Narrative Reporting and Liability

CBI The Companies Act 2006 Conference, 7 November 2007

Kathryn Cearns, Chairman, ICAEW Technical Advisory Committee

Narrative Reporting

• The Transparency Rules

• CA 2006

• Guidance on narrative reporting

• The Business Review and the Operating and Financial Review

• New law on business review applies “from” 1 October 2007

• And my message is …there are rules, but you can forget them!

Transparency rules

• Transparency Directive part of the EU Financial Services Action Plan

• Deals with the production of periodic financial information, its dissemination and its storage

• Companies with securities traded on a regulated market (NB varies as to whether equity, debt or any traded security)

• Accounting periods beginning on or after 20 January 2007

• Requires the existence of a liability regime for issuers in relation to periodic financial information

Transparency rules

• DTR 4 Periodic financial reporting– DTR4.1 annual financial report– DTR4.2 half yearly financial report– DTR4.3 interim management statement (IMS)

• First two of these must contain a “management report”– Fair review– Principal risks and uncertainties– It is required to be forward looking

• IMSs are new– Explanation of material events and transactions– General description of financial position/performance of

issuer

Transparency rules

• Responsibility statements are required for the annual and half yearly financial report

• Made by “persons responsible within the issuer”

• The board of directors for UK purposes

• State name and function of person making statement

• Statements are:– Accounts true and fair– Fair view in management report

Section 417: Content of directors' report: business review (non-small companies)

• All non-small companies

• The purpose of business review is to inform members and help them assess how the directors have performed their duty under Section 172

• Section 172 contains the duty to "promote the success of the company for the benefit of its members“, which was previously a common law test

Section 417: Content of directors' report: business review (non-small companies)

• Fair review of the business, and describe principal risks and uncertainties (subsection (3))

• Balanced and comprehensive analysis of the development and performance during the financial year, and the position at the year end (subsection (4))

• Where appropriate, include references to, and additional explanations of, amounts in the accounts (subsection (8))

Business review: Key Performance Indicators (KPIs)

• Use financial KPIs "to the extent necessary" (subsection (6)(a))

• Non-medium companies should use non-financial KPIs where appropriate, including environmental and employee matters (subsection (6)(b))

• Which? How many?

Section 417: Content of directors' report: business review (non small companies)

• May omit information about impending developments or matters in the course of negotiation where directors consider that disclosure would be seriously prejudicial to the interests of the company (subsection (10))

• May omit information about a third party otherwise required for quoted companies by subsection (5c) (essential contractual or other arrangements) where in the directors opinion it would be seriously prejudicial to that third party and contrary to the public interest (subsection (11))

Section 417(5): Business review (new bits for quoted companies)

• “Must include information "where necessary for an understanding of the business" on…

• Future trends and factors likely to affect future performance etc; environmental matters; employees; social and community issues…

• Including policies and effectiveness of those policies

• Describe essential contractual or other arrangements

• If nothing to report on environmental, employee, social and community matters or essential contractual or other arrangements, directors must say so

The guidance

• ASB Reporting Statement 1: Operating and Financial Review www.frc.org.uk/asb

• ASB review of narrative reporting by public companies www.frc.org.uk/asb

• DEFRA suggested environmental KPIs (76 pages) www.defra.gov.uk/environment/business

• Larger firms have put out briefing papers as well

What is the minimum required?

• It is what the law says

• Think about your stakeholders – do they look for more than the minimum?

• Why not use the business review to "sell" your business, be positive?

If you want to publish a proper business review, tell the story of your business…

• Set out where you want the business to get to

• How you plan to get there (strategy)

• Risks and uncertainties around your plan

• Controls/plans in place to mitigate those risks

• How you will monitor progress along the way (KPIs)

In your own way, reflecting how you manage your business.

Liability

• Outline of statutory regime for directors’ reports

• Periodic reporting liability regime

• There are complex issues that are still under consideration

Section 463: Statutory liability regime for Directors' Report and Directors' Remuneration Report

• “Safe harbour" provision

• Liability of the director to the company

• Documents sent to members (approval date is not applicable) on or after 20 January 2007

• Directors' report, directors' remuneration report (where required) and summary financial statements

Scope of the safe harbour provisions

Section 463: Statutory liability regime for Directors' Report and Directors' Remuneration Report

• To compensate the company for loss suffered by it as a result of…

• Untrue or misleading statements, if made knowingly or recklessly, or…

• As a result of omissions known to be a dishonest concealment of a material fact

• No liability to a person other than the company

• No effect on existing civil or criminal liabilities

Section 1270: Liability for false or misleading statements in certain publications

• Statutory liability regime for Transparency Directive periodic reporting plus related preliminary announcements

• Inserts sections 90A and 90B into Financial Services and Markets Act

• Establishes a regime for civil liability to third parties by issuers admitted to trading on a regulated market (full list)

• With effect from 8 November 2006

Section 1270: Liability for false or misleading statements in certain publications

• Applies to reports and statements required by Articles 4, 5 or 6 of the Transparency Directive

• These are the annual and half year reports, including the associated management reports and interim management statements

• Plus information in voluntary prelims that will subsequently be included in those reports have been brought into the scope

Section 1270: Liability for false or misleading statements in certain publications

• Liability to investor who suffered loss as a result of reliance on that statement, when and where reliance was reasonable

• Liability is limited to where the person responsible knows the statement to be untrue or misleading, or is reckless, or where omission is known to be a dishonest concealment of a material fact

What applies to whom

Companies Act 2006

Section 1270 Section 463

Listed companies All companies

Liability of company to shareholder Liability of director to the company

How to be compliant

• Responsibility statement– Can be signed by one board member on behalf of board– Named person’s liability no greater than that of other

board members• Cautionary wording over forward looking statements• Time line of new reporting deadlines, particularly in transition• Holistic approach, particularly to narrative reporting• Corporate governance issues

– Systems and controls, clear reporting lines up to the board

– Finance function up to strength– Right expertise on the board and audit committee– Time and attention of board members

The Davies Review of Issuer Liability: questions

• Trigger for liability

• Which information should be caught

• Timeliness

• Which companies should it apply to

• Who should be liable

• Who should be able to claim

• Priority of claims

The Davies Review of Issuer Liability: answers?

• Extend to cover “ad hoc” disclosures

• Extend to cover AIM and PLUS markets (i.e. non-regulated)

• Apply to all RIS announcements

• Extend to encompass liability for dishonest delay

• Extend to both buyers and sellers of shares, but exclude holders