Chapter 2: Accounts and Reports

Auditing of accounts

42.     The purpose of clauses 8 and 9 is to strengthen the rights of company auditors, by entitling the auditor to require information and explanations from a wider group of people than at present and by requiring the directors' report to contain a statement that the directors are not aware of relevant information which has not been disclosed to the company's auditors.

Clause 8 - Auditors' rights to information

43.     Under existing legislation (section 389A of the Companies Act 1985) a company's auditors are entitled to require from the company's officers such information and explanations as they think necessary for the performance of their duties as auditors. It is a criminal offence for an officer of the company to provide misleading, false or deceptive information or explanations. However, it is not an offence for them to fail to provide any information or explanation that the auditors require of them.

44.     This clause is intended to help auditors to carry out their duties by strengthening their right to require information or explanations, with the aim of increasing the reliability of, and confidence in, company accounts.

45.     It does this in two ways:

• it entitles the auditor to require information and explanations from a wider group of people. Specifically, it reflects a recommendation in the Company Law Review that those required to provide information and explanations to auditors should include employees (Modern Company Law for a Competitive Economy, Final Report July 2001, URN 01/942, paragraph 8.119 first bullet);

• it makes it a criminal offence to fail to provide information or explanations required by the auditor.

46.     Clause 8 substitutes new sections 389A and 389B for the existing section 389A in the Companies Act 1985.

47.     In new section 389A, subsections (1) and (2):

• re-enact the auditor's right to access relevant material; and

• add to the category of people from whom the auditor may require information. Auditors currently have the right to require "officers" of the company (which includes directors, managers and company secretaries) to provide information and explanations necessary for their work. However, others, in particular employees who are not "managers" may hold relevant information. Those to whom the requirement to provide information applies are set out in subsection (2).

48.     Subsections (3)-(5) in new section 389A re-enact existing provisions in relation to non-GB subsidiaries, extended to include employees and certain others. It is neither desirable nor effective to place a direct responsibility on a non-GB subsidiary and those associated with it to give information and explanations to a UK auditor. The responsibility is therefore placed on the parent company to do what is reasonable to obtain the required information and explanations from them.

49.     New section 389B sets out criminal offences relating to the provision of information to auditors. Subsection (1) re-enacts the existing provision in section 389A(2) of the Companies Act 1985 concerning the offence relating to providing false or misleading information or explanations to an auditor. The subsection also applies this offence to the new categories of people from whom the auditor may require information under new section 389A.

50.     There is at present no criminal sanction where an officer of the company is required to give information but fails to do so. Subsection (2) of new section 389B introduces a new criminal offence for such a failure as well as for a failure by the other persons from whom the auditor is entitled to require information or explanations.

51.     Subsection (3) provides a defence for a person to prove it was not reasonably practicable to provide such information or explanations. Subsection (4) provides for an offence where the parent company fails to take all steps reasonably open to it to obtain the information or explanations which the auditor has required it to obtain from its non-GB subsidiary and those associated with it.

Clause 9 - Statement in directors' report as to disclosure of information to auditors

52.     Clause 9 complements the auditors' rights to information contained in clause 8. It requires the directors' report to contain a statement that each director is aware of no relevant audit information of which the auditors are unaware and that the director has taken all the steps he should have taken as a director to make himself aware of such information and to establish that the auditors are aware of it.

53.     The aim of clause 9 is to ensure that each director will have to think hard about whether there is any information that he knows about or could ascertain which is needed by the auditors in connection with preparing their report. This is along the lines of one of the objectives of the recommendation in the Company Law Review (Modern Company Law for a Competitive Economy, Final Report July 2001, URN 01/942, paragraph 8.119 second bullet) that directors should be required to volunteer information to the auditors in certain circumstances. There are safeguards for the directors in terms of the information covered and the offence where the directors make a false statement.

