Audit and Corporate Governance Reform Measures: what is being proposed?

"Good corporate governance refers to the effective running of an organisation. Strategically implemented policies and practices provide companies with a number of benefits that ultimately drive their profitability, reputation, and success." (The Corporate Governance Institute, "What is good corporate governance?").

A draft Audit Reform and Corporate Governance Bill ("the Bill") was among the 40 laws announced by the government in the King’s Speech on July 17, 2024. With previous reforms in this area having been controversially omitted from the legislative agenda in November 2023, the newly elected Labour government's commitment to overhauling audit and corporate governance practices in the UK has been widely welcomed. It is hoped that the Bill, together with additional non-legislative measures like a new voluntary Code of Conduct for Directors (more about which is set out below), will prevent further instances like the collapse of Carillion which occurred, at least in part, as a result of poor audit quality and governance weaknesses. The aim of the reforms is to inspire confidence in the health of UK companies, restore trust in their governance and transparency, and ultimately deliver a more secure UK economy.

What will the Bill do?

The briefing note to the King's Speech outlines the changes that will be brought about by the Bill's introduction.

The Financial Reporting Council ("FRC") is to be replaced with a revamped regulator, named the Audit, Reporting and Governance Authority ("ARGA"). The establishment of the ARGA aims to tackle longstanding concerns regarding the FRC's effectiveness which were highlighted in an independent report into the FRC in 2018: "two major Select Committees have accused it [the FRC], in the strongest terms, of timidity, a lack of pace and excessive closeness to those it regulates".

ARGA is to be equipped with enhanced powers and responsibilities and it is envisaged that it will form a platform for other important changes, such as:

• Public Interest Entity (PIE) status being extended to the largest private companies.
• Unnecessary rules on smaller PIEs being abolished, reducing disproportionate burdens.
• Enhancing powers to investigate and sanction company directors for serious failures in relation to their financial reporting and audit responsibilities.
• Introducing a new regime to oversee the audit market, ensuring protection against conflicts of interest, enhancing sector resilience, and weakening the dominance of the Big Four.

Of course, ARGA’s role and the extent of its powers could evolve as the new government shapes the work previously done in drafting the Bill, so impacted organisations should ensure that they keep abreast of the Bill's progress.

Non-legislative Measures

In June of this year, two former directors of BHS were ordered to pay at least £18 million to creditors over their involvement in the chain's collapse eight years ago, having been found liable for wrongful trading and misfeasance claims. This case underscored the importance of company decision makers upholding exemplary values and integrity in both their business decisions and personal conduct to promote good corporate governance.

Directors of UK companies are subject to specific legal and regulatory responsibilities, including the directors' duties set out in the Companies Act 2006. Directors are expected to establish and instil organisational values, uphold high ethical standards and make decisions in complex situations which might involve balancing the rights of various stakeholders. Determining the best course of action in such contexts is often challenging.

The Institute of Directors is consulting on a new code of conduct for directors ("the Code"), with the aim of helping directors to "fulfil their responsibilities by providing a clearly articulated statement of what good conduct looks like" and to "clarify their thinking, with positive implications for themselves, their organisational culture and society as a whole". The Code would be voluntary in nature and apply to directors of organisations of all sizes in the private, public and not-for-profit sectors. It is not intended to constrain directors or create a new compliance burden.

Whilst the Code should not present any surprises for seasoned directors, it is likely to be a valuable resource for individuals stepping into a director role for the first time, offering practical guidance on complying with the statutory directors' duties. The Code may also help stakeholders hold directors accountable and promote a positive culture across businesses.

The Code is structured around six key Principles of Director Conduct, each one being underpinned by several specific undertakings:

• Leading by example: demonstrating exemplary standards of behaviour in personal conduct and decision-making.
• Integrity: acting with honesty, adhering to strong ethical values, and doing the right thing.
• Transparency: communicating, acting and making decisions openly, honestly and clearly.
• Accountability: taking personal responsibility for actions and their consequences.
• Fairness: treating people equitably, without discrimination or bias.
• Responsible business: integrating ethical and sustainable practices into business decisions, taking into account societal and environmental effects.

Summary

The Government believes that legislative measures are essential for driving change in this area, as they are enforceable and include mechanisms to hold individuals and companies accountable for breaches. However, non-legislative tools like the Code will offer practical guidance to those involved in decision-making, who play a prominent role in promoting good corporate governance. The Bill and the draft Code may represent progress towards building trust with stakeholders and supporting the long-term sustainability and success of businesses.

If you have any questions or want advice in relation to your business, please get in touch with any of the authors or your usual Brodies contact.