Is the FRC considering whether Sarbanes-Oxley should cross the waters?

18 December 2019

The general election is now over, and Parliament has more time to deal with matters other than Brexit. The spotlight has therefore returned to corporate governance, with The Sunday Times reporting that the FRC is developing a “British version of Sarbanes-Oxley”. It reported that this would “heap more responsibility on to directors, asking them to vouch regularly for the integrity of their financial controls and – if passed into law in the UK – opening the possibility of criminal proceedings against chief executives and finance directors for reporting misleading statements to the market.”

There has long been a debate about how best to tackle the proliferation of accounting scandals which have hit UK companies in recent years. In his Independent Review of the Financial Reporting Council (“FRC”) in 2018, Sir John Kingman (Chairman of Legal & General) made a number of key recommendations. One was that the FRC should be replaced by a new independent statutory regulator called the Audit, Reporting and Governance Authority (ARGA); and another was that the Government needs to

“give serious consideration to the case for a strengthened framework around internal controls in the UK, learning any relevant lessons from operation of the Sarbanes-Oxley (SOX) regime in the US. The pros and cons of such a change should be analysed and consulted upon, giving special consideration to the importance of proportionality in relation to the size of company”.

The Sarbanes-Oxley (“SOX”) Act came into force in the United States on 30 July 2002 with the aim of protecting investors from fraudulent accounting activities by corporations. It was introduced following high-profile financial scandals involving publically traded companies, such as Enron Corporation and WorldCom, which shook investor confidence in the financial markets. The stringent rules put the legal responsibility for internal controls and reporting onto chief executives and finance directors by holding them responsible for their company’s financial statements. Protection was also given to whistleblowing employees.

The introduction of a SOX style reporting regime in the UK would specifically look at internal controls, and seek assurances from directors around their internal control environment. This would be on the basis that, by placing the onus on CEOs and CFOs, it will improve the overall reliability of the reporting system, particularly as it would open the door to potential criminal proceedings against the CEO/CFO in the event of fraudulent financial reporting.

Sir Kingman’s proposal of a UK SOX regime was supported by many senior audit committee chairs, however, others fear that the increased costs involved in a highly prescriptive regime such as SOX, would be disproportionate for smaller companies. Sir Kingman acknowledged in his report that “Introducing SOX-style provisions would clearly be a very major step. It could impose significant costs, at least initially, particularly on smaller listed companies. The US experience shows that smaller companies are affected disproportionately and listing could become less attractive”. Although he went on to say that “Ongoing, recurring costs, however, are said to be lower. So too are the costs of auditing automated and centralised systems which, in itself, provides an incentive to improve controls.”

Whether it would improve director accountability is a question many are asking, with the ICAEW commenting that “If the UK decides a more US-style regime would be more appropriate than the status quo, there will be consequences for all of us.”

This would clearly be a significant shift in corporate governance, with potentially very serious ramifications for those leading listed companies. We will need to wait and see whether the FRC, or the ARGA when it takes over the FRC’s role and responsibilities, will decide to follow the American model.  

About the author

Christina Orthodoxou is an associate in our Regulatory teamShe specialises in the defence of a range of professionals in the legal and financial industries.  She also has a growing practice in advising on sexual misconduct cases in the higher education sector.

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.

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