Interview with Robert Talbut, chief investment officer at Royal London Asset Management. Talbut belongs to a long-term investor’s alliance that is concerned about the consequences of not applying the concept of prudence to produce accounts in compliance with company law.
The group of investors, with assets under management of about £372.3bn ($605bn), recently released a position paper where they argued the latest FRC’s review of the true and fair requirement falls short and leaves questions unanswered. The UK regulator said this subject has been raised many times and won’t take further action.
Carlos Martin Tornero, The Accountant: Why do a group of investors come up with this initiative?
Robert Talbut: We have been raising a number of topics over the last 18 months about some of the fundamental concepts underpinning financial reporting, such as the importance of stewardship, the importance of prudence. This initiative is about the importance of financial statements providing a true and fair view.
TA: Judging by your position paper, you are not satisfied with the current state of affairs.
Talbut: If you actually understand the concept of true and fair from a company law perspective, what you’re actually asking management to do is to produce accounts on a prudent basis.
In the one hand there’s the requirement of accounting standards; and on the other hand the requirements of company law. We believe that adhering to accounting standards is not enough. Directors are governed by company law and not by accounting standards.
We’ve involved an eminent barrister, George Bompas QC, who pretty strongly suggested the primacy of company law. Company law is over and above accounting standards.
TA: Do you mean there is a conflict between IFRS and national law?
Talbut: I would prefer to say there is actually a higher standard, and accounting standards are not the ultimate standard by which you judge a company’s financial statements.
It’s the ultimate responsibility of directors to comply with company law. Our concern is that there’s been the promulgation of a view that, as long as you apply the accounting standards, that’s sufficient. You’ve done your job as a director.
But company law is quite clear. It tries to form the judgement that management have been good stewards of the assets. And secondly, that any distributions made by the company are lawful. I mean that there is sufficient capital in the business to be able to make those distributions to shareholders or to creditors.
That’s where you get into the concept of capital maintenance, which is a bit of an old- fashioned phrase, but encompasses that the company is not in danger of over-distributing.
TA: In your position paper you argue that IFRS has become disconnected from true and fair requirements because company law and IFRS have different goals, is that correct?
Talbut: Yes, that’s right. If you’re going to produce a set of accounts which comply with company law you would employ the concept of prudence, because you would want to ensure that the company is not making any unlawful distributions. The issue with accounting standards is that currently they apply the concept of neutrality, and neutrality can be different from a prudent approach to the production of accounts.
TA: But the FRC maintains that neutrality and prudence aren’t contradictory concepts and that even excessive prudence wouldn’t be useful.
Talbut: We’re certainly not calling for excessive prudence or for companies to deliberately produce financial statements which understate their situation.
But we believe prudence allows longer-term shareholders to form a judgement about how well management has performed over successive periods. It allows us to have confidence that the company is in a sound financial position and can be expected to trade in an appropriate fashion in the foreseeable future.
TA: The FRC argues this is just terminology and that the fair and true view is at the heart of IFRS standards.
Talbut: Our view is that this is not a question of semantics. It’s something pretty fundamental and it really comes back to the point that the director’s responsibility is to comply with company law. It’s far better to make it very explicit and clear.
TA: Do you mean that if directors are compliant with IFRS they could not be compliant with company law?
Talbut: That’s one of the principal points that we’re actually flushing out. The directors’ responsibility is company law, not financial accounting rules.
TA: What about the point the FRC makes about overriding accounting standards to achieve this true and fair view
Talbut: We want accounts to give a true and fair view. Accounts should be produced on a prudent basis, according to company law, so the interests of creditors are protected.
I know everybody look back at the examples of the financial crisis. For us the lesson was that accounts were not produced on a prudent basis.
In the financial crisis we had companies that were distributing money that effectively was not available to distribute.
But we certainly had a situation where companies were signed off as being going concern but within a very short period of time those organisations went bankrupted.
TA: And therefore you point to IFRS?
Talbut: Our view is that at the time of the financial crisis accounts were not produced on a prudent basis. If they had been produce in a prudent basis numbers would have been different.
There’s a recent example, which is Betfair. It had to admit that they had illegally paid out sums of money that weren’t available for distribution. It’s not only a bank issue, and not only a 2008 thing. It’s about accounts giving confidence to investors, about companies not paying money out that it’s not available for distribution.
Betfair’s case comes from the lack of prudence and understanding of the director’s responsibilities to only distribute what it’s truly distributable.
TA: You referred to the "insidious role" accounting rules played in exacerbating the crisis, what do you propose to prevent this from happening again?
Talbut: The FRC and the European Commission need to look at this issue again and actually come out with a pretty categorical view, which we believe, will say company law is of paramount importance. So once and for all it’s not open for the debate about the importance of accounting standards versus the importance of company law. We are simply asking the FRC to clarify that point.
The House of Lords has actually looked at it and showed interest in this particular area. And to have uncertainty is just not helpful to investors and it’s certainly not helpful to company directors.
TA: Do you expect further action from the IASB? Should the standard setter make a move?
Talbut: There has been a separate debate with them about stressing the importance of prudence. There is a recent consultation which suggests the IASB believes that prudence should be emphasised to a greater extent. That’s a consultation under way at the moment, and we hope prudence will be re-emphasised. But accounting standards are what they are, and our point is that directors need to make sure that they understand they have ultimate responsibilities to company law.
TA: Do you mean is it down to how you interpret the standards?
Talbut: That’s one aspect. But we are not necessarily saying that accounting standards are wrong. We clearly want to increase the emphasis placed upon a prudent approach into the production of accounts. That appears to have certain momentum. But this belief that applying accounting standards would be enough, is fundamentally incorrect. We want this to be clarified.
Signatory funds AUM (£372.3bn)Threadneedle Investments: 92.8Royal London Asset Management: 75USS Investment Management: 40RPMI Railpen: 20Sarasin & Partners: 14London Pensions Fund Authority: 5GO Investment Partners: 0.5Other signatories Local Authority Pension Fund Forum: 125UK Shareholders Association: n/aNotes: The LAPFF brings together 60 UK local authority pension funds with combined assets of over £125bn; LPFA is part of the LAPFF