Directors' Compliance Statement - Section 45 - CLRG Shows Common Sense
Author:
Aidan Lambe
From an initial series of round table meetings three years ago, the ICAI has worked to raise awareness of the potential adverse impact of the Directors’ Compliance Statement as originally drafted. With the publication of the Company Law Review Group’s report in December, it is clear that many of the issues raised by ICAI have been taken on board. But it is not over yet. The CLRG’s recommendations - particularly those relating to terminology - suggest that there are further concerns still to be addressed.
Almost three years ago the Institute of Chartered Accountants in Ireland (ICAI) staged a series of roundtable breakfast briefings to which it invited senior members of the profession from both the practice and business arenas. Attendees included senior partners from many accounting firms and chief executives as well as executive and non-executive directors from many of the country's leading companies.
The purpose of this exercise was to inform members of the main proposals contained in the then Companies (Auditing and Accounting) Bill, 2003 (the Bill) and to seek their views on these with a view to formulating the ICAI’s policy and strategy going forward on the proposed measures contained in
the Bill.
While much of the Bill was concerned with the supervision and regulation of the auditing and accounting professions, it also contained other significant proposals impacting on the majority of Irish companies. Not least of these, and the one that attracted most attention at these sessions, was the so-called ‘Directors’ Compliance Statement’ (DCS). In fact the proposals required 2 statements: the ‘compliance statement’ and the ‘annual statement’.
Shortly after this exercise, the ICAI issued a paper entitled Audit and Accounting Issues facing Irish Corporates - a summary of the ICAI roundtables held in March 2003.
While the roundtables gave a cautious ‘welcome’ to the aims of the Bill, there was general agreement that the detailed requirements and scope of application of the DCS would have serious and adverse consequences for Irish business.
There was an acceptance among roundtable participants that, certainly for larger companies, it was reasonable to expect directors to comment on compliance with company law and tax law obligations. However, the additional category attached to the DCS of ‘any other enactments’ providing a legal framework in which a company operated and potentially having a material impact on its financial statements was regarded as being extremely onerous and certainly would place Ireland in a unique position internationally. Disquiet was also expressed at putting such detailed requirements into primary legislation.
Possible impacts cited of the Directors Compliance Statement as then proposed included:
4An adverse affect on competition internationally for foreign direct investment;
4A significant cost impact on companies as directors would inevitably seek additional assurance because of the legal formality imposed by the DCS and additional costs through new obligations imposed on external auditors;
4Creating a competitive disadvantage that may result in companies incorporating elsewhere;
4Resource mis-allocation as
directors focussed more time on compliance issues only rather than on guiding companies increased profitabilty;
4Adverse impact on the availability of non-executive directors.
Throughout 2003, the ICAI continued its efforts, alerting other interested parties to the new requirements of the proposed legislation and their possible impact on Irish business. A detailed submission on the Bill’s proposals was published by the ICAI and used to brief other representative bodies and public representatives.
When the Bill finally came to be enacted in late 2003, a number of amendments to the original proposal had been accepted by Government (relating to the DCS provision, now Section 45 of the Companies (Auditing and Accounting) Act,
2003 (45/2003)) .
The enacted section retained its focus on directors commenting on company processes and procedures and their effectiveness designed to ensure compliance with ‘relevant obligations’ but omitted the original provision of the Bill as published which required a categoric statement as to whether a company had complied or not complied with its relevant obligations, and if not, to provide the reasons.
Efforts were also made at excluding SMEs from the DCS requirement, where originally, only audit exempt companies were excluded. Significant issues, however, remained with the new requirement.
In summary, Section 45 of the 2003 Act had the following requirements:
Provisions relating to directors
4Directors to provide a compliance statement containing the following information:
6Company policies ‘respecting’ compliance with ‘relevant obligations’;
6Company internal financial and other procedures for securing compliance with relevant obligations;
6Company arrangements for implementation and review of effectiveness of such policies and procedures.
4Compliance statement must;
6Be in writing;
6Submitted for board approval;
6Reviewed at least every
3 years;
6Included in directors’ report.
4Directors to provide a further statement (‘the annual statement’) in directors’ report;
6Acknowledging responsibility for securing company compliance with ‘relevant obligations’ (defined as the Companies Acts, tax law, and any other enactments providing a legal framework within which the company operates and that may materially affect the company’s financial statements);
6Confirming the existence of internal financial and other procedures designed to secure compliance, or, if not, to specify reasons;
6Confirming that a review of effectiveness of procedures has taken place during the year or, if not, specify reasons;
6Providing an opinion as to whether they have used ‘all reasonable endeavours’ to secure compliance or, if not, specify reasons.
Provisions relating to auditors
4External auditor required to undertake an annual review of;
6Compliance statement; and
6Annual statement to determine whether it is ‘fair and reasonable’
4External auditor also required to report on, including conclusions, annual review of both statements in statutory audit report.
4If directors fail to prepare one or both statements, auditor required to report this fact to ODCE.
The sentiments expressed in section 45 are, of course, appropriate for all companies. Yes, company directors are responsible for ensuring compliance with a company’s legal and other obligations; and yes, they should have in place processes and procedures to address these which, of necessity, need to be reviewed on a regular basis. Indeed in some respects, the requirements reflect the Combined Code on Corporate Governance, particularly those elements addressing internal control.
