"The knock on effect of Enron on European initiatives in the area of corporate governance has been immeasurable and promises to revitalise the whole of the company law harmonisation agenda." Discuss

There was a somewhat negative response to the Higgs report as top UK companies felt the “SID” recommendations were divisive. Companies seemed to reject the sentiments of the report, for example many companies continued the practice of appointing retiring chief executives as chairmen such as J.Sainsbury who appointed Sir Peter Davis in March 2003. There was also express opposition to Higgs recommendation that at least half the board of a company should compromise independent non-executive directors. A senior representative of the Association of British Insurers stated that unless the Higgs recommendations received a critical mass of support, the subsequent revisions to the combined code would be inadvisable, and drawing reference to the ‘comply or explain’ approach to UK corporate governance, argued that companies would simply choose to ignore the revised code. 

        The government also commissioned a report into the role of the audit committee to accompany the Higgs report, namely the Smith report. The Cadbury report had pointed out the importance of the audit function in corporate governance stating that “The annual audit is one of the cornerstones of corporate governance and provides an objective check on the way in which the financial statements have been prepared and presented.”  The Smith report concentrated on the relationship between the external auditor and the client companies, and the role, composition and responsibilities of audit committees. The report considers that audit committees (first introduced by the Cadbury report) should consist of at least three members who should all be independent non-executive directors and at least one of whom should have significant financial experience. Similarly to the role of non-executive directors as considered in the Higgs report, the audit committees provide independence to corporate decision-making. However critics argued that the report was not sweeping enough and that sterner action such as the Sarbanes-Oxley Act would send out a better message.

The Financial Reporting Council approved the revised code and it came into effect in November 2003, incorporating almost all of the recommendations of the Higgs report (although watered down). The introduction of non-executive directors to meetings between institutional investors and executive directors has boosted communication between executives and shareholders. Institutional investors can now feel assured that their concerns are heard at board level via an outside party representing their interests. With companies more accountable to shareholders, it follows that corporate accountability to other stakeholders (e.g. customers, suppliers and employees) will improve. I feel that corporate fraud is less likely to occur with this greater transparency and increased independence at board level, and so the measures taken have reduced the risk of the corporate failures as witnessed in the case of Enron, from occurring again.  

Possibly the governments biggest step to date in direct reaction to the Enron scandal is the Companies (Audit, Investigations and Community Enterprise) Act 2004 which received royal assent on 28th October 2004. This ‘post-Enron Bill’ focuses mainly on audit and accounting matters and has been devised to prevent a similar corporate abuses taking place in the UK.

EUROPEAN HARMONISATION AND REFORMS ON A EUROPEAN SCALE

The UK is not the only country that has been striving to improve their corporate governance. Many European countries have developed initiatives on corporate governance, and many of them have been influenced by the Cadbury Code of Best Practice and Combined Code, such as the German code drawn up by Gerhard Cromme, which also operates on a comply-or-disclose basis. Such is the vast array of individual European codes, the European Commission were encouraged to initiate a study conducted by Weil, Gotshal and Manges, which discovered that there were in fact 42 corporate governance codes of practice in existence among European Union member countries (only Austria and Luxembourg were found not to have a code). It has been recognised for some time that at least some degree of European harmonisation of national laws is required to ensure a common market and Article 54, now Article 44(2), of the treaty establishing the European Community recognised this need. So why not establish a pan-European code of corporate governance? The study conducted by Weil, Gotshal and Manges found that the individual European codes were remarkably similar and in fact a converging force for corporate governance across the EU. It found that the differences were mainly attributable to merely the different regulatory systems of the member states and that the differences posed no threat to a single European equity market. The report concluded that a pan-European code was not necessary and that the best practice should be allowed to develop naturally under the influence of market forces.