54.     Clause 9 imposes a specific requirement that the directors' report contains a statement that, in the case of each individual director, the director is aware of no relevant audit information of which the auditors are unaware and that the director has taken all the steps he should have taken as a director to make himself aware of such information and to establish that the auditors are aware of it.

55.     Subsection (2) establishes the basic requirement for a statement in the directors' report. It applies to all companies whose accounts have been subject to a statutory audit for that financial year. Under the existing law, as recently amended by the Companies Act 1985 (Accounts of Small and Medium-Sized Enterprises and Audit Exemption) (Amendment) Regulations 2004 (SI 2004/16), most small companies with a turnover of £5.6 million or less and a balance sheet total of £2.8 million or less are exempt from the audit requirement.

56.     Subsection (3) sets out the content of the statement. It makes clear that the statement relates to each individual director's awareness of relevant audit information of which the auditors are unaware (new section 234ZA(2)(a)) and the taking of steps by each director to ascertain relevant audit information and the auditors' awareness of it (new section 234ZA(2)(b)). Taken with new sections 234ZA(4) and (5), new section 234ZA(2)(b) provides that the steps which the statement confirms have been taken by each director to make himself aware of relevant audit information and to ascertain the auditors' awareness of it are those required by the directors' existing common law duty to exercise due care, skill and diligence. New section 234ZA(3) defines "relevant audit information."

57.     New section 234ZA(6) sets out the offence and sanctions that apply if a false statement is made. (If the statement is not made at all, the existing offence in section 234(5) of the 1985 Act - failure to comply with the provisions of Part 7 of the Act as to the contents of the directors' report - will apply.) The offence applies to each individual director who knew or was reckless as to whether the statement was false and did not take reasonable steps to prevent the report from being approved. A person found guilty on indictment will be liable to imprisonment for up to two years and/or an unlimited fine, and on summary conviction to up to twelve months' imprisonment and/or a fine up to the statutory maximum (£5,000).

Defective accounts

Summary and background

58.     These clauses deal with the enforcement of accounting requirements, and in particular with strengthening the enforcement role of the person authorised under section 245C of the Companies Act 1985. The person currently authorised is the FRRP. At present the statutory role of the Secretary of State, or the person authorised for the purpose, is restricted to examining companies' annual accounts for departures from the accounting requirements of the Act and applying to the courts to order the preparation of revised accounts as necessary. Clauses 10-12 and clauses 14 and 15 enhance this existing regime in a number of ways: by (a) providing for a prescribed body (which will be the FRRP) to be appointed to monitor aspects of accounts or reports required under Listing Rules, such as interim financial statements; (b) providing for the authorised person and the prescribed body (the FRRP in both cases) to have a power to obtain information in order to carry out their functions; (c) opening an information gateway from the Inland Revenue to the FRRP.

59.     The person currently authorised under section 245C is the FRRP. In future it will be the Review Panel, a body formed under the constitution of the FRRP, which will be authorised under section 245C and also appointed under clause 14 for the purpose of monitoring aspects of accounts or reports required under Listing Rules. It is not envisaged that any other person or body is likely to be authorised or appointed. For that reason these notes refer to the FRRP or the Review Panel of the FRRP throughout, although the legislation itself does not name the FRRP.

60.     Strengthening the role of the FRRP was a key recommendation of the Coordinating Group on Audit and Accounting Issues, one of the reviews set up by the Government in response to the financial reporting scandals in the US at companies such as Enron. The Group reported to the Government in January 2003. The changes to the role of the FRRP also need to be seen in the context of overall changes to the Financial Reporting Council Ltd and its associated companies, of which the FRRP is one.

Clause 10 - Persons authorised to apply to court in connection with defective accounts

61.     Clause 10 makes certain changes in relation to authorising a person to apply to the court to correct defective accounts. The person who is currently authorised under section 245C of the Companies Act 1985 is the Financial Reporting Review Panel Ltd. It is expected that the person who will be authorised once this section has been amended as provided in this clause will be the Review Panel of the FRRP formed under the constitution of the FRRP. Clause 10 provides that where the authorised person is an unincorporated association (as the Review Panel will be) any proceedings brought in connection with the exercise of the functions by the authorised person may be brought in the name of the body corporate whose constitution provides for the establishment of the association. Clause 10 also makes alterations to the power under section 245C to allow the Secretary of State, if she considers it appropriate, to prescribe how the authorised person will exercise its functions.

