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In its pursuit to reform corporate governance and keep it up to date the fol-
lowing proposals were introduced by the UK government:
The Companies (Audit, Investigations and Community Enterprise) Act 2004
was introduced for better regulation of the accounting and audit profession,
to enhance the confidence of investors in company reporting and enforce-
ment and to add to investigating powers;
Under the Directors™ Remuneration Report Regulations 2002 quoted com-
panies were required to disclose and seek shareholder approval to remuner-
ation policies and to divulge how salaries connect with performance; and
In addition to legislative measures, the UK government also introduced non-
statutory measures like oversight and enforcement powers for the Financial
Reporting Council (FRC) to improve and reform company law (Sheikh, Saleem.
˜Company law reform: Part-1™, International Company and Commercial Law
Review, 2006, 17(1), 13“21).
It was proposed that all quoted companies should produce the Operating and
Financial Review (OFR), a type of report (referred to earlier) required to be pro-
duced by the company mentioning future strategies, resources, risks and uncer-
tainties. This requirement has been repealed by SI 2005 No. 3422, the Companies
Act 1985 (Operating and Financial Review) (Repeal) Regulations 2005 which
came into force on 12 January 2006. However, these companies are still under an
obligation to produce a business review as part of the director™s report and such
review must be in compliance with the Companies Act 1985 (see further com-
ment below and Butterworths Corporate Law Update, February 2006). Moreover,
since its repeal there has been extensive discussion regarding the best practice
that companies should observe as many had prepared in advance for the OFR and
had developed their corporate approaches with this in mind.
Chapter 21 “ UK corporate governance: reforms in the wake of corporate failures and the Enron case study 549

Proposals for change
The FRC is seeking views on proposals to introduce some changes to the
2003 Combined Revised Code (Butterworths Corporate Law Update,
February 2006) such proposals include:

* Relaxing existing provisions to allow the company chairman to sit on
the remuneration committee;
* Providing shareholders with the ability to vote by proxy with the choice
of withholding their vote; and
* Making it obligatory for companies to publish the results of resolutions
voted on a show of hands.

In response to the Enron collapse the UK government set up one review to look
into accounting and audit issues and another one to focus on the FSA Listing
Rules. The changes were adopted in the Combined Revised Code on Corporate
Governance 2003 (˜Code™) which came in force in November 2003 (Falencki,
Corinne A. George Washington International Law Review 2004).

The Combined Code
The Combined Revised Code on Corporate Governance 2003 (the Combined
Code) is the current authority on corporate governance in the UK, reflecting its
˜comply or explain™ approach in dealing with Enron-like frauds. Its enforce-
ment does not come through statute but through the obligation imposed on
companies to comply with the Code in order to be listed with the London Stock
Exchange (Lunt, M. Journal of Business Law 2006).
The important features of the Code are summarised below followed by a
discussion on how the Code affects corporate governance:
The Code splits the role between the chief executive officer (CEO) and chair-
man and provides that the number of independent non-executive directors
(NEDs) should be 50% of the board, excluding the chairman. Therefore the
independence of the board is emphasised;
There are also provisions for the best or most appropriate person to the board,
for informing them of relevant management issues and for induction and
training to ensure that their duties are carried out properly;
It provides for self-evaluation and for performance review of individual
It requires a contractual notice period of a year or less and that the outgoing
director should mitigate the loss by receiving reduced compensation;
There are also provisions as to financial reporting, requiring the board to
present a proper and comprehensible evaluation as regards the company™s
prospects and position along with the maintenance of annual internal control
Part E “ Case Studies of Business Risks

The audit committee should consist of only independent NEDs of whom at
least one has recent and relevant experience;
The audit committee is to oversee the auditors but can only make recommen-
dations to the board to hire or fire them;
To maintain transparency, the role and responsibilities assigned to the audit
committee have to be disclosed on the company™s website and in its annual
There is no prohibition on the supply of non-audit services although it has to
be explained how independence can be maintained in such circumstances;
The audit committees are responsible for entertaining complaints from
whistleblowers and for taking follow-up action; and
There is also provision for dialogue with institutional shareholders and the
attendance of all directors at the annual meeting is required (Waring and
Pierce 2005).

The Combined Code
The Combined Revised Code 2003, the result of the Higgs and Smith
Reports in January 2003, is considered to be well thought through as a
non-legislative response to Enron in comparison to America™s SOX
(Solomon, Aris International Company and Commercial Law Review
2004). The focus of the Higgs Report was the role of non-executive direct-
ors whereas the Smith Report concentrated on accounting standards. The
UK government, in response to Enron™s collapse, had set up one review to
look into accounting audit issues and the other one to focus on Financial
Services Authority Listing Rules.

Listing Rules: comply or explain
In order to be listed, companies in the UK are required to comply with the
Combined Code. Although the Combined Code is not binding on the companies
in the way that legislation is enforceable, nevertheless it is obligatory on them to:
Comply with the principles set in the Code and explain how those principles
were applied; and
Explain the reasons for non-compliance if there is no such compliance.
This kind of ˜comply and explain™ approach gives sufficient information to
investors about the company™s corporate governance practices and an opportun-
ity for them to respond in an informed manner (Mdntysaari 2005).

