Ministers have watered down plans for an overhaul of audit and boardroom rules in the UK, dropping a proposal to require directors to sign off on companies’ internal controls and scaling back an expansion of the number of companies falling under the most stringent requirements.
The changes will mean that the reforms will sweep just 600 more private companies into the tighter regulatory system, compared to an original plan to potentially double the number of so-called “public interest entities” (PIE) to as many as 4,000.
Proposals to make directors personally liable for internal controls over financial reporting, echoing the US’s Sarbanes-Oxley Act, were also dropped. Instead, a provision will be added to the corporate governance code, which applies only to the largest listed companies and which boards can opt not to comply with, provided they explain their reasons.
Regulators will, however, be given the power to penalise directors who breach their legal duties, ending an anomaly where only directors who were qualified accountants could face sanctions.
The long-awaited overhaul, which will be unveiled on Tuesday, is the culmination of three independent reviews over the past three-and-a-half years and a public consultation that closed in July last year. It is designed to prevent a repeat of scandals at companies including retailer BHS and outsourcer Carillion which collapsed in 2016 and 2018, respectively.
Kwasi Kwarteng, business secretary, will say the reforms will finally tackle the dominance of the Big Four audit firms — Deloitte, EY, KPMG and PwC. He will also confirm plans to replace the Financial Reporting Council with a new, more powerful regulator called the Audit, Reporting and Governance Authority (Arga).
But the government faces criticism for watering down the reform package. Sir Jon Thompson, chief executive of the FRC, said the failure to introduce Sarbanes-Oxley-style rules was “a missed opportunity to improve internal controls in a proportionate, UK-specific manner”.
Michael Izza, chief executive of chartered accountants body ICAEW, said the package of measures had “a halfhearted and lopsided feel to it”, adding: “Lessons from Carillion and other recent company failures have been ignored, with little emphasis now on tightening internal controls and modernising corporate governance.”
But Roger Barker, director of policy and governance at the Institute of Directors, said it was “understandable” that the government had limited its expansion of the PIE regime to a smaller group of private companies “given the need to minimise additional regulatory burdens on business in a challenging economic environment”.
Separately, Kwarteng will also announce a review of the corporate reporting burdens on businesses, including those from retained EU laws, in order to “maximise the benefits of Brexit”. As part of that the government will consider changing the definition of “microenterprises” on the basis that too many smaller companies are having to prepare unnecessarily detailed accounts because of an EU directive.
Earlier this month, the government omitted the audit and boardroom reforms from its legislative programme for the coming parliamentary year. Instead, it plans to publish draft legislation in the next 12 months, which could make it on to the statute books some time in the next two years. As a result, Arga is unlikely to be up and running before April 2024 at the very earliest.
One of the key reforms is that the largest private companies will come under the remit of the regulator, which currently oversees only listed companies. But, after pushback from business leaders, only an estimated 600 businesses with more than 750 employees and more than £750mn annual turnover will be designated as PIEs.
The business department said it had shifted the threshold to make the reforms more targeted. “Nobody is in favour of increasing burdens on business unnecessarily,” said Lord Callanan, a business minister.
Large businesses will also have to confirm the legality of dividends paid out and provide more information about what they have done to prevent fraud.
FTSE 350 companies will be told to hand part of their audit work to a mid-tier firm from outside the Big Four to tackle a lack of resilience in the market if one of the Big Four were to fail. Ministers will have the option to introduce a cap on audit firms’ market share in future if necessary.
Kwarteng will also take action to enable the current regulator, the FRC, to ban failing auditors from reviewing the accounts of large companies.