Clause 11 - Disclosure of tax information by Inland Revenue to facilitate application for declaration that accounts are defective

62.     This clause provides for the passage of information from the Inland Revenue (IR) to a person authorised under section 245C of the Companies Act 1985 and makes equivalent provision in Northern Ireland. That person is currently the FRRP. It adds new sections after section 245C of the Companies Act 1985 and Article 253C of the Companies (Northern Ireland Order) 1986, in order to permit the disclosure of information by the IR to a person authorised, under section 245C of the Companies Act 1985 and Article 253C of the 1986 Order, to apply to the court for a declaration that a company's accounts do not comply with the legislation in question. The clause also provides restrictions on use and further disclosure of the information.

63.     Subsection (1): 245D - Disclosure of information held by Inland Revenue to persons authorised to apply to court. This subsection adds a new section 245D after section 245C of the Companies Act 1985, permitting the Inland Revenue to pass information to the authorised person (currently the FRRP), if the disclosure is made for a permitted purpose. Subsection (3) of new section 245D defines what counts as a permitted purpose, that is to say in order to enable the authorised person to discover whether there are grounds for an application to the court, or to determine whether or not to make such an application. Subsection (2)(b) of new section 245D provides that personal data may not be disclosed in contravention of the Data Protection Act 1998. Under subsection (4) the Inland Revenue Commissioners may delegate the power to authorise disclosure to an officer of the Board of the Inland Revenue.

64.     Subsection (1): 245E - Restrictions on use and further disclosure of information disclosed under 245D. Subsection (1) also adds a new section 245E to the Companies Act 1985, which places restrictions on the uses to which disclosed information may be put; and on further disclosure by the authorised person. Under subsection (1) of new section 245E, the uses to which the information may be put are to enable the authorised person to discover whether there are grounds for an application to the court, to determine whether or not to make such an application, and in proceedings on any such application.

65.     Subsection (2) of new section 245E prevents information being disclosed by the authorised person to anyone else, except to the person to whom the information relates, or in connection with court proceedings. Subsection (3) of new section 245E makes it a criminal offence to breach the restrictions on use or further disclosure set out in subsections (1) and (2), and should be read in conjunction with the amendments in paragraph 10(3) of Schedule 2, to Schedule 24 of the Companies Act 1985. A person guilty of use or further disclosure in contravention of the restrictions is liable on summary conviction to imprisonment for a term not exceeding twelve months or a fine not exceeding £5,000, or both; or, on conviction on indictment, to imprisonment for a term not exceeding two years or a fine, or both.

66.     Subsection (4) of new section 245E provides a defence, namely that a person may prove that he did not know or had no reason to suspect that the information in question had been disclosed under this legislation or that he took reasonable steps to prevent wrongful use or disclosure.

67.     Subsection (5) of new section 245E applies to offences under new section 245E, sections 723, 733(2) and (3) and section 734 of the Companies Act 1985. Section 732 concerns restrictions on the institution of proceedings for offences. Section 733(2) and (3) concern the liability of individuals for corporate defaults. Section 734 makes provision for criminal proceedings against unincorporated bodies.

68.     Subsection (2) 253D - Disclosure of information held by Inland Revenue to persons authorised to apply to court; and 253E - Restrictions on use and further disclosure of information disclosed under Article 253D. Subsection (2) inserts, after Article 253C of the Companies (Northern Ireland) Order 1986, two new Articles 253D and 253E whose purpose and effect, in respect of their application in Northern Ireland, is equivalent to that of new sections 245D and 245E discussed above, in respect of Great Britain.

