
was a significant change in
tack between the Cadbury Report and the Hampel Report;
the latter clearly felt the
need to redress the balance between shareholders
and stakeholders and made
156
strong statements on these issues .
155.J.Solomon and A. Solomon , `Corporate governance and
Accountability `.
156.ibid
The Hampel Committee stated that:
The importance of corporate governance lies in this
contribution both to business
prosperity and to accountability. In the UK the latter
has preoccupied much public
debate over the past few years .We would wish to see the
balance corrected. Public
companies are now among the most accountable organisations
in society...We
strongly endorse this accountability and we recognise the
contribution made by the Cadbury and Greenbury Committees. But the emphasis on
accountability has
tended to obscure a board's first responsibility to
enhance the prosperity of the
Business over time (para.1.1).
Independent NED; while independence had been stressed in
the Cadbury, many
companies have appointed NEDs who have previously held
executive posts with
157
the company or have been their professional advisers
Committee. The Hampel
recommended that its broad principles together with
the Cadbury and Greenbury
Codes of Practice should be combined in a single
Code which will operate
158
alongside the Listed Rules. In 2002, the UK government
asked Mr Derek Higgs to
carry out a review of the role and effectiveness of
NED s in comparison with its
counterpart in the USA, the Sarbannes- Oxley Act.
The consultation published a Review ( DTI January 2003).
Mr Higgs noted in his
report that there was a widespread concern about the
potential liability attached to
non-executive directors, he therefore considered issues
relating to the liability of
NEDs in detail, and made some important
recommendations as follows:
*he provided guidance, now incorporated in the Combined Code,
on the position
of a NED
*he recommended that the Department of Constitutional
Affairs(DCA)should
considered step to promote active case management
(para.4.8-4.10).
157. Farrar's company law.
158 .ibid
2.3. Internal control in the UK
Internal control is the whole system of financial
controls established in order to
provide reasonable assurance of: effective and
efficient operations; internal
financial control; and compliance with laws and
regulations. Under the UK
corporate governance system, the board of directors is
elected by the shareholders
who in practice exercise their control in a number of
ways The recent scandals has
159
attracted considerable attention.
There was concern about systems for controlling
corporate action, particularly that
of company directors. The role of auditors and the
extent of their independence
were criticised; the audit report at the time
considered as being the ultimate
indicator of corporate based upon an independent
opinion on the company's
affairs became the subject of debate. The Cadbury Report
recommended that 'the
directors should report on the effectiveness of the
company's system of internal
control' and that this report should be reviewed by
the auditors. Moreover, to
enforce the recommendations of the Cadbury
Report, sanctions have been
imposed since 1993 for companies listed on the
London International Stock
Exchange. With the Cadbury Report, companies boards
became more responsive
to shareholders' concerns as it stated:
`Bringing clarity to the respective responsibilities of
directors, shareholders, and auditors will also strengthen trust in the
corporate system. Companies whose standards of corporate governance are high
the more likely to gain the confidence of investors and support for the
development of their business'(1.6, p.58).
The Cadbury Report considers that all directors, whether
or not they have executive
responsibilities, should be responsible for ensuring that
`the necessary controls over
the activities of their companies are in place and working'.
In addition, the Cadbury
report' view was that the board of directors is
responsible for the governance of
159. Rutternam Working Group,1994.p.1
companies, these responsibilities include the company'
strategic aims, providing the
leadership to put them into effect, supervising the
management of the business and
reporting to shareholders. However, one of the
requirements of the Code of Best
Practice on directors was to include a report
in their annual control on the
effectiveness of the company's system of internal control
(CBP, 4.5.p.59 ). This latter
requirement was not considered in the draft guidance of the
Working Group set up to
develop a set of criteria for assessing effectiveness. In
1995, the Combined Code of
the Committee on corporate governance (the Code) was
published. One of its
requirements was to assist listed companies about the
internal control question.
Principle D.2 of the Code states that' the board should
maintain a sound system
of internal control to safeguard shareholders' investment and
the company's assets';
the directors should, at least annually, conduct a review
of the effectiveness of the
group's system of internal control and should report to
shareholders that they have
done so. The review should cover all controls, including
financial, operational and
compliance controls and risk management'(D.2.1).
It was argued that a company's system of internal
control has a key role in the
160
management of risks that are significant to the
fulfilment of its business objectives.
A sound system of internal control contributes to
safeguard the shareholders'
investment and the company's assets; company's
objectives, its internal control
organisation and the environment in which it
operates are continually evolving
161
and, as a result, the risks it faces are continually
changing.
160.A.Chambers,'Tolley's corporate governance'
161.ibid
A sound system of internal control therefore depends on
a thorough and regular
162
evaluation of the nature and extent of the risks to which
the company is exposed.
Since profits are in part the reward for successful
risk-taking in business, the purpose
of internal control is to help manage and control
risk appropriately rather than to
163
eliminate it. The Turnbull Report was set up in 1999 to
address the issue of internal
control and respond to these Provisions in the
Combine Code. It represented the
culmination of several years' debate concerning
companies' systems of internal
control. The report was accompanied by the code of practice.
