Our view

Jul 06 - New EU directive is likely to erode UK’s ‘true and fair view’ principle in accounts and audits: threat to shareholder protection

Morley Fund Management today raised concerns that the impact of a new EU Amending Directive* which was adopted by the EU's Agriculture and Fisheries Council, without discussion, on 22 May 2006 appears set to reduce key shareholder protections.

The effect of the directive could reverse the moves agreed in 2005, between the Government, investors and accounting firms to re-assert and retain the full extent of the overarching ‘true and fair view’ principle, which is recognised as the cornerstone of financial reporting and auditing in the UK.

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

Morley will be calling upon investors and their representative organisations to approach the Government to clarify the effects of this Directive and find ways to ensure that the ‘true and fair view’ is not swept away or diluted given it is a fundamental, effective principle that underpins the quality of the UK 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 principle cannot be over-estimated. Any question mark about its survival, or a weakening of it, would be a matter of grave concern for shareholders.

"We need to find a way to explicitly re-assert the traditional form of override to the overarching true and fair view and to address concerns that giving international standards a quasi-legal basis will not re-define or dilute this fundamental principle and limit the UK to a compliance oriented model.”

The continual focus on a compliance orientated approach, at the expense of the intent and purpose of financial reporting - form over substance - has been a key issue in many of the accounting scandals in both the UK and US.

Two great ironies

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

The effect of this would encumber the strength of the UK ‘true and fair view’ principle. Traditionally this overarching principle was based on effective application and interpretation by the Courts where mere compliance with standards or presentational requirements on what is to be included in a company’s accounts, or notes to the accounts, would not be sufficient to give a true and fair view; hence necessary additional information would be required.

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

Back in 2005, Morley and other investors together with accounting firms and others made submissions to the DTI calling for the true and fair view to be reinforced within the new Company Law Reform Bill. Following those representations, the Government introduced a clear clarification and re-assertion of the over-arching true and fair view principle in the Company Law Reform Bill for all accounts, whether Companies Act accounts or IAS accounts.

“The second great irony is that in the autumn of 2005, after considerable consultation with Government, we all thought that through the Company Law Reform Bill would reinforce the UK stewardship concept and overarching true and fair view principles within the legal framework. The new Directives and recently prepared accounts already show that all that good work may now be undone,” added Jones.

The motivation for the Government’s clarification within the Company Law Reform Bill reflected the conviction that the strength of the UK governance and reporting system rests on its stewardship concept which extends to the role of the auditor - with its reliance on the overarching principles of the true and fair view and the precedence of substance over form, as well as the duty of care to shareholders.

This reflected the 2002 conclusions of the Treasury Committee in its "Sixth Report - The Financial Regulation of Public Limited Companies" (Nov 2002) Treasury Committee, which included, the recommendation that:

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

Regardless of the merits of individual standards, it was felt necessary, even essential, that the unencumbered true and fair view approach be explicitly retained in the UK legislative and regulatory framework, so that it becomes clear to all that it will be sustained into the future.

Morley believes that these principles have protected the UK from scandals such as Enron and the UK would become more vulnerable if they were diluted.

-ends–

* Press Release: http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/misc/89683.pdf

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

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

Notes to editors
Morley Fund Management

Morley Fund Management Limited is the UK-based asset management business of Aviva plc. Firms within the Morley group of companies manage Ł154bn from offices around the world as at 31 May 2006.

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

Awards

• Property Fund Manager of the Year, Pensions Management Awards 2006
• Best Commitment to Raising Standards of Trustee Education, Engaged Investor Awards 2006
• Property Fund Manager of the Year, Property Week Awards 2006
• SRI Provider of the Year, Global Pensions 2006
• Central European Property Awards 2005 - Outstanding Company of the Year & Investor of the Year
• UK Pensions Awards 2005 – Property Manager of the Year
• Property Week Awards 2004 – Best Property Fund Manager
• Pensions Management Provider Awards 2003 – Best Property Fund Manager
• Fund Manager of the Year - Pensions Week Awards 2002
• Specialist Manager of the Year - UK Pensions Awards 2002

Further information about Morley Fund Management can be found at www.morleyfm.com