Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum submitted by RSM Robson Rhodes



  Thank you for your letter of 25 March 2002 inviting RSM Robson Rhodes to submit evidence to the Treasury Committee's inquiry into the financial regulation of public limited companies. In this submission we focus on the regulation of UK-incorporated listed companies. Different requirements may be appropriate for unlisted entities. We firstly set out some general principles that we believe should govern policy-making in this area and then discuss their application to specific issues.


Overall Goal of System of Corporate Governance

  We believe the overall goal of our system of corporate governance should be to foster responsible and sustainable wealth creation for the benefit of all stakeholders. This objective is of vital importance to public policy given the economy's high level of reliance on the capital markets for its financial success. Listed companies also play a crucial role in the corporate sector's overall social and environmental performance.

Clarity of Objectives of Reviews

  The purpose of the reviews being undertaken by the Treasury Committee and by the government in the light of the collapse of Enron should be clear. We believe it should be about how we can make further progress towards the goal set out above. Whilst we should be willing to learn lessons from Enron we need to be conscious that the system of governance is different in the UK from that in the USA in a number of important respects and that one needs to be very cautious when considering general remedies based on the partly known facts of a particular case. That said, the Enron case highlights the potential threat the failure of a single large corporation can pose to the stability of the capital markets and is rightly acting as the catalyst for reviews in a number of jurisdictions. In looking at events that have taken place regard should also be had to issues arising from the severe decline in the share price of "dotcom" companies following their short-lived enormous popularity. Recent experience in the application of The Combined Code should also be considered and efforts made to identify current and likely future trends affecting listed companies.

Balancing Entrepreneurship and Risk Management

  An appropriate balance needs to be struck between entrepreneurship and effective risk management both within individual companies and for the economy as a whole. One without the other will not lead to sustainable national prosperity or to the creation of more UK-led world class companies, an imperative if we are to be successful in competitive global markets. In a competitive market economy profits are the reward for successful risk-taking and thus the aim is not to eliminate risk in companies but rather to ensure that it is managed effectively and that businesses are open about the level of risk they have assumed so that stakeholders can make informed decisions.

A Responsive System that Encourages Continuous Improvement

  Our governance system should be able to respond quickly and effectively to the ever-changing business environment and should encourage companies to see improvements to their governance model as integral to their ongoing quest for ever better economic, social and environmental performance. Good governance should be seen by boards as being essential to running a successful business as well as about complying with regulatory requirements. This is most likely to be achieved by fostering innovation in the area of governance by companies at the leading-edge of practice and then taking steps to bring standard practice up to the level of what has been seen as best practice within a reasonably short period of time. The Cadbury Code and subsequently The Combined Code, together with the Turnbull Report which is linked to it, have been fairly successful in this regard. Where a high degree of compliance can be secured, market-led reforms, coupled with appropriate enforcement pressures on companies resisting compliance, have advantages compared to legislative solutions which can stifle innovation and lead to "boilerplate" solutions.

A Preference for a Preventative Approach

  A governance model that aims to prevent problems arising has benefits over one that is principally concerned with addressing them once they become apparent though of course if they do occur they need to be identified and remedied as soon as possible. Given the board's responsibility for leading and controlling the company, this highlights the importance of getting the right board in place and ensuring it works effectively. This is not to underestimate, however, the role auditors, shareholders and, indirectly, analysts and the media have in contributing to good governance. An effective governance system requires all those with an oversight role to exercise their responsibilities actively, competently and in an independent manner.

Holistic Solutions Based on a Cost/Benefit Analysis

  Every system of governance needs to be viewed as a cohesive whole with the key players having interlocking roles that taken together if functioning appropriately lead to effective governance. In proposing reforms care needs to be taken to assess the impact as far as possible on the system as a whole and to avoid changes that have unintended but foreseeable negative consequences. It is also easy for advocates of a proposed change to emphasise the benefits and opponents the disadvantages. A rigorous assessment will take account of both aspects.


Auditors and Audit Committees

  Given their pivotal role in providing assurance on the integrity and transparency of financial reporting by companies, which makes an important contribution to the effective functioning of the capital markets, it is essential that auditors and auditing command the highest levels of public confidence. We recognise there are currently significant concerns relating to the auditing profession that should be addressed with reforms being based on reasoned analysis of the main issues involved.

