Company directors are becoming increasingly concerned about their potential liabilities and recent
Overview of Sarbanes-Oxley
The Sarbanes-Oxley Act requires chief executives and chief financial officers (CFOs) of companies registered with the Securities and Exchange Commission (SEC) companies — including companies incorporated in the UK that have securities listed on a US exchange or quoted on Nasdaq — to make numerous certifications regarding financial and other information contained in annual and quarterly reports. In particular, these certifications include confirmations that:
(i) they are responsible for establishing and maintaining internal controls to ensure that material information relating to the company is made known to them and that they have disclosed to the company’s auditors all significant deficiencies in the design or operation of the company’s internal controls which could adversely affect the company’s ability to record, process, summarise and report financial data; and
(ii) based on their knowledge, the relevant report does not contain any untrue statement or omissions of material fact and that the financial statements and information included in the report fairly present in all material respects the company’s financial condition. There are fines and criminal penalties for chief executives and CFOs knowingly providing false certifications.
Recent
Historically, directors in the
However, in April 2005 (following the well-publicised collapses of Enron and WorldCom) a new section was added to the Companies Act 1985 (234ZA) to introduce a requirement for directors’ reports to contain a statement by each director that:
(i) to their knowledge, there is no relevant audit information of which the company’s auditors are unaware; and
(ii) they have taken all the steps that they ought to have taken as a director to make themselves aware of any relevant audit information and to establish that the company’s auditors are aware of that information.
If this statement is false, any director who knew (or was reckless as to whether) it was false and who failed to take reasonable steps to prevent the directors’ report from being approved commits an offence and is liable to imprisonment, a fine or both.
These provisions are similar to Sarbanes-Oxley and, to some extent, go further than the
More recently, following the implementation in the UK of the European Union (EU) Transparency Directive (2004/109/EC), companies admitted to trading on a regulated market in the UK (for example the main market of the London Stock Exchange but not the Alternative Investment Market) whose home member state is the UK, are now required to include a responsibility statement in certain reports. Accordingly, for financial years beginning on or after 20 January, 2007, they must include in their annual report a statement for which the company will be responsible but which is required to be made by named people who are “responsible within the issuer” (for example, company directors), that to the best of their knowledge:
(i) the financial statements give a true and fair view of the assets, liabilities, financial position and profit or loss of the company and its consolidated undertakings taken as a whole; and
(ii) the management report includes a fair review of the development and performance of the business and the position of the company and its consolidated undertakings taken as a whole, together with a description of the principal risks and uncertainties they face.
The half-yearly report of such companies must also contain a similar statement. Again, these provisions bear a striking resemblance to Sarbanes-Oxley.
Potential liability of directors
In recognition of concerns that the implementation of the Transparency Directive could extend the scope of directors’ liability for company reports, a new section (90a) of the Financial Services and Markets Act (FSMA) 2000 has also been introduced. This provides that a listed company (and not its directors) may, in certain circumstances, be liable to pay compensation to investors who acquire its securities and suffer loss as a result of any untrue or misleading statement in the company’s annual report, half-yearly report, interim management statements or any preliminary statements (or as a result of the omission from any such publications of any matters required to be included).
A company will only be liable under section 90a if a person discharging managerial responsibilities (for example, a director) knew that the statement was wrong or misleading, was reckless as to whether it was, or knew any such omission was a dishonest concealment of a material fact.
While section 90a of FSMA appears to provide an element of protection for directors, this protection was eroded by section 463 of the new Companies Act 2006, which came into force on 20 January, 2007. It provides that a director will be personally liable to compensate the company of which he is a director (but not investors, shareholders or any other third parties) for any loss it suffers as a result of any untrue or misleading statement in, or omission from, the directors’ report, directors’ remuneration report or information derived from such reports contained in the company’s summary financial statements.
A director will only be liable under section 463 if he knew or was reckless as to whether the statement was untrue or misleading, or knew the omission to be the dishonest concealment of a material fact.
Read together, the new sections of the FSMA and Companies Act give rise to the possibility that an investor who brings a successful claim for compensation against a listed company under section 90a could, in turn, lead the company to seek to recover an equal amount from the director whose knowledge, recklessness or dishonest concealment gave rise to that claim. In addition, once the new derivative action regime of the Companies Act is implemented, shareholders could also potentially bring an action on behalf of the company against such a director if the other directors fail to do so (although the 2006 Act contains various procedural hurdles to bringing such a claim).
The legislative changes summarised above will add to the concerns of directors and, as they are still in their infancy, it remains to be seen what steps companies decide to take (for example, seeking an extension to directors’ and officers’ insurance, introducing additional verification procedures or even the establishing internal controls similar to those required under Sarbanes-Oxley) in order to make their directors comfortable that they can properly give the statements they are now required to make.