Corporate Governance - New Combined Code and Potential Future Development

The last year has seen important changes to corporate governance through the finalisation of the Combined Code on Corporate Governance (the "Code"), and changes to auditing of UK companies are likely to be implemented this year. The article considers the main aspects of the Code, and briefly looks at some of the proposed changes to the auditing regime.

1. The Code

The final version of the new Code was published on 23rd July 2003, and comes into effect for listed companies for reporting years beginning on or after 1st November 2003.

• Executive Directors. The Code requires non-executive directors ("NEDs") to undertake appropriate induction on joining the board, and to regularly update and refresh their skills, knowledge and familiarity with the company. Boards will be required to carry out "a formal and rigorous annual evaluation of their performance", including that of its committees and individual directors, and to include details of how the evaluation has been conducted in the annual report. The supporting principles to the Code also describe in some detail the role of NEDs.
• Independence of Directors. Boards will still be able to determine if particular directors are independent, but will need to justify their decisions against a set of indicators set out in Code. At least half the board, excluding the chairman, of larger listed companies must be independent NEDs. Smaller listed companies (outside the FTSE 350) must have at least two independent NEDs. NEDs will normally cease to be considered independent after serving for more than 9 years, and any NED that serves for longer must be subject to annual re-elections. Any term beyond 6 years should be subject to "particularly rigorous review".
• Audit Committee. The role of the Audit Committee, and the onus on its members (who must be independent NEDs) will greatly increase. The Audit Committee will be required to monitor and review the integrity of the company's financial statements (and will need to have a good knowledge of the company's internal financial controls and risk management systems), and is responsible for making recommendations in relation to external auditors. It must also ensure that arrangements are in place for employees to "whistle blow" in confidence, and for allegations to be investigated independently and followed up.
• Compliance. The Code now comprises main principles, supporting principles and code provisions. It is anticipated that the Listing Rules will require annual reports to state how companies have applied the main and supporting principles, and to confirm that they have complied with the code provisions (or explain why not). The Code requires institutional investors to engage reasonably and intelligently with any non-compliance by investee companies with the Code, in a way that recognises the particularities of each company.
• What should listed companies be doing now? Clearly, companies should make up their full compliment of appropriately qualified independent NEDs to take account of the Code's requirements on board composition and independence. They should also be considering areas such as:
  • reviewing matters to be disclosed in their annual report or elsewhere (a list is set out in Schedule C to the new Code);
  • finding out what particular concerns their major shareholders may be in relation to corporate governance (particularly where non-compliance is likely);
  • reviewing terms of appointment of NEDs (do they set out a clear indication of the amount of time to be devoted to the role, and particular responsibilities?);
  • considering the need to change the company's articles of association to require NEDs to submit themselves for annual re-appointment; and
  • setting up standard induction procedures, and regular training programmes, for directors.

2. Future developments

The Government's review of corporate governance matters is now focusing on audit arrangements. A new companies bill (the Companies (Audit, Investigations and Community Enterprise) Bill 2003) has recently been introduced to the House of Lords. This contains a number of measures to tighten the independent regulation of the audit profession, and on financial reporting.

These include requiring companies to provide details of non-audit services provided by their auditors, and reinforcing the rights that auditors have to obtain information in relation to companies which they are auditing. The Bill will also introduce an offence of knowingly or recklessly making misleading, false or deceptive statements to auditors.

The Bill will also require directors' reports in accounts to confirm that no information of relevance to the audit has been withheld from the auditors. If the statement is in fact false, directors who knew that the statement was false (or were reckless as to whether it was false) and failed to take all reasonable steps to prevent the report from being approved, would be guilty of an offence.

For further information please contact Bill Carr at

[email protected].