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New Irish Company Law Requirements - Directors' Compliance Statements and Related Statements in Directors' Report - IRELAND
by Donal Creaton
Introduction
The Companies (Audited and Accounting) Act, 2003 (“the
Act”) was enacted on the 23rd December, 2003. The
Act introduced a number of new requirements into Irish Company
law including the statutory framework for the establishment
of the Irish Auditing and Accounting Supervisory Authority
(a body comparable to the Public Company Oversight Board
in the US) and the requirement for the establishment of
audit committees in certain Irish companies. Perhaps, the
most significant new requirement, however, is introduced
by Section 45 of the Act which introduced a new section
205E to the Companies Acts, 1990. Section 45 of the Act
(yet to be commenced) obliges the directors’ of all
public limited companies and large private companies to
prepare, update, publish and report upon detailed statements
about their company’s compliance with ‘relevant
obligations’. Section 45 will not apply to private
companies limited by shares whose balance sheet totals do
not exceed €7,618,428 and whose turnover do not exceed
€15,236,856. In addition, the requirement will
not apply to companies registered outside the State.
The Act requires a company which falls within the scope
of Section 45 to produce a compliance policy statement
that sets out:
* its policies respecting compliance with its relevant obligations;
* its internal financial and other procedures for securing
compliance with its relevant obligations; and
* it arrangements for implementing and reviewing the effectiveness
of the policies and procedures referred to in the two paragraphs
above.
A company’s internal, financial and other procedures
are considered to be designed to secure compliance with
its ‘relevant obligations’ and to be effective
for that purpose if they provide a ‘reasonable assurance’
of compliance in all material respects with those obligations.
Compliance statements (including any revisions) must be:
* in writing;
* submitted for approval by the board of directors;
* reviewed at least once in every three year period following
its approval by the board (and if necessary revised by the
directors);
* included in the annual directors’ report to the
AGM.
As well as the requirement to prepare compliance statements
referred to above, the directors are also required to include
in their annual directors’ report an annual compliance
statement:
* acknowledging that they are responsible for ensuring that
the company is complying with its ‘relevant obligations’;
* confirming that the company has internal, financial and
other procedures in place that are designed to secure compliance
with its relevant obligations, and, if this is not the case,
specifying the reasons why; and
* confirming that the directors have reviewed the effectiveness
of the procedures referred to in the paragraph above during
the financial year to which the report relates, and, if
this is not the case, specifying the reasons why.
Furthermore, the directors must specify whether, based on
the procedures referred to and the review of those procedures,
they are of the opinion that they have used “all reasonable
endeavours” to secure the company’s compliance
with its relevant obligations in the financial year to which
the annual report relates, or, if they are not of that opinion,
specify the reasons why.
The Act also provides that a company’s statutory
auditor shall undertake an annual review of the directors’
compliance statements and the compliance policy to determine
whether in the auditors opinion, each statement is
fair and reasonable having regard to the information obtained
by the auditor, in the course of or by virtue of carrying
out audit work, audit-related work or non-audit work for
the company.
As can be readily seen from the above there are a number
of references in the Act (the most relevant ones having
been placed by the writer in italics) that are unclear to
say the least and as a result have given rise to considerable
debate between interested parties.
The Office of the Director of Corporate Enforcement (the
‘ODCE’), the statutory body charged with the
supervision and enforcement of Irish Company law, issued
draft Guidance on 22nd July, 2004 on the obligation for
company directors to prepare compliance policies and annual
compliance statements under the Act (the ‘draft Guidance’)
and invited interested parties to comment on the draft Guidance
prior to the publication by it of its final Guidance in
the form of an information booklet for company directors
and advisors. Interested parties have made submissions in
respect of the draft Guidance and the final Guidance is
expected to be available mid-December. The elements
of Section 45 of the Act giving rise to the most concern
and the manner in which such issues are dealt with in the
draft Guidance are discussed below.
Section 45 – the Key Terms
‘Relevant obligations’.
“Relevant obligations” are defined by the Act
as the company’s obligations under:
· the Companies Acts
1963 to 2003;
· any other enactments
that provide a legal framework in which the Company operates
and that may materially affect the company’s financial
statements; and
· tax law.
The draft Guidance provides that the first steps needed
would be to establish policies concerning compliance with
relevant obligations and to carry out and record an assessment
of those obligations by:
* identifying aspects of company and tax law that affect
the company;
* considering what other enactments provide a framework
within which the company operates and may materially affect
the financial statements, probably recording these on a
register or on a list. The Act specifies that directors
must make specific assertions about the adequacy of controls
in relation to a particular set of obligations, and helpfully,
the draft Guidance indicates that the term “other
enactments” refer only to Irish law.
