Co-authored by Evie Tamasova and Jay Sattin

The number of penalties and litigation for untrue or misleading information in companies’ Annual Reports under the latest narrative reporting regulations is likely to increase in the upcoming months.

Companies report on environmental and social impacts because stakeholders require it. So far, though, the provisions are failing to deliver the high-quality, forward looking, balanced and insightful analysis on company environmental and social policies and performance that stakeholders need.  What will be the consequences of such failure in the future? What litigation or reprisals are we likely to see? We examine the key issues in this blog.

Studies by the European Union of non-financial information in environmental and social areas have shown that “…only a limited number of large companies regularly disclose non-financial information, and the quality of the information disclosed varies largely, making it difficult for investors and stakeholders to understand and compare companies’ position and performance.”^[1]  The narrative section of the report has become unhelpfully cluttered. Those important messages used by shareholders to assess the performance of the company are being lost in the mass of textual information. In addition, existing provisions in the law often do not match current best practice in reporting or shareholders’ needs.^[2]

In the UK, the government introduced regulations that increased requirements for quoted companies’ non financial reporting from 1 October 2013.  The current business review was replaced by a strategic report. This will retain the requirement for large companies incorporated in the UK[3], to file a narrative report that includes information about environmental matters, and employee issues. Quoted companies must still report on their social and community issues and from 1^st October, on human rights issues and Greenhouse Gas emissions.  Investors are entitled to such information in order to make fully informed decisions about the likely future performance of their investments[4].

There is concern from all stakeholder groups about the patchiness of current practice, including the lack of forward looking information and a lack of proper analysis, particularly in relation to how risks are being managed in line with companies’ strategic objectives.  The Financial Reporting Council (FRC)[5] and Defra[6] have both issued guidance documentation to help with these content requirements.

If reports do not comply with legal requirements, then the Conduct Committee, who has the power to get the company to amend their report without having to apply to the court, will firstly take a voluntary approach, enquiring into cases of non-compliance and asking directors’ to update their reports.  Investigations will look into non-compliance, as well as into complaints received from third parties (e.g. investors).[7] The disclosure of outcomes of investigations of non-compliance will be published (e.g. by way of press releases and in subsequent Annual Reports); with the aim of improving the evaluation of Strategic Reports (previously Business Reviews), as well as recruiting individuals with specialised expertise in environmental and social risk management and reporting.[8] This public disclosure by the FRC can have a negative impact on a company’s reputation in general, and particular amongst existing shareholder and potential investors.

If the directors’ do not update the report in line with legal requirements, then the Conduct Committee have the power to apply to the court for a declaration that the Annual Report does not comply with the requirements of the regulations, and for an order requiring the preparation of a revised report[9]. The non-compliance with the regulations will not only have a material effect on the financial statement but can result in a fine or potential disqualification of the company’s director. For instances where there may be penalties see ss 415, 419, and 463 of the Companies Act 2006.

This means that in order to avoid penalties, it will be mandatory for companies with reporting years ending after 30^th September 2013 to prepare their Strategic Report in line with the new regulations.

The Companies Act also allows for directors to be held liable to compensate their company if it suffers any loss as a result of any untrue or misleading statement (or any omission) arising from the the strategic report and the directors’ knew that the statements were untrue or misleading, or if they knew that the omission was a dishonest concealment of a material fact.

Shareholders may also be able to bring a successful claim against a company if the shareholder can establish an action for negligent misstatement provided that the shareholder can establish that the alleged negligence caused them to suffer loss as a result of an untrue or misleading statement.[10]

In the upcoming year the new regulations, increasing requirements and guidance, and heightened awareness by investors of the financial impact of non-financial information could see a rise in investigations by the Conduct Committee.

For further information see our FREE Strategic Reporting webinar available here.

If your organisation is interested in developing a robust ESG process which complies with UK reporting requirements find out more about our upcoming Training Masterclass Workshop here.