It can be argued that what happened with Enron was realistically, solely an American corporate governance problem, and that European countries have remained relatively immune to the Enron syndrome. Countries such as the United Kingdom where the shareholding is typically public, experienced no comparable crisis, nor did others where shareholding is sometimes concentrated in the hands of a few majority stakeholders, like in many EU countries. However, serious questions have to be asked about whether European standards of corporate governance, which have not yet fully converged would allow Enron type activities to be uncovered in Europe. Many believe that Europe's Enron's are out there, in that a number of major European companies may face accounting difficulties that shareholders are not fully aware of. Nonetheless, European markets are far from being fully harmonised and well functioning. There was probably no need for the Enron case, in order for Europe to realise that some steps still need to be taken in order to achieve the internal market for financial services but Enron’s collapse has increased awareness in Europe that proper corporate governance is essential to the efficient functioning of capital markets and high quality financial reporting. There is also the added urgency given the situation with the forthcoming accession of a number new member states, many with a poor history of open corporate markets due to their post-war soviet occupation.

In June 1998, the European Commission were invited to prepare an action plan to develop the EU single capital market resulting in the Financial Services Action Plan, which was published in May 1999. It consists of a set of forty-two measures intended to fill gaps and remove remaining barriers to the EU single capital market by 2005. In April 2002 an informal meeting of ECOFIN Ministers was held in Oviedo, Spain. The commission along with EU finance ministers, governors of the central banks of the fifteen member states, and the European central bank met to discuss the aftermath of Enron. A widening of the mandate of The High Level Group of Company Law Experts, chaired by Dutch professor Jaap Winter (set up in September 2001 by the Commission), adding more corporate governance issues, was agreed. The High Level Group presented its second and final report, ‘A Modern Regulatory Framework for Company Law in Europe’ (‘Winter Report’) in November 2002, having widely consulted industry representatives and others. It shared the same approach to the Weil, Gotshal & Manges study, and suggested that, while the European commission should issue a recommendation to member states, the main source for codes of corporate governance should continue to come from the markets and their participants. It did however recommend that each member state should nominate just one corporate governance code to which it’s resident companies must ‘comply or explain,’ and that an EU structure should be established to facilitate a co-ordination of member state efforts on a non-binding basis.

The key recommendation in the Winter Report was for the Commission to launch an action plan on company law, including corporate governance. The ‘Modernising Company Law Action and Enhancing Corporate Governance in the European Union – A Plan to Move Forward’ (‘Action Plan’) is the Commission’s response to the recommendations in the Winter Report, and has been well received. The Action Plan aims to progress harmonisation whilst appreciating the variety of corporate governance practices and different legal systems within the EU and avoiding a ‘one-size-fits-all’ single EU corporate governance code. At the same time it aims to break down the barriers that restrain a single capital market. The aims of the Action Plan include shareholder and third party protection, but at the same time appreciates the improvements needed for the competitiveness and efficiency of EU businesses. The recommendations were divided into short term (2003 to 2005), medium-term (2006 to 2008) and long term (2009 and later) aims with a policy mix of non-binding soft law, and hard law with a central role for disclosure. The proposed short-term measures include a directive requiring listed companies to publish an annual corporate governance statement to enhance disclosure, along with a ‘comply-or-explain’ reference to their designated national corporate governance code, and the development of a legislative framework to help shareholders exercise various rights (such as being able to ask questions, table resolutions, vote without being present at meetings and participate in general meetings via electronic means). It also included the proposed measure of a directive on collective board responsibility for the disclosure of financial and key non-financial information, including the annual corporate governance statement. It proposed a European corporate governance forum will coordinate, monitor, and facilitate convergence of national corporate governance codes, with each country designating one code only, and that there is a directive to overcome obstacles to cross-border shareholdings and the use of voting rights across borders, facilitating shareholder participation. Other recommendations included the strengthening of the role of non-executive directors, setting minimum standards regarding the composition and role of the audit, remuneration and nomination committees. It was also recommended that an appropriate regime for the approval of remuneration programs of executive directors be implemented.

On a medium-term basis, the Commission said it would request, in a directive, that institutional investors disclose their investment and voting policies, and that beneficial holders be able to obtain specific voting records. A further directive will allow companies to choose between a single-tier or dual-tier board and another directive will target sensitive issues, enhancing board members’ responsibility by setting out procedures for directors’ disqualification, wrongful trading, and a special investigation right for investors.