Clause 12 - Power of person authorised to require documents and information; and Schedule 1 - New Schedule 7B to the Companies Act 1985

69.     The FRRP (as the person authorised under section 245C of the Companies Act 1985) currently has no power to require a company to provide it with the information it needs to carry out its functions. To date, it has relied on the voluntary co-operation of the company in question to provide explanations and documents which are not publicly available.

70.     The view of the Government and the FRRP is that with the move to a more proactive approach, in which the FRRP will be considering more cases, such co-operation cannot be relied on in every instance. Moreover, the Committee of European Securities Regulators has recently set out a number of key enforcement principles, including that any competent enforcement authority should have adequate powers. Clause 12 therefore provides the FRRP with a statutory power to obtain relevant material.

71.     Subsection (1) inserts a new section 245F into the Companies Act 1985. Subsections (1) to (3) of this new section provide the FRRP with a statutory power to require a company and its officers, employees and auditors to provide documents and information. The effect of subsection (1) is that FRRP may use its power to obtain information, explanations and documents only when it considers that there is a question as to whether the accounts or reports comply with the relevant requirements relating to that report or those accounts. It will not be able to exercise the powers as part of a random sampling or sector-wide review of accounts where there is no reason to believe there is any particular problem with the accounts of the company in question.

72.     The person against whom the power is used must produce any document that the FRRP may reasonably require in relation to such accounts or reports or provide any relevant information that the FRRP may reasonably require. Subsection (8) ensures that a "document" can refer to information stored on computer as well as hard copies.

73.     Where a person refuses to provide information or documents to the FRRP, the FRRP may apply to the court for an order. The court may make an order requiring disclosure. Failure to comply with such an order would be contempt of court.

74.     Restrictions on further disclosure of information obtained under section 245F.

A new section 245G is also inserted into the Act, ensuring that information obtained by the FRRP under the new powers will be subject to restrictions on onward disclosure. Information may not be disclosed by the FRRP without the consent of the individual or business in question, except for the purposes of carrying out its functions, or to specified persons or for specified purposes set out in a new Schedule 7B of the Act which is inserted by Schedule 1 of the Bill.

75.     New Schedule 7B provides for the type of disclosures of information obtained by the authorised person under new section 245F and permitted under new section 245G. It lists the specified persons to whom disclosures are permitted and the specified descriptions of disclosures which are permitted. It also sets out the circumstances in which a disclosure to an overseas regulatory authority is permitted. Under subsection (4), the Secretary of State has the power to amend the Schedule. Under subsection (5) the Schedule can only be amended to specify persons exercising functions of a public nature or to specify descriptions of disclosure, where the purpose for which the disclosure is permitted is likely to assist in the exercise of a function of a public nature.

76.     Subsection (7) of new section 245G provides an offence if information is disclosed in contravention of the new section. A person guilty of such an offence is liable on conviction on indictment to two years' imprisonment or a fine or both; and on summary conviction to twelve months' imprisonment or a fine. Subsection (8) provides a defence, namely if a person can prove that he did not know or had no reason to suspect that the information in question had been disclosed under this legislation or that he took reasonable steps to prevent wrongful use or disclosure.     

Directors' reports

Clause 13 - Power to specify bodies who may issue reporting standards

77.     Clause 13 amends section 257 of the Companies Act 1985 which confers power on the Secretary of State to amend the accounting and audit provisions in Part 7 of the Act.

78.     New subsection (4A)(a) gives the Secretary of State the power to specify a body to issue standards relating to reports which the directors are required to prepare under Part 7 of the Companies Act 1985. Directors are currently required to prepare a directors' report and, for the directors of a quoted company, the directors' remuneration report. This clause would allow standards to be drawn up for these reports, which are not covered by the "accounting standards" issued by bodies prescribed under section 256 of the Companies Act 1985. The provision is, however, primarily intended as a paving device to allow a specified body to issue a standard in relation to a new report, the operating and financial review, which it is proposed to require of directors in due course by regulations under section 257. Such reporting standards would not have the "true and fair" authority of accounting standards. In order to confer statutory authority, new subsection (4A)(b) confers power on the Secretary of State to provide in regulations that compliance with the reporting standard will be presumed, unless the contrary is proved in civil or criminal proceedings for breach of the Act's requirements, to be compliance with the Act's requirements in respect of the report to which it relates.

