Tuesday, 11 January 2011

FRC urges companies to cut the flannel in annual reports

Well the latest publication of the FRC, Effective Company Stewardship, doesn’t use those precise words but it does urge directors to reduce the length of annual reports whilst making them more useful. The FRC also specifically urges the reduction in legal boilerplate, particularly in relation to reporting principal risks and uncertainties.

I have blogged about this before, citing the example of GlaxoSmithKline that agreed in 2010 a $750m financial settlement of a US lawsuit that alleged appalling misconduct in relation to the supply of drugs there. Their annual report did refer to the lawsuit - boilerplate - but reported nothing about how it had occurred or actions taken to improve governance or to prevent a recurrence. That is a pretty remarkable lack of reporting (despite pages and pages devoted to risk committee structures and broad, uninformative statements of principal risks) when the total costs of the governance fiasco must have been around $1bn.

But although there is much sense in the FRC report there is also much to make you weep. Despite paying lip service to proportionality and avoiding excessive compliance costs they find it impossible, in practice, to restrain their urge to impose increasingly prescriptive (and costly) demands on business. They never seem to wonder whether any of it does any good – serves any purpose. Do they commission any academic studies, I suspect not?

Companies take risks in order to earn financial returns. That is what business does. Sometimes they fail and the result may be business failure. Expanded reporting of risks and uncertainties will not stop that. Wider responsibilities for audit committees and enhanced reporting will not stop that. There is also no undisputed, published evidence that shareholder value is enhanced by all this reporting detail.

But there is sense here too
  •  Not quite demanding an audit of the directors’ report but requiring auditors to disclose incompatibilities between the directors report and financial statements or information gathered during the audit.
  • Encouraging greater auditor scepticism
  • Enhancement of auditor reporting to audit committees
  •  Enhanced audit committee reports to shareholders
But then they go and spoil it by suggesting the auditors report on the ‘completeness and reasonableness of the audit committee report’ – that is two sets of cost and the auditors are effectively writing the committee’s report anyway; why not get the auditors to report in the first place?

And worse…they propose investor involvement in auditor appointment. On the one hand, many will not want to be involved and on the other hand, which investors? Do you involve an activist hedge fund or a foreign, sovereign wealth fund or a union? Who gets excluded and why exclude individual private investors? No, it is a silly idea and profoundly discriminatory.

But then back to some sense again
  • In return for requiring directors, executives and auditors to make ‘forward looking statements of belief or judgement’ the FRC proposes a ‘safe harbour defence’ as long as they were not made ‘recklessly, dishonestly or fraudulently’

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