Despite being created with good intentions, with its mix of policy instruments, it may be more difficult than envisaged, to implement the Action Plan. There is a delicate balance between broad principles and technical details, and the use of the action plans legislative proposals may undermine the harmonisation of corporate governance practices within the EU. The Commission have argued that certain disclosure elements need legislative enforcement, but having to dictate corporate government practices at local level to this degree would seem to throw into doubt the amount of market discipline there is in adhering to Commission recommendations and even codes. Despite the sentiments of the Winter report that harmonisation should be allowed to develop naturally under the influence of market forces, and agreeing that there is no need for the creation of a European corporate governance code, the commission has pressed ahead to speed up the process and this can be partly put down to Enron, with Europe wanting to show an equally positive response to the Sarbanes-Oxley Act.

One of the latest developments in European harmonisation that deserves mention is the enactment of European Public Limited Liability Company Regulations 2004, which came into force on the on 8 October 2004. This has given effect to the European Company or the Societas Europaea. This is a company organised under a supra-national European law rather than the law of the individual member state. Although the Societas Europaea is meant to be an optional form of incorporation, its aim is to offer companies the facility of operating throughout Europe without the constraints and burdens presented by the present system, where a number of domestic company laws will apply. The numbers of benefits arising from a European company include increased freedom of movement, enhanced protection for shareholders and creditors, the use of the ‘European Company’ label, lower costs, and overall should help achieve a common single market. This illustrates a further step towards harmonisation and corporate governance under community law rather than national law.

CONCLUSION

It is difficult to find fault with the aims of the Action Plan, or even many of the principles behind them, however there is concern about the approach to these principles.  The true and practical impact of the Action Plan will depend on the extent of the regulation imposed at EU level and the degree of discretion allowed to member states to legislate and set appropriate guidance at their national level. For example, although the Action Plan is based on the belief that it should be flexible in application but firm in its principles, there have been concerns about the proposal for a directive setting out the principles that companies must apply when preparing the annual corporate governance statement. Also the suggestion that member states must have monitoring procedures in place for corporate governance will not be well received by all. Countries such as the UK, who have developed an approach to corporate governance based on best practice, the use of codes and the comply-or-explain approach, the prospect of prescriptive legislation and rigid enforcement is not a welcome one. Many see the hasty production of the Action Plan as a mere attempt by the Commission to stake its claim on the international corporate governance scene. It still seems premature to expect the imminent harmonisation of corporate governance in a European arena that looks set to be a diverse place for some time to come.

Cyclic crises, economic expansion and contraction, and even fraud are no stranger to financial markets, but what has made the present situation so critical is its dimension, which is no longer national but global. As more companies seek to raise finance on foreign stock exchanges global markets have emerged. The fear caused by the Enron disaster, which highlighted weaknesses in a major component of the global system (namely the US) has urged us to reconsider corporate governance. A European common ground would be a good starting point for a further overseas dialogue and cooperation, but the problem is finding it. The lessons learnt from Enron have catalysed the harmonisation process and revitalised European corporate governance to prevent such disasters from occurring again.

BIBLIOGRAPHY

Text Books

Cheffins, B.R. (1997) Company Law, Clarendon

Farrar, J.H. & Hannigan, B.M. (1998) Farrar’s Company Law 4th ed., Butterworths

Gower & Davies (2003) Principles of Modern Company Law 7th ed., Sweet & Maxwell

Hannigan, B.M. (2003) Company Law, Lexis Nexis Butterworths

Pettet, B. (2001) Company Law, Longman Law series

Sealy, L. (1996) Company Law and Commercial Reality, Sweet & Maxwell

Journals

Chandler, R.A. & Rees, N. (2002) Company Lawyer Briefing, Regulating company accounts: all change please, In The Company Lawyer Vol. 23 No. 5 Sweet & Maxwell Ltd (& Contributors)

Copp, S. (2003) Corporate Governance: Change, Consistency and Evolution Part 1, In International Company and Commercial Law Review  (I.C.C.L.R.), Issue 2 – Sweet & Maxwell Ltd (and Contributors)

Copp, S. (2003) Corporate Governance: Change, Consistency and Evolution Part 2, In I.C.C.L.R., Issue 3 – Sweet & Maxwell Ltd (and Contributors)

Solomon, A. & Solomon, J.F. (2004) Assessing the Potential Impact of the Revised Code on Corporate Governance, In I.C.C.L.R., Issue 4 – Sweet & Maxwell Ltd (and Contributors)

Electronic resources

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