Audit Committees

  The relationship between auditors and audit committees needs to be strengthened. The auditor's primary relationship with the company, in practice as well as formally, should be with the audit committee, representing shareholders' interests, rather than with senior management. A working party, led by independent directors who sit on audit committees and including auditors, should be established to provide fuller guidance on matters relating to auditors and audit committees dealt with in the Combined Code just as the Turnbull Report provided implementation guidance on risk management and internal control issues covered in the Code.

  Audit Committees should approve in advance any non-audit services to be provided by the auditing firm and subsequently the annual report should contain a full analysis of the nature of non-audit services clearly distinguishing between those related to auditing, eg due diligence work and assurance assignments linked to social and environmental reports, and those of a consultancy or advisory nature if they continue to be permitted.

  The Combined Code currently says audit committees should comprise at least three non-executive directors a majority of whom should be independent. We believe audit committee membership, just as for the remuneration committee, should be required to be made up wholly of independent directors. The audit committee should also keep under review whether it has the necessary blend of knowledge and experience as well as sufficient time available to properly discharge its responsibilities. Such a review would be likely to lead to a number of audit committees increasing the frequency of their meetings and the time devoted to the work of their committee.

The Provision of Non-Audit Services

  It is not possible to demonstrate conclusively whether the provision of non-audit services does or does not jeopardise their independence. Only individual auditors know for sure what factors were to the fore when they made judgements that with hindsight appear open to challenge. What is more susceptible to assessment, however, is whether there is a broad-based perception that the provision of non-audit services impairs auditor independence. There appears to be widespread concern about the scale of non-audit services in relation to the audit fee in a number of instances, albeit that a significant proportion of these will often be audit-related. If independent research confirms concern among investors and others about auditors undertaking work of a consultancy or advisory nature for their audit clients we would strongly support a prohibition on such work being carried out in the future. In any event, we consider it would be helpful for a review to be undertaken of the type of additional services it is appropriate for the auditor to provide.

Compulsory Rotation of Auditors

  There has been much speculation about the need for the mandatory rotation of auditors. If there is renewed confidence in the independence of auditors from management as a result of the measures proposed in this submission, the rationale for this speculation lessens. Moreover, the difficulties of introducing such a change in the current environment where there are soon likely to be only four firms undertaking a large majority of listed company audits should not be underestimated especially if one or more of the firms is not eligible for appointment in a particular instance on the grounds that they are ongoing advisers in other fields such as taxation.

Increased Competition in the Market for Audit Services

  We believe greater competition in the market for audit services would be in the public interest. The increased concentration in the market for audit services over the past couple of decades or so is marked and in the long term may well be injurious to investor confidence. It is the responsibility of leading firms outside the Big 4/5 such as ours to provide the necessary competition and we are fully committed to doing so.

Private Sector Audit Commission

  We do not support the concept of an Audit Commission for the private sector with responsibility for making audit appointments. This would harmfully weaken the links between the auditors of a company and the shareholders to whom they are accountable. By contrast, we believe the changes proposed in this submission would strengthen this vital relationship for effective corporate governance.


  As Principle A.1 of The Combined Code on corporate governance indicates "every listed company should be headed by an effective board which should lead and control the company".

  There have been a number of general improvements in boardroom governance in recent years, most notably the splitting of the roles of Chairman and CEO; an increase in the number of non-executive directors; the introduction of the concept of independent non-executive directors together with the introduction of the senior independent director role; greater emphasis on the board's oversight role; and the stressing of the need for a formal and transparent procedure for the appointment of board members. This process of evolutionary change should continue. We would, in particular, advocate the introduction of a provision in The Combined Code calling on boards to review their own performance on a regular basis and at least annually and the commissioning of a review of the provisions relating to "independent" and "non-executive" directors as there seems to be some confusion in the way each of these terms is used.