However, Turnbull aimed not to transform companies' systems of
internal control but
to make explicit the systems of internal control, which many
of the top- performing
companies had developed, in order to standardize internal
control and achieve best
164
practice. Solomon suggests that without an effective
system of internal control,
companies can undergo substantial financial losses as
a result of unanticipated
disasters. In the UK as in the USA the recent
collapses of Maxwell, Barings and
Enron have been attributed in part to a failure of the
company's system of internal
control. The board of directors is responsible for the
company's system of internal
control; it should set appropriate policies on internal
control and seek regular
assurance that will enable it to satisfy itself that the
system is functioning effectively;
the board must further ensure that the system of
internal control is effective in
165
managing risks in the manner which it has approved.
Moreover, it is the role
of management to implement board
policies on risk and control.
162.A.Chambers,'Tolley'sCorporate governance'.
163.ibid.
164.J. Solomon and A. Solomon , ' Corporate governance and
Accountability'.
165.ibid
In fulfilling its responsibilities, management should
identify and evaluate the risks
faced by the company for consideration by the board and
design, operate and monitor
a suitable system of internal control which implements the
policies adopted by the
166
board. In the Enron case, the function of the NEDs was
as they did not detect
fraudulent accounting activities through their internal
audit function; indeed, the
167
internal audit committee failed completely in policing their
auditors. Serious conflicts
of interest have arisen involving members of Enron's
internal audit committee, for
example, Lord Wakeham was on the audit committee
at the same time as
168
having a consulting contract with a
consulting contract with Enron.
These examples show that people in responsible positions who
should have detected
unethical activities, were themselves not independent. Enron
illustrated that the board
of directors was composed of a number of people who have been
shown to be of poor
moral character and willing to conduct fraudulent activity;
this was the genuine root
169
of the company's corporate governance failure.
Moreover, the internal audit
committee did not perform its function of internal control and
of checking the external
170
auditing function. However, it seems that on a practical level
the Turnbull Report has
had a far-reaching impact on corporate risk disclosure, as
companies have been
encouraged to comply with its recommendations by producing
detailed reporting of
171
their risks.
166.J. Solomon and A . Solomon , ' Corporate governance and
Accountability'.
167.ibid
168. The Economist , 7 February 2002.
169. J. Solomon and A . Solomon ,'Corporate Governance and
Accountability `.
170.ibid
171. ibid
The Cadbury Committee Working Group, limited the
directors' s reporting
responsibilities to internal financial control which are
those established to provide
reasonable assurance of the maintenance of proper
accounting records and the
reliability of financial information. In fact, the
internal control process shows the
importance of the non- executive director in the
UK corporate governance.
Chapter 3 Harmonisation of the European Company
Law.
Under the European Commission, there are several ways of
in reforming company
laws. As far as the Member States of the EU
are concerned, accounting
harmonisation is an integral part of the development of
the Union into a single
«Economic Space». Traditionally, the fundamental EU
Directive relating to financial
reporting is the Fourth Company Law Directive of July
25,1978. This relates to the
accounts of limited companies. It was followed by the
Seventh Company Law
Directive of June 13,1983, which extends the principles of
the Fourth Directive to
the preparation of consolidated ( group ) accounts.
The fourth Directive seeks to provide a minimum of
coordination of national
provisions for the content and presentation of
annual financial accounts and
172
reports, of the valuation methods used within them, and of
the rules for publication.
In addition, the Seventh Directive applied and broadly
extended the provisions of
the Fourth Directive to the preparation and
publication of consolidated accounts
(Article 1 of Table 6). On the other hand , the
harmonisation of the fundamental
rules governing accounting and financial
information shows that the EU
has made no further progress. The above Directives
have brought about a real
173
improvement in the quality of financial information.
172 . Boyle & Birds 's company law'.
173 . http://europa.eu.int/scadplus/leg/en/lvb/126020.htm
However, large European companies wishing to raise
capital on international
markets are obliged to prepare a second set of accounts,
which is a lengthy and
174
costly procedure and may give rise to confusion. In the
last few decades, a number
of company law directives have been brought into force
by the decision of the
Council of Ministers and were subsequently implement by
the UK government;
for example, the Seventh and the Eighth Directives
deal respectively with
consolidated accounts prepared and published by companies
with subsidiaries and
175
with the independence and professional
qualification and control of auditors.
The Eighth EU Council Directive addresses the
harmonisation of the conditions
for the approval of auditors: professional
qualifications, personal integrity and
176
independence. The lack of precision of the
Directive, particularly where the
independence is concerned, has led to inevitable
differences in national legislation
177
and, in some cases, to an absence of legislation backing.
The issues are important in
178
so far as they affect the smooth operation of the
single market:
* audited financial statements of a company established in
one Member State are
used by third parties in other Members States;
* significant differences in national legislation prevent
the establishment of
a genuine European market in auditing services.
