This is the eighth in a series of articles in which we explore the role of a director from various angles, some of them slightly unconventional. Each article identifies a fact of which directors need to be aware – whether concerning their duties, their relationship with other key players or their responsibilities under the Companies Act 2006 – and uses it as a starting-point to illuminate a particular aspect of their role.
This article highlights the fact that the financial reporting regime is built not around the company’s shareholders or accountants, but around its directors.
A diligent director who appreciates the importance of the company’s financial reporting obligations and wants to develop a sound understanding of their scope is faced with a problem: the financial reporting regime is exceedingly complex.
The relevant portions of the Companies Act 2006, which are contained in Parts 15 (Accounts and Reports) and 16 (Audit), run to more than 150 sections, and yet they represent just the tip of the iceberg. The regime also encompasses extensive regulations made under the Act, accounting standards and elements of the Financial Conduct Authority Handbook and the AIM Rules for Companies.
Perhaps it is inevitable that a regime which deals with an inherently difficult topic and which ranges over so many sources will be somewhat complex. The fact is, though, that the way in which the obligations are presented renders this particular regime far more complicated than it needs to be. The core provisions, which are contained in Part 15 of the Act, are a case in point. Whereas the essence of the equally difficult law on directors’ duties has been captured in a dozen or so sections, grouped together in Chapters 2 and 3 of Part 10, nowhere in Part 15 is there a simple, clear statement of the companies’ principal obligations, let alone the directors’ responsibilities in relation to them.
The role of the directors
The division of powers between the shareholders and the directors is fundamentally a matter for the shareholders to determine, in that it is they who decide to what extent the board is responsible for managing the company’s affairs. The Companies Act 2006 does, however, allocate some powers and responsibilities to directors. It is the directors, for example, who initiate the shareholder decision-making process by proposing a shareholders’ written resolution or calling a general meeting, and it is the directors (and, if the company has one, the company secretary) who are responsible for ensuring that special resolutions are filed with the registrar. Perhaps the most important of the responsibilities which are conferred on directors by the Act are those concerning the company’s accounts and reports.
A complete list of those responsibilities is beyond the scope of this article, not least because the details differ considerably depending upon the size and circumstances of the company in question. For the purpose of illustrating their extent, it suffices to note that they include the following:
ensuring that the company keeps adequate accounting records (sections 386 and 387)
preparing accounts which give a true and fair view of the company’s financial position (sections 393 and 394)
approving the accounts (section 414)
preparing a directors’ report (section 415)
preparing a strategic report (section 414A) – this report contains a review of the company’s business and a description of the risks which it faces (section 414C)
providing the company’s auditor with such information as it may require (section 499)
circulating the accounts and reports to the shareholders (section 423)
filing the accounts and reports with the registrar (section 441).
Directors who fail to discharge their responsibilities face a number of possible sanctions. Most alarmingly, from their perspective, many breaches of the financial reporting provisions constitute a criminal offence on their part. If they fail to prepare a directors’ report, for example, any director who failed to take “all reasonable steps” to ensure that one was prepared commits an offence (section 415(4)). They may also find themselves disqualified under the Company Directors Disqualification Act 1986 (see section 3, for example), pursued by the company for breach of duty or, indeed, removed from office by disgruntled shareholders.
In relation to the obligation to file the accounts and reports with the registrar, companies which fail to meet the filing deadline specified in the Act are subject to a late filing penalty (section 453). The amount of the penalty depends upon the extent of the delay in filing, but, by way of example, a private company which files its accounts more than six months late is liable to a late filing penalty of £1500. Whilst the penalty is imposed on the company rather than the directors, shareholders will not look kindly upon a director whose failure to comply with such a basic requirement has cost the company money.
In any consideration of the nature of directors’ responsibilities in this area, it is important to bear in mind the policy which underpins the financial reporting regime. First and foremost, the regime exists in order to protect the interests of creditors and shareholders by keeping them informed as to the financial position of companies with which they deal or may wish to deal.
The point was made in an earlier article in this series that the obligation to publish accounts is part of the price a company pays for the privilege of allowing its shareholders to limit their liability for its debts. A prospective creditor who knows that his only claim in respect of unpaid debts in the event of the company’s failure will lie against the company itself should at least have access to accurate and up-to-date information about its financial position when he is deciding whether or not to do business with it.
A prospective shareholder, too, needs to have access to details of a company’s financial standing if he is to take an informed decision as to whether or not to purchase its shares.
Existing shareholders are in a slightly different position. Their need for information stems, at least in part, from their supervisory role, in the sense that they cannot oversee the board’s activities effectively if they do not have an accurate picture of the company’s financial situation. In this connection, section 414C(1) is of particular interest, for it states expressly that the purpose of the strategic report is to keep the shareholders informed and enable them to assess whether the directors are complying with their duty under section 172 to promote the company’s success.
Of course, well-informed directors, too, are essential to a company’s success. Whilst the financial reporting obligations are aimed primarily at protecting creditors and shareholders, clearly directors benefit from having accurate and comprehensive information about the company’s financial standing when they take strategic decisions concerning its business.
Directors play a central role in the corporate financial reporting regime. No doubt there are some directors who will find the motivation to comply with their responsibilities only in the thought that a failure to comply will expose them to the risk of potentially severe sanctions. Others will take a wider view of the regime, and will understand that it is designed to help companies to function properly. By meeting their responsibilities and preparing high-quality, timely accounts and reports, they will play their part in encouraging third parties to do business with the company and in maintaining the balance of power within the company.