Restoring confidence in UK plc

Trust in company accounts is the keystone of the whole edifice of business and finance. If numbers cannot be relied upon, the faith of investors, employees and the public is undermined. Confidence in UK plc has been shaken by several high-profile failures in recent years, and the response has been slow. That has left Britain facing a balancing act: introducing an equivalent to the US Sarbanes-Oxley regime without piling unfair costs and burdens on to companies struggling to recover from the pandemic.

Though belated, the government’s white paper on auditing and corporate governance sets out a sensible framework. On audit, it endorses the main recommendations of three earlier reviews. It is fair to expect audit firms to act not as mere watchdogs policing the figures but bloodhounds sniffing for the scent of fraud or abuses. Ending cross-subsidy of audit by firms’ lucrative consulting businesses will make audit more expensive, but is the right thing to do to avoid potential conflicts.

When it comes to nurturing competition to the Big Four auditors, which conduct 97 per cent of FTSE 350 audits, the government rejects calls for mandatory joint audits with “challenger firms”. It favours “managed shared audits”, requiring companies to use a challenger to conduct a “meaningful portion” of audits. But it holds in reserve possible caps on the Big Four’s share of FTSE 350 audit work unless competition improves.

The real steps forward are on corporate governance. At the least, directors would be required to sign off personally on the effectiveness of companies’ internal controls and risk management. That stops short of the US approach, where top executives must certify the accuracy of accounts. But making directors sign off on management, compliance and internal audit controls is a significant step — especially backed by the threat of fines, suspensions, or clawing back bonuses if sizeable errors or fraud are later found. It could also potentially make it easier to bring legal charges against them.

More stringent options proposed in the paper would require auditors to report on their views of how effective internal controls are, or — closest to the US system — give a formal opinion on directors’ assessment of controls. Jumping straight to the strictest option risks imposing unreasonable costs on post-Covid business. The answer might be a phased approach where companies must progress from the first option to the strictest within, say, five years — though rules should be enacted as soon as possible. Restricting larger companies, meanwhile, from paying dividends and bonuses without evidence they have sufficient cash reserves to avoid insolvency risks is surely wise.

Toughening governance will also have to be balanced with avoiding undermining the efforts of the Hill review to make UK public markets more attractive. Yet while Sarbanes-Oxley “red tape” is sometimes blamed for reduced US initial public offerings and listed companies, factors such as the huge increase in funding for private companies have had a bigger impact.

Businesses will worry over compliance costs; similar fears accompanied Sarbox’s launch in 2002. The US controls are not perfect, but accounting restatements went down, as did high-profile fraud cases. Large companies soon adjusted, and the 2012 Jobs Act reduced the burden on smaller ones.

Will it be harder to recruit directors if they can be held personally responsible? The rewards of such roles will still be considerable. And for those genuinely committed to building businesses in a responsible and sustainable way, tougher sanctions if things go wrong ought to be no deterrent.