However, the absence of a common definition of the
statutory audit in the EU
179
creates a damaging expectation gap. Moreover, numerous
studies have shown that
there are considerable differences between what the public
expects from an audit and
what the auditing profession believes that the auditor should
do; a common approach
174. http :// europa.eu.int /scadplus/leg/en/lvb/126020.htm
175. L .Evans and C . Nobes , 'Harmonisation relating to
Auditor Independence : the Eight Directive , The UK and Germany».
176.Green Paper on the statutory auditor.
177.ibid
178.ibid
179 . ibid
to the statutory audit, taking account of the latest
developments at international level,
seems desirable: if the audit is to add confidence to
published financial statements,
180
users need to know what the audit certificate means
in terms of guarantees.
Traditionally in the UK before the Directive s.389 of CA1985
excluded a person from
being an auditor if he was an «officer or
servant of the company», or a partner or
employee of an officer or servant of the company, or a
corporate entity. Moreover,
this prohibition is extended to the company's
subsidiaries, holding company and
fellow subsidiaries.
The UK implemented the Eighth Directive through Part
II of the Companies
Act 1989; this resulted in few practical changes, and its
main impact appears to have
been that more rules were laid down in legislation, instead
of, as previously, being
181
left to the profession to regulate. The 1989 Act (section 27)
specifies cases in which
a person would be ineligible to act as auditor, thus
implementing Article 24 of the
182
Directive, which gives scope to define lack of
independence to the Member States.
Included here is ineligibility if the auditor was also
ineligible to audit an associated
undertaking; further, the Act requires auditors to be
»fit and proper persons». This
relates to Article 3 of the Directive, which requires
auditors to be «persons of good
183
repute...» As we can see, the EU legislation
on company accounting was
adopted in the 1970s and needs to be updated if is to meet
the needs of today's
investors.
180.L. Evans and C. Nobes ,'Harmonisation relating to auditor
Independence : the Eighth Directive , the UK and Germany `.
181.ibid
182.ibid
183.ibid
Chapter 4 Conclusion
The independence and objectivity of auditors is vital
for the efficient functioning
of UK corporate governance. It is essential for business
integrity, and shareholders
confidence. However, independence cannot be complete but
its role is relatively
important. The current rules are inadequate and
unsatisfactory to protect the
interest of shareholders, bankers and employees of
companies.
Moreover, a different problem remains wrongly
approached, which is the
requested independence of an external auditor. To
definite independence is an
uncertain task as long as its different faces are
unstable. Simultaneously, it is hard
to find an auditor remaining independent from the
company which he is auditing,
both protagonists have a business relationship and even
if the risk of reputation
and being investigated independence are constraints.
In recent collapses, criticisms argued that auditors
were not independent in their
work. Some criticism has called into question the
multidisciplinary and the
communication defect to other parties concerned in
the company functioning.
As far as the multidisciplinary aspect is
concerned, it is not bad in itself.
However, conflicts of interest need to be banned for
the auditors who audit and
give advice in the same time to the audit client.
First, firm rotation would be
seen to overcome these issues. Its benefit is that,
together with the commercial
pressure to retain this long-term relationship, it may
impede the independence of the
auditors at a minimum; it impacts the perception of
independence. Therefore, it can
be said that individual rotation of auditors is also
important. Normally, the same
auditor who sign the client account cannot stay
for a long period in the
company even if the firm of auditors does not
change as after some period
an auditor is a little bit linked as he have signed
already in the past, he will
get used some difficulties to another strategy
and becoming too close to
the audit client with whom he is involved.
On the other hand, self-regulation is an important
issue. The separation of audit
and advice is irresistible. Recently the recent
companies collapses, some
auditor firms sold their consultancy branches or operated a
distinctive separation.
However, the auditor alerts which facilitate a
co-ordination with people ( NEDs,
Lawyers, Bankers) who hold company information
need to be widened.
He may have a permanent contact with the banker and
other actors. After all,
if the auditor meets the investment banker only during the
alert procedure then that
may accelerate the collapse of the company as everyone
is aware of the problem.
On the other hand, if these meetings are
institutionalised, the question is irrelevant
and every possible meeting with the investment bankers
cannot launch a confidence
loss.
The auditors bring into the company an element of
transparency. However, questions
still remain about the self-regulating system. If the
relationship between the auditors
and the management cannot be avoided, how to establish
a perfect system of
corporate governance?
It may be said that there is not a single and perfect
system in modern economy.
As in some case, the collapse of a company is caused by
a series of factors which
may be external from the auditor's work. More
recently, some critics called
the German corporate governance as a model.
S. Suchan pointed for example that the fall of Enron has
been understood primarily
as a failure of the gatekeepers, which means the
intermediaries who provide
verification and certification services to the investors
(e.g. securities analysts and
especially the auditors); under German law the auditor is
not only considered to be a
gatekeeper, assuring the interest of the investing public (so
called « Kontrollfunktion»
or « Garantiefunktion») but also acts as
assistant for the supervisory board in its
184
internal control of the management. The auditors play an
important role in modern
companies. Moreover, they contributed in a decisive way
to the development of
welfare markets. The topic on their role is linked as on the
corporate governance and
for that reason will continue for some years.
184.Dr S.W. Suchan ,« Post-Enron and German corporate
governance», Cornell law School, 2004.
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