What sanctions are necessary?

the Accountancy Bodies4 which set and enforce standards of conduct5 for their member firms by conducting investigations into complaints with regard to the conduct of their members.

The Courts in the Virtuous Circle

The potential for civil claims through the Courts against directors for breach of their common law fiduciary duties is part of the Virtuous Circle. However, owing largely to the fact that these duties are owed to the general body of shareholders taken as a whole, and are enforceable against the directors only by the company acting on their behalf, these duties have not historically played a prominent role.

Under the common law, an individual shareholder may bring a derivative claim against a director or board in his own name for the company’s benefit and join the company as a party to the proceedings. Such actions are only available in a very narrow set of circumstances (usually when the conduct of directors is tainted by fraud) and the extent of the pressure they apply to boards or individual directors is, therefore, limited.

However, from 1 October 2007, the following aspects of the 2006 Act have been brought into force which may significantly alter that position:

first, the codified statement of directors’ duties which includes the duty to promote the success of the company whilst adhering to the principles of ‘enlightened shareholder value’ – these duties are those which the Government considered to be the most significant general duties existing in the common law;

second, provisions which will place into statute for the first time this common law right of shareholders to bring a derivative claim on the company’s behalf against directors as well as extending the grounds upon which shareholders may bring such a claim to include breach of trust, negligence and breach of directors’ duty.

There are safeguards built into the 2006 Act to guard against vexatious claims being brought by ‘activist’ shareholders but, even so, the expectation is that the 2006 Act will increase the involvement of the Courts in applying pressure on boards (even though, strictly speaking, this will take place through the combination of the common law and legislation).

Individual shareholders do have the ability to bring a statutory claim under the Companies Acts to the extent that the company’s affairs have been conducted in a manner which is unfairly prejudicial to the interests of its members generally

4Comprising, among others, the Institute of Chartered Accountants in England and Wales, the Institute of Chartered Accountants in Scotland, the Institute of Chartered Accountants in Ireland and the Association of Chartered Certified Accountants.

5For example, in the area of audit, compliance is required with the ‘Audit Regulations and Guidance’ and the ‘Designated Professional Body Handbook’.

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or some part of its membership. However, such actions are rare and can be discounted as a source of genuine pressure given the ease with which a company may defeat a claim. Accordingly, such claims do not appear in the Virtuous Circle.

The narrow segment in this part of the Virtuous Circle represents therefore the somewhat limited impact that this area has had to date on conditioning board behaviour. However, the provisions of the 2006 Act may significantly increase the importance of these influences on board behaviour in the near future.

Shareholder and market pressure in the Virtuous Circle

Shareholders and the esoteric concept of the market apply at least as much pressure on boards as law and regulation. The influences at work here have been summarised by the FRC: ‘Companies and pension funds, supported by their professional advisers and encouraged by the investor community, have the primary responsibility for achieving high standards of reporting and governance.’6

The way in which this pressure is applied is primarily through voluntary codes of conduct associated with corporate governance in its purest form. Therefore, shareholder and market pressure is exerted through or by reference to:

the Combined Code, which is seen as the cornerstone of the UK corporate governance regime for Officially Listed companies; the requirement to include a statement in the annual report and accounts as to whether a company has complied with the provisions of the Code or, to the extent it has not, the reasons why not, is embedded in the Listing Rules and, ultimately, the pressure for compliance comes from shareholders’ reaction to company disclosures under this comply-or-explain principle;

the Corporate Governance Guidelines for AIM Companies produced by the Quoted Companies Alliance (QCA) – companies listed on AIM are not formally required to comply with the Combined Code, although some choose to do so; consequently, the QCA has produced a code which it feels is more appropriate for companies listed on the junior market; more recently, the National Association of Pension Funds (NAPF) has produced a similar AIM focused corporate governance policy document;7

the updated8 Turnbull Guidance on Internal Control which deals with risk management issues;

other guidance appended to the Combined Code which includes the Smith Guidance for Audit Committees as well as guidance for board chairmen and for non-executive directors;

6FRC Regulatory Strategy, May 2006, version 2.1, p. 5.

7NAPF: Corporate Governance Policy: Policy Voting Guidelines for AIM companies, March 2007.

8The FRC has published an updated version of the Turnbull Guidance which is effective for financial years beginning on or after 1 January 2006.

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What sanctions are necessary?

Best Practice Guidelines issued by the institutional shareholder representative bodies, either collectively under the umbrella of the Institutional Shareholders’ Committee (ISC) or individually by the following:

–the Association of British Insurers (ABI)9 which often publishes guidelines in conjunction with the National Association of Pension Funds (NAPF);10 through IVIS,11 members are provided with a monitoring service in respect of companies which comprise the UK FTSE All-Share Index and other companies on request; the service focuses on the Combined Code and ABI guidelines (and IVIS reports are colour-coded to help users identify ‘non-compliant’ or ‘inconsistent’ issues);

–the NAPF;12 through RREV13 members are provided with research and voting recommendations, again covering all companies in the FTSE All-Share Index; those voting recommendations are based on NAPF’s corporate governance policies;

–the Investment Management Association (IMA) which is the trade body for the UK investment management industry – its members provide investment management services to institutional investors and private clients;

–the Association of Investment Companies (AIC) which is the trade body of the investment industry and represents investment companies and their shareholders; the AIC also works closely with the management groups which administer the companies concerned;

the AGM process and, in particular, by the constituent elements of the ISC and other bodies, such as the Pre-emption Group;14 it is corporate reporting and the AGM process that also bring into play those organisations that provide voting services or act as intermediaries in the voting process for larger shareholders – including IVIS, RREV, PIRC, ISS and Manifest;15

sponsors, nomads and other advisers – the part played and advice given by sponsors for Main Market listed companies, nomads for AIM

9For example, the ABI’s guidelines on executive remuneration (December 2006).

10For example, Best Practice on Executive Contracts and Severance – A Joint Statement by the ABI and NAPF (December 2003).

11Institutional Voting Information Service.

12For example, the NAPF’s 2004 Corporate Governance Policy (December 2003) which sets out good-practice principles and voting guidelines on a number of issues.

13Research, Recommendations and Electronic Voting – a joint venture between NAPF and ISS.

14The Pre-Emption Group provides guidance on the considerations to be taken into account when disapplying pre-emption rights. It is constituted by representatives of, among others, the Hundred Group, the ISC, LIBA and the Securities and Investment Institute.

15PIRC: Pensions and Investment Research Consultants. PIRC produces, among other things, Shareholder Voting Guidelines (February 2005); IVIS: Institutional Shareholder Service – a provider of ‘global’ research and proxy voting services; Manifest: Manifest Information Services Limited.

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