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Thursday, 25th April 2024 |
| The new audit committee regime for directors |
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Good corporate governance is a vital and growing concern in the Irish corporate sector. It is widely acknowledged that sound and effective corporate governance principles are crucial to shareholder and creditor protection, director protection from criminal or civil sanctions, as well as successful business development. There are a number of recognised key contributors to the corporate governance process: the board of directors, the auditors, the management team and the members of board committees such as the remuneration committee, the nominations committee and the audit committee.
Audit committees are a valuable tool in minimising certain risks inherent in the corporate process. An audit committee, if established and operated in accordance with accepted standards, will be well-positioned to contribute significantly to improving a company's corporate governance as a whole.
The valuable role played by audit committees in the corporate governance process has been recognised in many jurisdictions for some time. In the US, the New York Stock Exchange and the National Association of Securities Dealers sponsored a 'blue ribbon' committee to develop a series of recommendations for the operation and ultimate empowerment of audit committees as the protectors of shareholder interests. The report of the committee was published in 1999, 'Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees'. A similar study was carried out in the U.K. and the recommendations were incorporated into the 2003 Combined Code on Corporate Governance (which has now been up-dated and re-issued as the 2006 Combined Code) (the 'UK Combined Code'). In the Irish corporate sector, the importance of audit committees has also been recognised for some time. However, it was not until 2003 that statutory provisions on audit committees were incorporated into Irish company law by virtue of Section 42 of the Companies (Auditing and Accounting) Act 2003 (the '2003 Act').
Audit Committees in Ireland
Section 42 of the 2003 Act, which has not yet been commenced, inserts a new Section 205B into the Companies Act 1990, as amended (the '1990 Act') which provides for the establishment and responsibilities of an audit committee.
The Section requires that all Irish-registered ('Plcs'), whether listed or not, establish and adequately resource an audit committee. An exception is made for Plcs wholly owned by another Irish Plc and any additional Plcs exempted by the Minister.
Private companies limited by shares exceeding a €25m balance sheet total and a €50m turnover threshold in both of the last two financial years also fall within the Section's gambit as do 'relevant undertakings'.
Qualifying private companies and relevant undertakings must either establish an audit committee or can decide not to do so. If they decide not to establish an audit committee they must give the reasons for such decision.
Section 205B provides for certain duties and responsibilities to be carried out by the audit committee. These duties include reviewing the company accounts before they are sent to the board with a view to determining whether the accounts have been prepared in accordance with the relevant financial reporting framework and whether they give a true and fair view of the company's financial position. The audit committee must determine, at least annually, whether it considers that the company has kept proper books of accounts in accordance with Section 202 of the 1990 Act. It must also advise the board as to the board's recommendation to be made to the shareholders concerning the appointment of the company's auditor. The audit committee is also required to monitor the annual external audit process and satisfy itself that both the arrangements made and the resources available for internal audits are in the committee's opinion suitable.
It is clear from a review of that Section and the summary of those duties as set out above that it is envisaged that the audit committee will play an integral role in the monitoring of a company's financial processes. Accordingly, a significant amount of time and effort from audit committee members will be required to fulfil such duties.
In addition to the requirements of Section 205B, public interest entities (which include listed companies, credit institutions and insurance undertakings) will be required to establish an audit committee with specified functions by the 29th June 2008 at the latest, in accordance with their obligations under the Directive 2006/43/EC of the European Parliament and of the Council of 17 May, 2006 (the so-called Eighth Company Law Directive). The Eighth Company Law Directive requires that at least one audit committee member have accounting and/or auditing competence and that the audit committee monitor the effectiveness of internal control, internal audit and risk management systems. It should be borne in mind that transposing the provisions of the Eighth Company Law Directive into Irish law may therefore require the amendment of Section 205B.
Best practice
In addition to the requirements set out in Section 205B, the recommendations in the UK Combined Code provide guidance with respect to the best practice of audit committees. The UK Combined Code recommends that an audit committee should be comprised of at least three, or in the case of smaller companies two, members who should all be independent non-executive directors. Section 205B is less demanding in this regard and provides that one eligible director can serve as the sole member of the audit committee if no other eligible directors are available. A director will not be eligible if he is a current employee of the company or a subsidiary of the company (or an employee within the previous three years) or the chairperson of the board (Section 205B(7)). However, these eligibility criteria may be dispensed with in respect of a two person audit committee if one member of the committee is an eligible director and that director is appointed as the chairperson of the audit committee and has the casting vote (Section 205B(8)).
Availability of non-executive directors in Ireland
Notwithstanding the high calibre of non-executive directors available in Ireland, there is a shortage of truly independent executive directors in the Irish corporate sector. This shortage is recognised by Section 205B, which, as mentioned above, seeks to encourage independent non-executive director membership of audit committees, but recognises that this may not be possible in Section 205B(8). Very often non-executive directors lack true independence in that it is common for a non-executive director of a company to have served as an executive director of the board or to have been in a position of senior management within the company on whose board he now sits.
This shortage of truly independent non-executive directors in Ireland is compounded by the ever increasing regulatory burden on company directors. One of the most recent additions to this regulatory burden is the new common framework for testing the fitness and probity of directors and senior management of financial services firms, which came into effect in January, 2007. This increase in regulation could arguably see the pool of independent non-executive directors in the financial services sector dwindle further.
Another consideration for non-executive directors is the fact that in law there is no distinction made between the executive directors of a company and the non-executive directors. Both categories of director share the same duty of care and fiduciary responsibilities towards the company and both are exposed to the same types of liability if these duties are not fulfilled. Both executive and non-executive directors alike can be made personally liable for the losses of the company and both are subject to the restriction and disqualification provisions contained in Part VII of the Companies Act 1990.
Conclusion
The potential benefit of audit committees will only be fully realised if they are comprised of a majority of independent non-executive directors on whose integrity the board may rely. However, considering the substantial responsibilities, regulatory burden and significant risks outlined above, it is possible that many independent non-executive directors may be reluctant to accept a position on an audit committee. The level of responsibility and regulatory burden is set to increase even further in June 2008 with the transposition of the Eighth Company Law Directive into Irish law.
However, notwithstanding these risks and responsibilities, significant protection is now available for non-executive directors in the form of directors and officers insurance, the prohibition on which was removed by Section 56 of the 2003 Act. Pursuant to Section 56, a company may now purchase and maintain for any of its officers or auditors insurance in respect of liability for a wide range of offenses to include negligence, default, breach of duty or breach of trust of which he/she may be guilty in relation to the company. The security provided by such an indemnity will hopefully provide sufficient comfort to both current and potential non-executive directors to ensure that a sufficient number of them will continue to act as such and to provide valuable support to the boards and committees on which they serve. |
Claire Vaughan is a solicitor in the corporate department and Paula Kelleher is a partner in the regulatory and compliance department at Dillon Eustace.
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| Article appeared in the May 2007 issue.
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