New EU directive is likely to erode UK s ‘true and fair view principle in accounts and audits: threat to shareholder protection

Article date: 3 July 2006

Morley Fund Management today raised concerns that the impact ofa new EU Amending Directive* which was adopted by the EU'sAgriculture and Fisheries Council, without discussion, on 22 May2006 appears set to reduce key shareholder protections.

The effect of the directive could reverse the moves agreed in2005, between the Government, investors and accounting firms tore-assert and retain the full extent of the overarching ‘trueand fair view’ principle, which is recognised as thecornerstone of financial reporting and auditing in the UK.

The principle has been a key part of the UK's Companies Actlegislation. It obliges companies to prepare accounts that give a‘true and fair view’ of the state of affairs of thecompany. This obligation overrides any conflicting requirements onthe preparation and presentation of accounts under the Act or fromstandards. The concern is that the Directive will redefine andencumber the' true and fair view' as meaning compliance with thestandards and, thereby, change the over-arching principle to acompliance orientated requirement.

Morley will be calling upon investors and their representativeorganisations to approach the Government to clarify the effects ofthis Directive and find ways to ensure that the ‘true andfair view’ is not swept away or diluted given it is afundamental, effective principle that underpins the quality of theUK financial reporting and shareholder protection framework.

Keith Jones, chief executive of Morley Fund Management, said:"The importance of the over-arching true and fair view principlecannot be over-estimated. Any question mark about its survival, ora weakening of it, would be a matter of grave concern forshareholders.

"We need to find a way to explicitly re-assert the traditionalform of override to the overarching true and fair view and toaddress concerns that giving international standards a quasi-legalbasis will not re-define or dilute this fundamental principle andlimit the UK to a compliance oriented model.”

The continual focus on a compliance orientated approach, at theexpense of the intent and purpose of financial reporting - formover substance - has been a key issue in many of the accountingscandals in both the UK and US.

Two great ironies

Concern first emerged when it was realised that the amendingDirective would require accounts to be drawn up in line withexisting provisions of the EU’s two ‘true and fairview’ Directives** and, where applicable, inaccordance with the international accounting standards adopted inaccordance with the IAS Regulations. Morley hasalready seen that evidence in recent UK annual report and accountswhich have been prepared on an IAS basis rather than a true andfair view basis, thereby already containing an encumbered‘true and fair view’ audit opinion. Companies refer toa statement that says: ‘the accounts give a true and fairview, in accordance with IFRSs adopted for use in theEU.’

The effect of this would encumber the strength of the UK‘true and fair view’ principle. Traditionally thisoverarching principle was based on effective application andinterpretation by the Courts where mere compliance with standardsor presentational requirements on what is to be included in acompany’s accounts, or notes to the accounts, would not besufficient to give a true and fair view; hence necessary additionalinformation would be required.

“Where the true and fair view is encumbered as being inaccordance with the rules-based international accounting standards,then the onus and burden of proof is switched in favour ofcompliance. So, the first great irony is that the originalintention of the EU’s move to use international accountingstandards for listed company accounts was to enhance comparabilityof the underlying financial position of companies, not makeaccounts uniform, rule compliant constructs,” said Jones.

Back in 2005, Morley and other investors together withaccounting firms and others made submissions to the DTI calling forthe true and fair view to be reinforced within the new Company LawReform Bill. Following those representations, the Governmentintroduced a clear clarification and re-assertion of theover-arching true and fair view principle in the Company Law ReformBill for all accounts, whether Companies Act accounts or IASaccounts.

“The second great irony is that in the autumn of 2005,after considerable consultation with Government, we all thoughtthat through the Company Law Reform Bill would reinforce the UKstewardship concept and overarching true and fair view principleswithin the legal framework. The new Directives and recentlyprepared accounts already show that all that good work may now beundone,” added Jones.

The motivation for the Government’s clarification withinthe Company Law Reform Bill reflected the conviction that thestrength of the UK governance and reporting system rests on itsstewardship concept which extends to the role of the auditor - withits reliance on the overarching principles of the true and fairview and the precedence of substance over form, as well as the dutyof care to shareholders.

This reflected the 2002 conclusions of the Treasury Committee inits "Sixth Report - The Financial Regulation of Public LimitedCompanies" (Nov 2002) Treasury Committee, whichincluded, the recommendation that:

“Pressures to agree a comprehensive range of[International] Standards by 2005 must not dilute standardsapplicable in the United Kingdom, particularly in relation to a'true and fair' view.”

Regardless of the merits of individual standards, it was feltnecessary, even essential, that the unencumbered true and fair viewapproach be explicitly retained in the UK legislative andregulatory framework, so that it becomes clear to all that it willbe sustained into the future.

Morley believes that these principles have protected the UK fromscandals such as Enron and the UK would become more vulnerable ifthey were diluted.


* Press Release:

** Directive 78/660/EEC Article 2 (3) and Directive 83/349/EECArticle 16 (3) - the EU's 4th and 7th Company Law Directives (the'Accounting Directives' or 'true and fair Directives'.

For further information please contact:
Corporate Communications
Morley Fund Management
tel: 020 7809 8618

Notes to editors
Morley Fund Management

Morley Fund Management Limited is the UK-based asset managementbusiness of Aviva plc. Firms within the Morley group of companiesmanage £154bn from offices around the world as at 31 May2006.

Morley manages both institutional and retail funds under the Morleybrand. It also acts as investment manager for a range of retailinvestment funds, marketed in the UK under the Norwich Union brand,and international funds marketed under the Aviva Funds brand.


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