Keith Johnstone and Will Chalk

Has the legislature gone too far? One of the main aims behind company law reform and the promulgation of the 2006 Act was to remove ‘unnecessary burdens to directors and [preserve] Britain’s reputation as a favoured country in which to incorporate’;20 the BERR has claimed that the deregulatory aspects of the 2006 Act will save businesses as much as £250 million. The CBI’s concern is that, notwithstanding the (new) ability of auditors to limit their liability, these new offences alone will wipe out the rest of the 2006 Act’s cost savings. By making auditors even more cautious, thereby increasing the time spent performing audits, it is feared that the cost of producing accounts will spiral.

It is clear that legal requirements should only be imposed if the effect of those requirements is proportionate to the benefits accruing and, in relation to the recent requirements imposed on directors and auditors, this does not appear to be the case. One might wonder whether these measures are necessary at all given the checks, balances and sanctions attendant to the rest of the corporate reporting regime? If they are necessary, could the same result have been achieved by increased resources for both the POB and the FRRP?

Shareholders and legislative sanctions

Shareholders also have a prime role in the context of legislative sanctions. While a narrow view of accountability under the 1985 Act would focus on the limited ability of individual shareholders to bring claims, this ignores the impact on board behaviour of shareholder meetings and the AGM process generally. In any event, that narrow view must widen to bring into the picture the new category of statutory derivative claims introduced by the 2006 Act.

This importance of shareholders under the Companies Acts is also reflected in the corporate reporting regime – in particular, the requirement for public company accounts and, separately, the directors’ remuneration report to be laid before shareholders for approval in general meeting. While the vote of members in relation to remuneration is indicative only, a vote not to approve either the accounts as a whole, or the remuneration report itself, would send a strident warning to a board of discontent and of likely shareholder reaction to other resolutions put to members, not least those in relation to the re-election of directors.

FSMA: sanctions in a regulatory context

For listed companies, regulation also plays a prominent role in the Virtuous Circle. Sanctions in relation to companies with an Official Listing derive from Part VI of FMSA and are enforced by the FSA. They can be divided into:

20 Company Law Reform Bill – White Paper, March 2005.

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civil sanctions, including sanctions for listed companies, directors and other persons discharging managerial responsibilities (PDMRs);21 and

criminal sanctions for misleading the market.

Sanctions for listed companies, directors and PDMRs

Where breaches are ‘minor in nature or degree, or the person may have taken immediate and full remedial action’,22 the FSA may issue a private warning. Such warnings are not classed as formal disciplinary action but are kept on record as part of an issuer’s or an individual’s compliance history.

On a day-to-day level, perhaps the most effective deterrent to breaching the rules is in the pro-active enforcement policies of the FSA. Best-practice letters are frequently sent to issuers in relation to conduct which does not breach the letter of a particular rule but where the conduct nevertheless shows room for improvement. The FSA also uses its periodic publication – List! – to disseminate informal guidance to companies and advisers on issues such as rule breaches that have come to its attention, particularly where a breach has occurred owing to a misapprehension as to the requirements of a rule. Further, the FSA also targets sensitive areas where they consider non-compliance to be a possibility. For example, when, in the run up to Christmas in 2004, the trade press reported slow trading and poor consumer demand on the high street, the FSA wrote to all listed retailers reminding them of the obligation to keep the market updated of their expectations as to company performance ‘as soon as possible’, and not simply to delay that announcement until their scheduled trading updates after Christmas.

For more serious breaches, the FSA may publish a statement of censure in relation to either a listed company and/or any person who was, at the time of the breach, a director of the listed company and knowingly concerned in it. This sanction is given teeth because of the effect of the statement on the reputation of the listed company or director sanctioned. Thus, Eurodis Electron plc was censured23 for a breach of its disclosure obligations in failing to notify the market promptly of a marked deterioration in its working capital position. Sportsworld Media Group plc24 was also censured for failing to update the market promptly of a change in its business performance and expectations as to its pre-tax profits. However, as is often the case, the companies concerned were in serious financial difficulties anyway (the latter being in receivership), and it is arguable in these circumstances that the effectiveness of the sanction is undermined, as neither the company nor its management has a reputation left to lose.

21There is no definition of ‘persons discharging managerial responsibilities’ in FSMA but informal guidance issued by the FSA suggests that this relates to a senior tier of management immediately below board level.

22Note that these factors, by themselves, will not determine the course of action taken by the FSA.

23See: www.fsa.gov.uk/pubs/final/eurodis.pdf.

24See: www.fsa.gov.uk/pubs/final/sportsworld – 29 mar04.pdf.