79.     Regulations under section 257 introducing the new requirement for an operating and financial review will be subject to affirmative resolution. New subsection (4B) stipulates that the order to be made by the Secretary of State specifying the body or bodies authorised to issue the new reporting standards will be subject to negative resolution.

Supervision of accounts and reports

Clause 14 - Supervision of periodic accounts and reports of issuers of listed securities

80.     Clause 14 provides the Secretary of State with the power to appoint a body (intended to be the Review Panel of the FRRP) to monitor compliance by issuers of listed securities, or certain classes of these issuers, with accounting requirements of the Listing Rules.

81.     These rules are made and enforced by the Financial Services Authority (FSA). Under section 74(1) of the Financial Services and Markets Act 2000 (FiSMA), the FSA is required to maintain an official list. Under sections 74(4) and 96 of that Act, the FSA may make Listing Rules governing the admission of securities to the official list and specifying the requirements on companies and other entities which list securities.

82.     The clause will allow the Government to create a role for the Review Panel in checking the financial information contained in some of the documents which are required to be produced periodically under Listing Rules: namely, the half yearly (interim) report and the annual report. Currently, the FRRP checks the annual reports of Companies Act companies only (it performs a similar function under Northern Ireland companies legislation). The clause thus allows the Secretary of State to extend the scope of the FRRP's activities in two directions:

• she may appoint the Review Panel to look at interim reports and any other periodic reports required by Listing Rules, in addition to annual reports;

• she may appoint the Review Panel to look at annual and interim reports of entities which are on the official list but are not Companies Act companies; this covers entities whose securities are listed in the UK but which are not UK companies, such as some UK building societies, as well as overseas companies and other entities. By virtue of subsection (5), the body may be appointed in respect of certain classes of issuer only, and in respect of certain types of reports and accounts. For example, the power could be used to extend the Review Panel's remit to cover the accounts of overseas companies which have a primary listing in the UK, and the accounts of UK issuers which are not companies but which issue equities or domestic debt.

83.     The clause also allows the FSA to refer individual cases which may not fall within the Review Panel's remit (for example issuers of specialist debt) to the Review Panel for it to review. The FSA would conduct their own assessments and refer cases to the Review Panel only where they identified a risk in respect of the reports and accounts.

84.     The clause is drafted to allow maximum flexibility in these regards: ongoing negotiations in Europe (for example in the Committee of European Securities Regulators, and on the Transparency Directive) and internationally (on international accounting standards) may have an impact on the precise remit which will be set out in the order.

85.     The Review Panel's function under this clause will be to check that the accounting information contained in the accounts and reports complies with the accounting requirements of the Listing Rules, and to inform the FSA of any conclusions it reaches. The FSA will then decide what further action should be taken, and has a range of sanctions available to it under FiSMA 2000.

86.      This will be in addition to the FRRP's existing activities in respect of annual accounts under section 245C of the Companies Act 1985, where the enforcement route is through an application to the court for an order requiring revised accounts.

Clause 15 - Application of sections 245D to 245G of the Companies Act 1985 to bodies appointed under section 14

87.     Clause 15 applies the provisions relating to the disclosure of information by the Inland Revenue in clause 11 to the body appointed under clause 14. It also applies the provisions concerning the power to obtain documents and information and the restrictions on use of the information so obtained in clause 12 to the body appointed under clause 14. The effect is that the Review Panel will have the same power, and the same access to IR information, in respect of its activity under clause 14 (checking interim reports and reporting to the FSA) as it will when exercising its remit under section 245C of the Companies Act 1985 (checking annual reports of Companies Act companies).