Originally published in BLG’s Directors’ and Officers’ Liability Review, Winter 2006
Now that the Companies Act has received Royal Assent, we look afresh at the corporate reporting requirements for listed companies and consider to what extent these new requirements give effect to the EU legislation which lies behind many of them. We also consider the vulnerability of directors to cross border claims against directors of UK companies.
Whilst suggestions from America indicate that the tide may be turning against their Sarbanes-Oxley reforms (see the News digest on page seven of this edition), the position in the UK is poised to become more onerous.
Directors here face enhanced narrative and financial reporting obligations under the Companies Act 2006 (the "Act"), which received Royal Assent on 8 November 2006. The financial reporting provisions are due to be brought into force as soon as January 2007, with the rest of the Act to follow by October 2008 at the latest.
Insurers will take some comfort from the fact that the Government has included statutory protection for directors against proceedings from aggrieved, or opportunistic, investors who claim to have relied on reports that fail to measure up to the new standards. That will not, however, assist those directors of English companies who increasingly find themselves at the mercy of foreign courts in jurisdictions with more claimant-friendly liability regimes.
The Companies Act re-introduces, for quoted companies, the core forward looking reporting requirements of the Operating and Financial Review (‘OFR’). The Government brought in the OFR for reporting years beginning 1 April 2005, but then announced it was scrapping it in December 2005, before it had taken effect. This was promoted as a measure to cut red tape and avoid ‘gold plating’ European requirements.
But in order to comply with the EU Accounts Modernisation Directive, the OFR is back, albeit with a new name - Business Review - and has found a supporter in the ABI which recently called on companies to be more forward-looking in their reporting analysis. Section 423(5) of the Act now provides that: "In the case of a quoted company the business review must to the extent necessary for an understanding of the development, performance or position of the company’s business, include: … the main trends and factors likely to affect the future development, performance and position of the company’s business".
One area where directors will particularly find themselves under pressure to promise much in their Business Review is their company’s impact on the environment. As the recent derivative claim against BP’s directors in the courts of Alaska shows (see previous article for full details), claimants will try to use such promises as a way of pinning liability on the directors if their actions subsequently depart from published objectives.
The Companies Act also contains enabling provisions for the implementation of the European Transparency Directive. This applies to all quoted companies. The FSA is in the process of finalising its detailed plans, including amendments to the Listing Rules. These will relate to the following key aspects of the Directive:
- Annual and half-yearly financial reports must now include a ‘responsibility statement’ by the directors that the accounts give a true and fair view. Although this does not alter the legal basis for producing the accounts, it provides greater visibility and may increase the potential for claimants to argue reliance.
- Quoted companies will now be required to publish ‘interim management statements’: effectively quarterly reporting, albeit without an audit requirement. This will formalise a process that will already be familiar to many large corporates.
- Time periods for filing accounts will be shortened, and content requirements generally will be tightened and become more prescriptive.
Other aspects of the Transparency Directive include an explicit obligation on companies to treat holders of the same securities equally, and reforms to the voteholder notification regime.
New statutory liability regime
The Transparency Directive initially caused much controversy because it requires the imposition of a liability regime. No-one knew quite what that meant at the time but many, including the Government, feared the Directive’s explicit emphasis on investor protection and the publication of financial reports throughout Europe. There was also concern about the absence of any ‘safe harbour’ in the original OFR provisions, with the consequent risk of directors incurring liabilities when their projections for the company fail to materialise.
Fortunately, in respect of quoted companies there is now good news here on both counts. The Government has introduced a statutory regime of liability for both narrative and financial reporting that amounts to a statutory exclusion of such liability to shareholders for honest and diligent directors:
- Where there is faulty reporting, a director now is only to be liable to his company; he will have an absolute statutory defence if sued by frustrated investors who claim to have relied on the report.
- Although directors will remain exposed to claims by the company, there are further restrictions here to protect directors.
- In relation to the Business Review, the director is only liable to the company if he knew or was reckless about errors or omissions in it. For insurers, this restricted liability would in any event not be covered by standard policy terms.
- The result is much the same for financial reporting, but here it is achieved by restricting the company’s liability to the investor to situations where a director (or other relevant person) knew or was reckless about errors or omissions in the report.
This regime does not apply to liabilities for defective financial reporting by non-quoted companies. Here, under common law principles, directors can still find themselves exposed to liability on the basis of negligence, both to the company and also to investors. However, as a result of the Caparo decision of the House of Lords in 1990, this is generally considered unlikely in ordinary cases.
There are other risks for directors whose companies have an exposure in other jurisdictions. For all UK quoted companies this will mean at least the whole of Europe, in light of the new wider obligation to publish their financial reports.
Complex jurisdictional and choice of law issues will arise where, say, an investor in another European state wants to bring proceedings there against the directors of an English company. Will he be allowed to do so, and will he be able to take advantage of the local liability rules? The Government was sufficiently worried the answer to both questions may be ‘yes’ in some European countries that it tried, unsuccessfully, to push for an amendment to the Directive.
There is also a risk that the European Court of Justice might eventually strike down the new liability regime in the Companies Act as an inadequate implementation of the Directive. This would align English law more closely with claimant-friendly European states.
It also remains the case that derivative claims are far easier to bring in certain European states and, of course, beyond in the US and Canada.
For now, though, directors and their insurers have some additional protection as a result of the new statutory liability regime for corporate reporting, at least in respect of proceedings brought in the UK.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.