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In relation to the relatively new power under FSMA to impose unlimited fines on companies and directors (or former directors), the FSA’s general approach has not been to impose a tariff of financial penalties, but to look at all the circumstances of the breach and the person committing it, as well as the wider effects of the breach on the market. This is because the FSA maintains that there are few cases in which the circumstances are essentially the same and the FSA considers that, in general, the use of a tariff for particular kinds of breach would inhibit ‘the flexible and proportionate approach it takes in this area’.25

The ability to impose financial penalties is a necessary and effective sanction, particularly in relation to directors knowingly concerned in any breach. In the Sportsworld case, while the company itself would have been fined were it not for the fact that it was in receivership, arguably the more effective sanction was the fine of £45,000 imposed on the former Chief Executive. Not only does this send a clear message to the market and other directors of the consequences of non-compliance, but it also punishes, without adversely affecting the position of shareholders, creditors and other stakeholders.

Suspensions and cancellations

The FSA has the power to suspend or cancel a company’s listing but classes the ability to do so as a non-disciplinary measure. The FSA will consider a suspension in circumstances where the smooth operation of the market is temporarily jeopardised – for example, if a company has failed to publish financial information or is unable to assess accurately its financial position, or where the FSA considers that there are reasonable grounds to suspect non-compliance with the Disclosure and Transparency Rules generally. The power to cancel permanently a listing is available if the FSA is satisfied that there are ‘special circumstances that preclude normal regular dealings in [a company’s listed securities]’. Therefore, it is conceivable that, in extreme cases of persistent rule breach where market integrity is threatened, suspensions and cancellations could be used as a sanction of last resort.

Should they be used as a disciplinary measure more often? In our view, they should not. To use suspensions or delisting as a sanction penalises blameless shareholders, particularly when there are more effective sanctions at the FSA’s disposal; it is only when the integrity of the market is consistently and seriously threatened that they should be contemplated. To do otherwise would be counterproductive as, ultimately, it runs the risk of damaging the reputation and competitiveness of the market as a whole.

The Listing Principles – facilitating the enforcement process

The FSA’s fundamental review of the Listing regime in 2004/5 precipitated the introduction of seven overarching Listing Principles; these apply to companies with a primary listing of equity securities and are enforceable in the same way

25 FSA Handbook, ENF 21.7.4.

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as other provisions of the Part VI Rules. According to the Listing Rules, their purpose is to ensure that ‘listed companies pay due regard to the fundamental role they play in maintaining market confidence and ensuring fair and orderly markets’.26 The Principles were also introduced to address the FSA’s perception that the way in which the Listing Rules and associated guidance were drafted before their amendment in 2005 encouraged ‘issuers and their advisers to adopt a literal interpretation of each rule rather than promoting compliance with the overarching standards which the listing sourcebook . . . is designed to achieve’.27 The FSA wanted a way to ensure compliance with not just the letter of the rules but also their spirit.

There was a great deal of concern surrounding the introduction of the Listing Principles, not least because they have been drafted in broad terms and, with certain exceptions, are not objectively verifiable. The Listing Principles are not a sanction in themselves, although they smooth the path for enforcement action to be taken. While, under each of the Principles, the onus is on the FSA to show that an issuer has been at fault, their introduction has undoubtedly strengthened the FSA’s hand and they certainly play a part in the Virtuous Circle. Indeed, the FSA may discipline an issuer on the basis of the Principles alone, such as where an issuer has committed a number of breaches of detailed rules which individually may not merit disciplinary action, but the cumulative effect of which indicates a breach of a Listing Principle.

Sanctions for AIM listed companies

Sanctions for AIM listed companies are similar to those for companies with an Official Listing save for the fact that they derive not from statute but from the contract that exists between the LSE and the listed company (that is, in return for listing the securities of the company in question, the company agrees to abide by the rules of the LSE in the form of the AIM Rules).

The AIM Rules provide that companies may be fined and censured. Delisting is also considered to be a sanction under the AIM Rules as opposed to a device for the protection of the market. As for nomads, they may be censured and have their registration revoked in addition to (in contrast with Official List sponsors) being subjected to financial penalties.

Sanctions for sponsors and nomads

If the FSA considers that a sponsor has breached any provision of the Listing Rules it may publish a statement censuring the sponsor.

Perhaps more significantly, just as auditors add a level of sophistication to the regime of sanctions in the context of corporate reporting, the same may also be said in relation to the role of sponsors relative to the Part VI Rules (and, indeed, nomads in the context of the AIM Rules). In the extreme, the FSA may cancel a sponsor’s accreditation if it considers that it has failed to meet certain

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