BBC news alerts on our phones seem to be constant these days. There is of course the small issue of Brexit which is keeping journalists occupied. However, the state of the economy also features heavily in the news: large corporate collapses have dominated the headlines in recent times.
From construction (Carillion), to dining (Patisserie Valerie), to travel (Thomas Cook), to retail (Mothercare); our news reels bring details on an increasingly regular basis. Prior to these recent high profile events, the focus was on the banking sector: we had the financial crisis in which Lehman Brothers collapsed, Merrill Lynch was saved by Bank of America and RBS and other banks were bailed out by the UK taxpayer. No sector seems to be protected from the forces of economics, or the vagaries of corporate governance.
From the public’s point of view, there will be the question of “how on earth did that happen?” From a regulator’s perspective, this question is not rhetorical. Such events need to be investigated. The focus is then on the Board and the company’s auditors – the public’s “how did it go so wrong” question forms the basis of a regulator’s investigation. The spotlight will be particularly bright on the Financial Director (FD) or Chief Financial Officer (CFO) sitting on the Board: that individual has the greatest oversight of the financial solvency of the business, and will often be at the centre of a regulator’s investigation.
A Financial Director’s responsibilities
All Board directors have duties under the Companies Act 2006 [S.170 – s.181], including to exercise independent judgement; to promote the success of the company; to act within the powers in the company’s constitution; and to exercise reasonable skill, care and diligence. If a Board member is a professional, it could be argued that, under s.174 of the Companies Act, their responsibilities are greater, in that the director needs to display “the general knowledge, skill and experience that the director actually has”, which is a subjective test. Breach of such duties could lead to civil liability. In an insolvency situation directors may be liable for wrongful trading or fraudulent trading and can face disqualification proceedings.
An FD/ CFO sitting on the Board will be subject to additional regulatory requirements, distinct from those under the Companies Act. The individual in that role in a UK company will normally be an accountant, most likely a member of the ICAEW, ICAS, ACCA or CIMA. Depending upon the sector in which the company operates, they may also be a Senior Manager, under the FCA’s Senior Managers Regime. When something goes wrong, the regulatory scrutiny could be significant.
The actions of the FD (and auditors) could be pored over carefully by the Financial Reporting Council (FRC). If the FD is also an FCA Senior Manager, the FCA could take action if there is any breach of the individual or senior manager conduct rules, a failure to be fit and proper, a breach of the senior manager’s duty of responsibility or if the FD is knowingly concerned in a breach of a relevant requirement by the company.
The role of an FD is challenging. It not only involves oversight of a company’s financial health, which, in large organisations will include responsibility for numerous business departments, but also includes regulatory and statutory reporting, and being involved in setting the strategic direction for the business. When a company is in good financial health, juggling the various roles will likely be manageable. However, when a business is in difficulty, the FD could find him or herself being pulled in various directions. There are many reported instances of pressure being put upon an FD to ‘find a solution’ to a company’s financial problems, when an easy solution cannot be found. One can understand the pressure an FD could face: on the one hand, they may want to walk away from the company, if they feel that their ethics are being compromised (which in itself could be a breach of the terms of their employment contract unless they are not required to hold office as a director, or they are entitled to treat themselves as constructively dismissed allowing them to resign both their office as director and their employment, with immediate effect). On the other hand, from a personal financial perspective, doing so could cause them significant difficulty. What then should an FD be considering when faced with such pressure, and what steps could they take to protect themselves?
Let’s consider what sort of behaviours the regulators will be focussing upon, if any intervention becomes necessary. They will of course be interested in any technical accounting breaches which have taken place. However, a significant proportion of regulatory findings incorporate a breach of the principle of ‘integrity’. There can be a lot of confusion about what integrity actually means. In case law, it has been described as a “nebulous concept”. Recent judicial decisions have sought to make it clearer, but many still are confused about what sort of actions could constitute a breach of integrity.
Where is integrity defined?
Most regulators have a code of ethics which sets out that standards of integrity must be maintained. For example, the ICAEW and ACCA describe integrity as being “Straightforward and honest in all professional and business relationships”. The FCA, under its Code of Conduct (COCON) which applies to Senior Managers, states that “You must act with integrity”.