The draft Guidance provides that (whilst it is not possible
to set out a comprehensive list of applicable law that constitutes
a framework) the legal framework within which a company
operates includes, inter alia:
* legislation relating to employment, for example, law relating
to employees’ rights, pensions and Pay Related Social
Insurance (PRSI);
* legislation with which by virtue of its operations, the
company is required to comply for example, environmental,
consumer protection, data protection, health and safety,
construction, copyright and other sectoral legislation;
* those laws which govern the activities undertaken by the
company which are subject to the issue of a licence by a
State body or those laws non-compliance with which may affect
the company’s ability to continue trading; and
* those laws in relation to which a company is required
to provide financial or other information to regulatory
or other authorities.
The draft Guidance further provides that the methods by
which a company’s directors might satisfy themselves
that all of the components of the company’s legal
framework have been identified include:
* discussing with senior management the policies and procedures
in place for the timely identification of additions or changes
to legislation relevant to the company’s activities;
* making enquiries of, and seeking regular reports from
senior and local management (and, Internal Audit, where
applicable) on legal and regulatory issues (including details
of significant instances of non-compliance and any consequences
arising);
* liaising with the company’s auditors and internal
and external legal advisors; and
* reviewing correspondence with the company’s legal
advisors, auditors (including previous management letters),
regulators and any other relevant parties.
Following the determination of the legal framework within
which a company operates, the directors must determine those
elements of the framework non-compliance with which may
materially affect the company’s financial statements.
The draft Guidance outlines that this is obviously a matter
of judgement for the directors. However, it further provides
that in forming that judgement, directors may wish to have
regard to the following definitions of what constitutes
a material affect on the financial statements: -
1. “Information
is material if its omission or misstatement could influence
the economic decisions of users taken on the basis of the
financial statements. Materiality depends on the size of
the item or error judged in the particular circumstances
of its omission or misstatement. Thus, materiality
provides a threshold or cut-off point rather than being
a primary qualitative characteristic which information must
have to be useful(definition taken from International Auditing
and Assurance Standards Board’s (IAASB) International
Standard on Auditing (ISA) 320 ‘Audit Materiality’)”;
and
2. “Materiality
is an expression of the relevant significance or importance
of a particular matter in the context of the financial statements
as a whole. A matter is material if its omission would reasonably
influence the decisions of an addressee of the auditor’s
report; likewise a misstatement is material if it would
have a similar influence. Materiality may also be considered
in the context of any individual primary statement within
the financial statements or of individual items included
in them. Materiality is not capable of general mathematical
calculation and it has both qualitative and quantative aspect:”
(definition taken from the Auditing Practices Board Statement
of Auditing Standards 220 ‘Materiality and the Audit’)”.
The ODCE has indicated following requests in submissions
received concerning the draft Guidance that a list of company
law offences is in development (but that this list will
not be complete) and a list of other obligations are
also in development.
‘Reasonable Assurance’
As mentioned above the Act provides that “a company’s
internal financial and other procedures are considered to
be designed to secure compliance with its relevant obligations
and to be effective for that purpose if they provide reasonable
assurance of compliance in all material respects with those
obligations”.
The draft Guidance provides that directors should consider,
inter alia, whether:
i) the company’s relevant
obligations have been identified and the identification
process has being properly documented;
ii) there are internal financial and other
procedures in place to secure the company’s compliance
with its relevant obligations;
iii) those internal financial and other procedures
have been properly designed in a manner to secure compliance
with the company’s relevant obligations in the event
of their improper operation and application; and
iv) the internal financial and/or other procedures,
as have actually been operated during the period under review,
provide the directors with reasonable assurance of compliance
in all material respects – in other words whether
the internal financial and other procedures have been operating
effectively.
The draft Guidance specifically provide that with regard
to paragraph (iii) above, the process of determining whether
those procedures in place had been properly designed to
address adequately the risk of non-compliance with the company’s
relevant obligations if operated correctly is a complex
task and the draft Guidance suggest that in some circumstances
boards may wish to enlist professional assistance in this
regard. It is pointed out that in essence, in order
for a control or procedure to have been properly designed,
it must be capable, if operated correctly, of minimising
the risk of a particular instance of non-compliance crystallising.
The draft Guidance suggests that specific procedures need
to be carried out to examine (and effectively, to test)
the actual operation of the company’s control procedures
in order to support the assertions in the director’s
annual compliance statement – at a relatively detailed
level and that includes inspection of documentation and
re-performance. However, it is not entirely
clear what level of detail is required by the legislation.
‘All reasonable endeavours’
It is emphasised in the draft Guidance that the effect of
this phrase is to impose a significant obligation on directors’
to take all reasonably necessary steps to ensure compliance
and the draft Guidance includes an illustrated list (set
out below) of the type of matters likely to be included
– ranging from communication to staff and testing
of controls to assessment of any actual instance of non-compliance
that come to light.
