UK: The Devil of Over-Regulation

Last Updated: 18 December 2002

By Kenneth McKenzie and Richard Highley

In the latest of a long line of authoritative reports on reform of the mechanism of corporate provenance, Sir Derek Higgs proposes a two tier board structure mirroring the Continental model and codification of Directors' duties. His report has arrived on the heels of the recent corporate and financial revelations in the US, when the UK Government is under pressure again to act. In the US, statutory reform has been introduced which threatens Directors with jail if they produce inaccurate accounts. The British Government is considering introducing similar legislation here. But to have a thriving economy and a regulatory environment, which encourages Directors to make profit for their companies and shareholders, do they not need the freedom to pursue their corporate vision with no more constraint than is consistent with prudent governance? If we have a structure that is too encumbered by regulation, how can they make decisions freely? A balance needs to be struck between avoiding the stifling of enterprise and ensuring that fraud and the abuse of a free environment are prevented.

How good are the checks and balances in place in the UK? UK Accountants have pointed to the differences between the US and UK audit approaches when suggesting that an Enron or Worldcom will not happen here. They point out that the US method is reliant on technical rules, which encourages exploitation of loop-holes, in contrast to the UK perspective which is based upon the exercise of judgement on the part of the auditors, who express an opinion as to whether the Company Accounts are true and fair. The accountants may be right, but Maxwell was not based on exploitation of technical accounting rules, it was simply abuse of executive power on a large scale.

Since the UK's own crop of high profile collapses in the 90's - BCCI, Maxwell, Polly Peck, Barings - an increased emphasis has been placed here upon the role of non-executive Directors. According to the recommendations of the Turnbull Report, non-executive Directors should:-

  • Challenge the decisions of the Board when appropriate
  • Protect the company and its shareholders from mis-management.
  • Exercise objective judgement.
  • Ensure that the Board has adequate systems to safeguard the interests of the company and control and monitor performance.
  • Be independent.

If auditors and the company accounting process are counted only as the first line of defence, what should the conscientious non-executive Director do to fortify the company's integrity and what should the company do to assist him in discharging his role?

First, let us start with re-stating accepted truths. The company must be seen to be selecting and appointing non-executive Directors for their skills, independence and judgement and not from some notional gene pool of the great and the good, or worse still the old pals of the executive board. Secondly, the company and the Directors themselves should make sure the non-executives are allowed to exercise all three of their selection criteria. Thirdly, they must be equipped at all times with the information necessary to the task. This last requirement is vital but not easy to fulfil given the necessarily limited involvement of non-executives.

If non executives are failing to fulfil their role as a legal check or as a whistle blower because of their fundamental lack of full information then there needs to be a fourth means to minimise the risk of corporate fraud. We suggest the answer lies in greater "vertical" transparency. Setting up more transparent internal reporting, tracking and alarm mechanisms means that should the worst happen, and the company comes under scrutiny, it will have prepared the ground adequately and will have a complete and transparent chain of responsibility. If this is built into the corporate ethos, both structurally and philosophically, not only will the company be better able to cope with vagaries of fortune, but the non-executive Directors will have both a panic button and a record by which their conduct can be judged and, it is to be hoped, exonerated.

Directors do not want over regulation but the scrutiny of their activities will increase, as will the penalties for misconduct. It is vital that Directors both full-time and non-executive avert over-regulation in the future and preserve their commercial freedom to drive a thriving UK economy by demonstrating to Government, the watchdogs and the public that they have their house in order. Will proposals like those of Sir Derek Higgs limit problems caused by management abuses? Possibly, but only if the non-executive Directors chosen to achieve this goal are the right people equipped with the right tools - including all the necessary information - to do the job.

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