Review of Board's Performance

  A formal review of the board's performance, perhaps assisted by an outside facilitator, will give it the opportunity to ask whether:

    —  it collectively has the right blend of skills and experience to take the company forward;

    —  there is a clear strategy and flowing from it a sound approach to risk management;

    —  the board receives and discusses performance measures (financial and non-financial) related to the fundamental drivers of business performance;

    —  the board provides a challenging yet supportive environment for the executive team, with full discussion of major items at board meetings prior to clear decisions being taken;

    —  it failed to anticipate any foreseeable events which had a significant impact on the business and how successfully it responded to those that were unforeseeable.

Independent Directors

  The Combined Code states that the board should include non-executive directors of sufficient calibre and number for their views to carry sufficient weight in its decisions. It goes on to say that non-executives should comprise not less than a third of the board and that a majority of them should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement. It would therefore be possible to comply with the Code if just over one-sixth of the directors were independent. The Code should at least be amended to call for a third of the board to be made up of independent directors and best practice might be regarded as having a majority of independent directors on the board. The definition of an independent director could also usefully be amplified to indicate, for example, that previous executives, those with consultancy agreements or those receiving incentive awards should not be deemed to be independent although they may still have a valuable role to play as non-executive directors. A strong case can also be made for requiring the independent directors to recommend to the board the names of proposed new independent directors. Such a move would require amendment to the provisions of the Code relating to nomination committees.

Choosing Independent Directors from a Wider Pool

  In choosing independent directors, opportunities exist for enhancing the overall quality of boards as well as their diversity, by seeking to recruit them from a wider pool which could include those with leading positions in the public or not-for-profit sectors. Boards should also make sure there are no glass ceilings relating to the appointment of female directors or those from ethnic minorities to either executive or non-executive positions. Further thought needs to be given as to how best these objectives can be achieved as success to date in this area has been limited. In calling for a wider pool, we would wish to emphasise the importance of continuing to attract high quality independent directors who are executive directors in other business organisations or who have a business background and hold a small portfolio of non-executive appointments as this greatly facilitates the sharing of experience and best practice across the business community.



  Accounting standards have been the subject of major improvement in the United Kingdom in the past decade and a substantial programme that will lead to convergence with International Financial Reporting Standards is now underway. Reporting, however, extends beyond the financial statements to include the Operating and Financial Review and various requirements of Company Law and the Listing Rules. A proposal has been made, as part of the Company Law Review process, to introduce a mandatory OFR for some companies and we understand the Accounting Standards Board also has an initiative underway on the OFR.

  We strongly support efforts to increase the level and quality of reporting on the following issues which fall within the broad scope of the OFR whilst recognising that those at the leading edge of reporting practice are already making substantial disclosure on at least some of the matters covered below:

    —  the strategy of the business;

    —  the key drivers of the company's performance (in many instances these will be intangibles such as brands, the people in the business, R&D and/or patents);

    —  financial and non-financial measures of the key dimensions of business performance and a discussion of how this leads towards achievement of the strategy;

    —  environmental and social performance;

    —  future prospects;

    —  the principal risks to achieving the strategy (few companies disclose actual risks at present and the Turnbull Report focuses largely on discussing board processes in managing the key risks).


Institutional Shareholders

  Given that a substantial majority of shares in UK-incorporated listed companies are held by institutions any review of the effectiveness of our governance system needs to focus on the extent to which the institutions are actively fulfilling their duties as shareholders, eg in exercising their rights to appoint directors and in doing so bringing about changes in board membership when they are needed. The institutions should promote good governance in the companies in which they own shares and as part of this commitment should, for instance, generally encourage full compliance with The Combined Code.

Compliance with The Combined Code

  A recent PIRC Survey "Corporate Governance 2001" found that only 28 per cent of companies felt that they fully complied with The Combined Code. The main reasons being given for non-compliance include no senior independent director having been appointed, contract notice periods exceeding one year and remuneration committees not being fully comprised of independent directors. Consideration should be given as to how to increase significantly the levels of full compliance with the Code including addressing whether the provisions of the Code should be fully brought within the Listing Rules and hence made mandatory.

The Role of Analysts in Corporate Governance

  Concern has recently been expressed about the degree of independence displayed by analysts in certain circumstances when making recommendations on companies' shares. This issue should be addressed as high quality, independent external assessment of a company's performance and prospects has an important part to play in the efficient working of the capital markets.

5 April 2002


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