Directors will have to exercise their judgement in relation
to whether they have used all reasonable endeavours to ensure
compliance having regard to the extent to which they have:
· identified all of
the company’s obligations under the Companies Acts,
1963 to 2003 and tax law (irrespective of whether non-compliance
may materially affect the company’s financial statements);
* identified the company’s legal framework (i.e. other
than company and tax law);
* determine those elements of the company’s legal
framework (i.e. other than Company and tax law), non-compliance
which may materially affect the Company’s financial
statement;
* documented the company’s relevant obligations;
* developed policies respecting the company’s compliance
with its relevant obligations;
* communicated those company policies to staff and management;
* developed financial and other procedures for the purposes
of securing compliance with those obligations;
* implemented financial and other procedures for the purposes
of securing compliance with those obligations;
* monitored and examined, on an ongoing basis, the effectiveness
of those procedures in achieving their objective of providing
reasonable assurance of compliance in all material respects
with the company’s relevant obligations;
* conducted an annual review of control effectiveness based
on, inter alia, reports received during the year; and
* in instances of non-compliance or control weakness/failure,
taken appropriate corrective and/or remedial action in an
expeditious manner.
Unfortunately the draft Guidance does not elaborate on how
directors’ should report if they conclude that they
cannot confirm that this demanding standard has been met.
However, the ODCE has indicated as a result of submissions
received that it is developing a selection of scenarios
with comment on what might be the appropriate statement
by directors in each case (but ultimately directors will
decide on content).
‘Fair and reasonable’
It has been commented that the inclusion of the requirement
for company’s auditors to form an opinion as to whether
the directors’ statements are “fair and reasonable”
is somewhat of a mismatch with the actual obligations imposed
on directors pursuant to the legislation. The requirement
for the statements to be “fair and reasonable”
is not in fact imposed on the directors. The draft Guidance
however, provides that given that the company’s auditors
are required to form this opinion, it follows that directors
are expected to meet this standard in preparing the statements
and addressing the relevant issues therein.
Consequences of Non-Compliance
The draft Guidance also outlines the consequences of non-compliance
with the statutory provisions requiring the preparation
of statements.
Where the directors of a company are required to prepare
a compliance policy or any other compliance statement and
they fail:
* to prepare, or cause to be prepared, either statement;
or
* fail to include their statement in their directors’
report.
each director to whom the failure is attributable is guilty
of an offence. Moreover, given that these offences are indictable,
where such failure comes to the auditors’ attention
during the course of the audit, the auditors would be required
to report the matter to the Director of Corporate Enforcement.
In the case of company law, in addition to criminal prosecution
(for which the maximum penalty available to the court on
conviction on indictment is €12,700 and/or five years’
imprisonment), non-compliance can also give rise to certain
civil consequence including, restriction, disqualification
and the imposition of personal liability on directors.
Any person who, in purported compliance with any provision
of the Companies Acts, 1963 to 2003, including the
requirement to prepare a compliance policy statement and
annual compliance statement: -
* makes a statement or produces, lodges or delivers any
return, report or other document that is false in any material
particular, knowing it to be false; or
* recklessly makes a statement or produces, lodges or delivers
any such document that is false in a material particular
shall be guilty of an offence.
Given that the compliance policy and the annual compliance
statement will be included in the directors’ report
appended to the financial statements, once the company’s
annual return is lodged with the Companies Registration
Office they become public documents. Accordingly, if:
* directors are unable to provide confirmation that they
have used all reasonable endeavours to secure compliance
with the company’s relevant obligations; or
* the company’s auditor has formed the opinion that
either (or both) of the statements are not fair and reasonable;
or
* the company’s auditor has been unable to form an
opinion as to whether either (or both) of the statements
are fair and reasonable.
this fact will be on public record and may, therefore, come
to the attention of a company’s creditors, bankers,
regulators and the wider public. The consequences of being
unable to provide assurance that all reasonable endeavours
have been used may, for example, adversely affect a company’s
credit rating or maybe taken into account by a regulator
in deciding whether to carry out an examination of the company’s
affairs.
Concluding Remarks
As of the date of writing it is expected that a final Guidance
from the ODCE will be finalised in mid-December. Quite
helpfully, it should be noted that as a response to submissions
received by the ODCE, template statements are in development
but of course will need to be tailored to the individual
company, its area of business and the choices which the
directors make as to the necessary procedures and arrangements
to secure compliance.
It is not known as of yet when Section 45 of the Act will
be commenced. It has been suggested in 2005 and perhaps
from the 1st January, 2006. The principle options
for commencement as outlined by the ODCE are as follows:
· Financial year starting
on or after 1st July, 2005;
· Financial year starting
on or after 1st January, 2005;
· Financial year starting
on or after 1st January, 2006; or
· Phased approach over
two year period (July 2005 to June 2007).
It is hoped that the final Guidance due to be published
in mid December by the ODCE will provide as definitive as
possible a guide to the obligations imposed on company’s
directors by virtue of Section 45. It is imperative that
the legislation is clarified to the extent possible so that
directors are in a position to understand the requirements
and so that this jurisdiction is not made unattractive for
foreign or local investors.
[PRINTER FRIENDLY VERSION]
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