INTRODUCTION
"Risk comes from not knowing what you're doing." In their consultation document of April 2014 on Risk Management, Internal Control and the Going Concern Basis of Accounts, the Financial Reporting Council (FRC) in the United Kingdom took the advice of the Sage of Omaha to heart.
WHO IS AFFECTED?
As part of its review of its guidance for directors (Turnbull Guidance) on internal controls for all listed companies, the FRC issued draft guidance, the purpose of which is to "make a clearer link between the assessment of business viability risks and the broader risk assessment that should form part of a company's normal risk management and reporting processes." Specifically the guidance requires a link between the going concern certification in accounts and the completion of risk assessment processes.
SUMMARY
The guidance itself states "an understanding of the risks facing the company is essential for the development and delivery of its strategic objectives, its ability to seize the opportunities, and to ensure its longer term survival. It is one of the most important issues with which boards must concern themselves." As a result, the guidance specifies that risk management should be incorporated within the company's normal management and governance processes and should not be treated as a separate compliance exercise.
The board is charged with making a "robust" assessment of the principal risks to the company's business model and ability to deliver its strategy. Both this assessment and the ongoing monitoring and mitigation of risks must be disclosed in the Strategic Report as part of the company's Annual Report and linked to relevant disclosures it makes in the financial statement in relation to its going concern status.
"The directive should state whether, taking account of the company's current position and principal risks, they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due, drawing attention to any qualifications or assumptions as necessary."
CONCLUSION
In practical terms this means that starting in October 2014, in any listed corporate failure or investigation in the United Kingdom by the Serious Fraud Office, the police, the central government, or any other regulator, the authorities or insolvency practitioners, with the benefit of 20/20 hindsight, will carefully examine what steps the board took to comply with FRC requirements. In particular there will be a focus on what the board and individual directors knew or should have known at the point when the relevant risk emerged. The linkage of risk assessment, corporate governance requirements, and going concern certification could lead to wrongful trading-type arguments in the context of overall risk assessment. Under insolvency laws, directors can become personally liable for insolvent company liabilities if they know or should have known that a company was unlikely to avoid insolvency but continue to permit the company to trade. The prospect of similar arguments being used in the context of civil or criminal proceedings relating to risk assessment procedures and what directors did or should have known seems to have become more likely with the new FRC requirements. Importantly, all of this also relates to international companies that are listed in London.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