Comply and explain
Listed companies are required to confirm that they have complied with
the provision of the Code and “ if the provisions are not complied with “
then it has to be explained why not.
Chapter 21 “ UK corporate governance: reforms in the wake of corporate failures and the Enron case study 551

The FSA™s Listing Rules require companies to file a two part corporate govern-
ance statement:
In the first part they state how the provisions of the Code were complied
with; and
In the second part they state the confirmation of the compliance or explain
the reasons for non-compliance (Waring and Pierce 2005 “ see the Web links
at the end of the chapter).
The approach may be compared with the regulatory approach of SOX in the
US. Therefore, for example, whereas Section 301 of SOX (see Chapter 22)
specifically forbids companies to provide certain non-audit services, the Code
merely asks companies to explain in their annual reports how independence
can be maintained if non-audit services are provided with audit services.
Whereas the Code emphasises the significance of NEDs to maintain the confi-
dence and trust of the investors like SOX instead of a regulatory approach in
the UK this objective is achieved by means of stock exchange listing require-
ments (Waring 2005). Sir Higgs has therefore said that the Code describes the
best practice to be followed by listed companies in the UK (Newing, R.
Financial Times, 16 January 2004).

Corporate governance in practice
The Combined Code is the sum total of the wisdom of all the Reports which had
dealt with specific aspects of the corporate governance. As explained, compli-
ance with the Code is made essential by Listing Rules of the LSE which demand
explanation for non-compliance. The narrative statement must be included by
the company in its annual report as to how the provisions of the Code have been
complied so that investors can establish the extent to which compliance has
been made (para. 12.43A of the London Stock Exchange Listing Rules).
While the provisions contained in the Code seem to be soft and non-oblig-
atory when compared with SOX, in practice strong market forces ensure com-
pliance with the provisions contained in the Code instead of leaving it to
companies to fabricate excuses for non-compliance. As noted, the Code requires
the chairman to be an independent non-executive director and half of the mem-
bers of the board to be non-executive (excluding the chairman). The requirement
for a listed company to have audit, nomination and remuneration committees is
also laid down. It has been argued by some practitioners that the overemphasis
on the need for a dominance of NEDs on the board may lead to poorer perform-
ance of the company. The effectiveness of the supervisory and monitoring func-
tions of the independent NEDs may be affected by such factors as their:
Obtaining information prepared and received by the management;
Lack of knowledge of the company™s business; and
Lack of time or commitment.
The independent non-executive may indeed turn out to be a professional
whistleblower who abandons the collapsing company to avoid personal liability.
Part E “ Case Studies of Business Risks

In practice it is difficult for so-called independent non-executive directors to
avoid the influence of the management (Plessis et al. 2005). Therefore critics in
the UK seem to be concerned regarding the dominance of independent non-
executive directors on the board just as in the US. The apprehension is that a
lack of cooperation between the board and management will lead to poor per-
formance of the corporation.
The Code also addresses the problem related to compensation of execu-
tives, which was highlighted in Enron where the executives capitalised on a
short-term rise in stock in order to pocket millions from the sale of inflated
stock (see box above). The code requires long-term incentive plans to be
approved by shareholders. In addition the compensation report to shareholders
must be approved by them (Garrett 2004).

Key changes
The significant changes brought about by the Code in UK corporate govern-
ance include:

* The importance of the role of non-executive directors;
* Their relationship with shareholders; and
* Representation of the shareholders at the board.

The Code also addresses the audit issues which were at the core of the fall of
mighty Enron. The audit committee is conferred with a supervisory and moni-
toring role to rein in external auditors and “ like SOX in the US “ provisions
have been laid down to ensure the independence and competence of the audit
committee. The principles laid down in the Code not only help to improve cor-
porate governance by laying down specific requirements to be followed by
listed companies but will also provide further guidance to courts when decid-
ing on issues like directors™ duties (Morse 2005).
Therefore, it has been concluded by commentators that, despite the fear of
over-reliance and overemphasis on the role of non-executive directors, the
Code undoubtedly enhances good corporate governance. It achieves a positive
step towards the UK™s systematic strategy to curb frauds and malfeasances of
management, thereby protecting investors.

The Company Law Reform Bill
The collapse of Enron and other companies have brought not only fraudulent
executives and false accounting into scrutiny but also the role of directors. The
Companies Act Reform Bill (the Bill) introduced in House of Lords on 1
November 2005 sought to codify duties owed by the directors to the sharehold-
ers and creditors (Swain 2006). It is the result of the study of British company
law by Company Law Review that was established in 1998. The Bill once
enacted will not replace the Companies Act 1985 but will only affect provisions
Chapter 21 “ UK corporate governance: reforms in the wake of corporate failures and the Enron case study 553

common to large and small companies or only relating to small companies
(Mayson et al. 2005“06).
The Bill is expected to come into force as the Companies Law Reform Act
2006 in 2007 and its main objectives are to:
Simplify the administrative burden on smaller companies;
Facilitate shareholder engagement especially in quoted companies; and
Update and clarify the law in key areas specifically with regard to director™s
The Bill has been the subject of extensive debate and comment here is limited to
aspects of corporate governance and risk management. It should be noted that
the duties of the directors, as laid down by the courts in various judgments, are
being codified in the Bill, with the objective to make them clearer and more
accessible. Existing rules prevent a director from taking advantage of an oppor-
tunity which a company cannot avail of. It has been proposed to change this in
certain circumstances so that start-up business activity is not hindered.
The rules regarding transactions between directors and companies have
been considerably changed and duties of the directors have been codified in the
Bill (the codified duties of the directors are stated in clauses 154“170 of the
Bill). In particular there has been much lobbying by the Core coalition “ a
grouping of over 100 green groups, charities and other lobbyists “ to seek to use
the Bill as a lever to impose tougher statutory duties on directors in relation to
environmental and social issues (see box).

Business review Core amendment
The Labour MP Jon Trickett, working with Core, put down an amendment
requiring the business review that directors will have to produce each year
to be audited:
* Follow standard reporting rules; and
* Include information on the supply chain.
This brings back the information disclosure requirement that had led to
the repeal of the OFR.

Transactions of the company with directors
Certain transactions need to be approved by the shareholders. These include:
Substantial property transactions;
Payment for loss of office;
Long service contracts;


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