The definition of integrity was subject to a lot of judicial discussion a couple of years ago. The Court of Appeal considered the concepts of honesty and integrity in the case of Wingate v SRA [ EWCA Civ 366]. It ruled that honesty and integrity were distinct concepts. When considering the definition of integrity, the Court stated:
Integrity is a more nebulous concept… In professional codes of conduct, the term ‘integrity’ is a useful shorthand to express the higher standards which society expects from professional persons and which the professions expect from their own members… The underlying rationale is that the professions have a privileged and trusted role in society. In return they are required to live up to their own professional standards…. Integrity connotes adherence to the ethical standards of one’s own profession. That involves more than mere honesty.”
There may be a number of regulated professionals on a company’s Board, or there may only be one: the FD or CFO. In times of intervention by a regulator, the focus may therefore be on the actions of that one individual. By dint of his or her professional responsibilities under the Companies Act, and the definition in Wingate, that individual has to display “higher standards”, even potentially from his fellow Board members.
What sort of behaviours would breach the principle of integrity? Like an elephant, it can be difficult to describe, but you know it when you see it. One basic example might look like this: an audit is taking place and a member of the audit team is questioning the FD on aspects of the accounts. The auditor asks to see a certain document, but inadvertently names the document incorrectly. The FD knows what document the auditor is referring to, but is uncomfortable with its contents, so would rather not disclose it. Instead, the FD takes the request literally, and provides the exact document sought by the auditor. In doing so, the FD’s actions are not dishonest, as he has done what he has been asked to do. However, arguably, his actions would breach the principle of integrity, as, in not applying his professional judgement to assist the auditor, his actions fell short of “the higher standards which society expects from professional persons, and which the professions expect from their own members”, as the case law describes.
The outcomes of recent FRC investigations provide further flavour of the types of issues which can amount to a lack of integrity, mainly relating to recklessness when preparing and approving financial statements, particularly with regard to ‘going concern’ and ‘revenue recognition’. The ‘recklessness’ described does not amount to positive dishonesty (as such a finding would need to be articulated), but a finding of a lack of integrity still has a profound effect on one’s ability to practise as an accountant. A large number of regulatory outcomes involve a lengthy ban from the profession, a large fine and, often, a much larger costs award against the FD.
If you’re an FD, how can you protect yourself
In a busy and high pressure role, such as that of an FD, decisions need to be taken quickly, and there can be little time for keeping lengthy records of conversations. However, in a regulatory investigation, such records become invaluable. The old adage of “if it isn’t written down, it didn’t happen” can become the basis of a line of inquiry. In order to be able to protect yourself, especially when decisions are taken which could, without additional information, be questionable, make sure that you keep contemporaneous and adequate notes of important conversations. Follow up conversations with emails and file them appropriately. If a regulator later scrutinises your decisions, you will be able to evidence your rationale behind those decisions: this will become vital.
If you are an FCA regulated Senior Manager, keeping records will also help you demonstrate that you have discharged your duty of responsibility but there are several additional steps you should take to protect yourself.
Firstly, be clear on the scope of your responsibilities and keep your Statement of Responsibilities and Responsibilities Map up to date. Be curious about how things happen in practice in your area of responsibility, and if you find a problem, review and improve processes. Devise a detailed handover report template, and insist on a comprehensive handover. When you delegate work or areas of responsibility, monitor those carefully and make sure that you follow up with the individual to whom you have delegated. Lastly, ensure that you notify the insurers of any claim.
Seeking early advice is paramount
We understand that in a complex and heavily scrutinised role, one can feel compromised and conflicted, and can find it difficult to find a way out, especially when there are both professional and personal factors to take into account. In such a situation, please take advice as early as you can: doing so may prevent you inadvertently falling squarely into the regulator’s spotlight, which can be a very uncomfortable place to be. Contact a member of the team.
About the authors
Julie Matheson is a Partner in the Regulatory team, specialising in defending professionals in the financial and legal fields. She has particular expertise in defending accountants and accountancy firms in regulatory proceedings brought by the FRC, ICAEW and ACCA. She also regularly provides advice on FCA conduct issues, particularly under the Senior Managers and Certification Schemes.
Adrian Crawford is a partner in the Employment Department. A large part of his practice involves advising employers and senior employees in the financial services industry and professional services firms and their partners in the City. He frequently advises on issues involving conduct, regulatory duties and responsibilities under the Senior Managers and Certification Regime and regulatory references.