“Between the Balance Sheets – Tales of Corporate Financial Behaviour”

The last time that the accountancy profession made major substantive recommendations on changes to company law was in 1977, almost 50 years ago.  There have been a number of important submissions since, particularly that made in 2005 by the Institute of Chartered Accountants in England and Wales during the preparation of the Companies Act 2006, but none have been as extensive as that of 1977.  Back in those days, the profession expressed disappointment that the legislative code of company conduct was some 30 years old and that “events of the last few years, including several causes celebres have proved that the law relating to companies needs to be updated”.

Those causes celebres include a number of findings from reports produced by independent inspectors appointed by the Government of the day – usually an eminent accountant and an eminent barrister - where there were circumstances suggesting (i) that a company’s shareholders had not been given all the information with respect to its affairs that they might reasonably expect, or (ii) that persons concerned with the formation or management of a company’s affairs have been guilty of fraud, misfeasance or other misconduct towards it or towards its shareholders, or (iii) that a company had been formed or its business conducted with intent to defraud or in a manner oppressive of any part of its shareholders.  The reports often included persuasive evidence in favour of changes in the corporate governance regime and accountability.   However, publication of any such report was at the discretion of the relevant Secretary of State and, as the years have passed, publication seems to have become the exception rather than the norm.   With many reports unpublished, press attention has been avoided, Government embarrassment has been minimised and the impetus for improvements has diminished.

Without the impact of real-life examples of corporate shortcomings, such as those provided by inspectors’ reports or insolvency inquiries, the evolution of company law depends on representations to Government by worthy interested parties – like professional practitioners, trade associations and academics – and any particular issues identified by Government departments themselves.  There are earnest and lengthy consultations on matters that emerge, followed by proposals for legislation and a certain amount of lobbying, but inevitably much of the lobbying is by vested interests aimed at stopping or minimising change.

One of the reasons why the Government seems reluctant to appoint inspectors to investigate company scandals is probably the sheer cost involved.  But the benefits of a reliable, independent and well-informed exposure of defects in corporate regulation must have a value too.   And it would almost certainly speed up remedial action in the worst cases. 

So while it would be churlish not to acknowledge the improvements in company law that have emerged during the past 50 years, it does not mean that the law is anywhere near perfect.   On preparing “Between the Balance Sheets” I came across these examples of perceived weaknesses in regulation, a few of which are now being addressed by Government:

• Private companies have been avoiding disclosure of shareholders’ identities in their annual returns as required by law, instead referring readers to the share register which is not available to public view. 
• Private companies have been delaying the deadline for public filing of their accounts by shortening their accounting year end by a single day just before the officially registered year end date arrived, taking advantage of the existing law that, in such circumstances, allowed the filing deadline to be extended by a further three months.   By changing the year end date twice in a year, the filing deadline could be extended by six months.i 
• Directors of a public company have been able to acquire businesses in a private capacity and later sell them on to that public company without disclosing the gain (or loss) derived from doing so, thereby depriving shareholders of evidence necessary to decide (i) whether such a director has exercised independent judgement and avoided a situation in which he or she has had, or may have had, a conflict with the interests of the public company, and (ii) whether such a director has acted in the way he or she considers would be most likely to promote the success of the public company for the benefit of its shareholders as a whole, as the law requires.  
• Managers of a failing company have been able to create a new company that buys it back from the receiver or administrator at a modest price after ordinary creditors, bankers and shareholders have lost much, if not all, of their investmentii.   
• It has been possible to avoid disclosing the identity and financial performance of individual companies within a larger group by ensuring that each such company is individually so small that it only has to prepare “micro accounts” with the bare minimum of disclosure requirements. 
• Under legislation enacted in 2006, the public’s ability to identify the owner-managers of companies could be impeded because it excused the disclosure of the residential addresses of their directors at Companies House or anywhere elseiii.  
• Public companies have been permitted to give undue prominence to the promotion of a “headline” profit figure that excludes all exceptional, non-recurring and otherwise inconvenient items as if they had never occurred.

The last of the above examples shows that it is not just company law that needs attention.  There are also unresolved controversies arising from financial reporting standards prescribed by the International Accounting Standards Board, not least the trend towards a more academic approach that sometimes belies reality.   It’s what I call “as if” accounting, an approach that pays too much attention to presenting financial results “as if” some transactions had a different purpose to that reflected in related contracts. Taken to extremes it justifies the use of the abovementioned “headline” results.  But the approach is also applied to some deferred acquisition payments which are not permitted to be presented as part of the purchase price but instead as if they were simply remuneration payments.   The approach has resulted in violent oscillations in reported profit and needs to be addressed.