Much of the criticism of section 45 centred on
4the highly prescriptive nature of the requirements resulting in significant costs for many companies;
4the inclusion of such detailed requirements in primary legislation would result in unnecessary formality as company directors saw the need for greater legal certainty;
4the extensive definition of ‘relevant obligations’
4external costs arising from dependence on external advisors and from the role of the statutory auditor.
Of course, 45/2003 has never been ‘commenced’ by the Minister for Enterprise, Trade and Employment. Following its enactment, the ICAI, in a joint initiative with the Office of the Director of Corporate Enforcement, invited interested parties, including IBEC, the Institute of Directors, Revenue and the Financial Regulator to come together to consider what guidance was needed on the new 45/2003. This was finalised in late 2004.
It was as companies and their directors began to consider exactly what the new requirements might entail that the full potential cost implications became clear and a further groundswell of opinion against the 45/2003 emerged. An informal survey conducted by the ICAI suggested that the costs of the proposal to corporate Ireland could be as much as €500 million.
Against this background, the matter was referred by Minister for Trade and Commerce, Michael Ahern T.D., to the Company Law Review Group (the CLRG) in April 2005. The CLRG was asked, in making its report on 45/2003, for its views on the proportionality, efficacy, and appropriateness of the DCS having regard to:
4Accepted principles of corporate governance;
4Scope and application of the DCS requirement;
4Potential cost issues;
4Potential competitiveness issues; and
4Potential implementation issues.
The CLRG review prompted a further round of consultation and submissions.
CLRG reported to Government at the end of July 2005. It published its report on the DCS on 1st December. On the same day, Minister Ahern announced that Government had accepted the CLRG proposal which would be ‘given effect in forthcoming legislation’.
The CLRG report runs to some 155 pages and reviews the genesis of the DCS proposal from the recommendations of the Review Group on Auditing (RGA) in 2000 to its eventual enactment via 45/2003. It provides some cost/benefit analysis - the first time that any formal attempt has been made to quantify the costs of this legislation to Irish business; compares the proposal to similar measures in other jurisdictions. And, while the first recommendation of the CLRG by a majority decision of 11 out of 19 was to repeal 45/2003 with no replacement, it has come up with a compromise proposal that has the support of a significant majority of the CLRG members, while attempting to achieve the same result of the original measure.
In the short time available to it, the CLRG has carried out an assessment of the potential costs to the Irish economy of the measure. Alarmingly, the CLRG estimated that, based on the evidence made available to it, initial set up costs to business of the measure for the first year of its operation ranged from €377m to €692m with ongoing annual costs of between €202m and €343m. While even the lower amounts are significant, the wide variation is attributed to differences and difficulties in interpreting the legislation - surely a reason in itself for its non-commencement.
An even more convincing argument against commencement is the analysis provided by the IDA. It has estimated a reduction of 10% in the inflow of Foreign Direct Investment involving a loss of 1,000 new jobs per annum.
The CLRG conclusions won’t come as any surprise to the ICAI’s round table participants who had raised these issues three years ago. The CLRG accepts as valid arguments put forward against commencement in its current form, including:
4The overly prescriptive nature of 45/2003;
4That the inclusion of the so-called third limb of the definition of ‘relevant obligations’ is a significant ‘contributory factor to the increased costs that 45/2003 is likely to create for companies’ as companies are likely to adopt a highly prescriptive approach to the legislation . The report further comments that ‘no other jurisdiction requires companies to speculate on contingent eventualities that may or may not affect ...financial statements…’;
4The potential damage to foreign direct investment in Ireland as ‘multinational companies are continuously comparing locations in terms of their cost-quality proposition’.
In essence, the CLRG proposal is
as follows:
4Companies within the scope of the DCS requirement should be confined to ‘large’ companies as defined in the Companies Acts for filing purposes and that the relevant balance sheet totals and turnover amounts for this be increased to €12.m and €25m respectively.
4The definition of ‘relevant obligations’ should be amended by removing the ‘third limb’ and also by introducing an element of ‘materiality’ to company law obligations as those relating to indictable offences.
4 A less prescriptive compliance statement requirement with more ‘principles based’ annual confirmations being required from directors.
The CLRG is also recommending removal of the requirement that the statutory auditor conduct a review of, and issue an opinion on, the directors’ statements.
In an attempt to provide clarity to its proposal, the CLRG has actually drafted the proposed new ‘section 45’ and included this in its report.
CONCLUSION
So now that the Government has accepted the CLRG proposals, when can we expect to see this enacted? The CLRG recommends deferral of the implementation of the revised DCS requirement until the enactment of the proposed consolidated companies’ act, likely to be late 2006, with possible commencement from 1 January 2007. The Ministerial announcement accepting the CLRG proposal simply states that it will be given effect in forthcoming legislation.
However, company directors should not take lightly the requirements of this compromise position. They will undoubtedly present a challenge for some and will require careful scrutiny. As with the original DCS proposal, there is nothing 'new' in this legislation in terms of imposing additional responsibilities and obligations on company directors - these have always been there.
Although only 'suggested text', the CLRG revisions undoubtedly raise some further issues, including some of the terminology used, that are likely to need some more consideration and discussion and also, perhaps, guidance.
The ICAI looks forward to continuing playing its part in such debates.
Aidan Lambe, FCA, is Director, Representation & Technical Policy with the Institute of Chartered Accountants in Ireland.