Taking the Positive Route to Negative Assurance

By Sandra Seah, Partner, Alban Tay, Mahtani & de Silva

The source of the “Negative Assurance” rule is Listing Rule 705(4) “705(4)

In the case of an announcement of interim financial statements (quarterly or half-yearly, as applicable), an issuer’s directors must provide a confirmation that, to the best of their knowledge, nothing has come to the attention of the board of directors which may render the interim financial results to be false or misleading. In order to make this confirmation, Directors would not be expected to commission an audit of these financial statements. The confirmation may be signed by 2 directors on behalf of the board of directors.”

The “Negative Assurance” Rule

It has been close to a year after the “Negative Assurance” rule was first introduced to the corporate governance landscape in Singapore, requiring the directors of listed companies to confirm that, to the best of their knowledge, nothing has come to their attention which may render the interim financial results to be false or misleading. This article examines the role of directors, and the safeguards which directors should have in place before giving such “Negative Assurance”.

The “Negative Assurance” rule does not apply for announcement of full year results. The rule is intended to strengthen accountability for interim financial results and supplements the existing requirements under section 201 of the Companies Act whereby directors are required to state that the audited accounts give a “true and fair view” of the results of the business of the company and the state of affairs of the company and, that there are reasonable grounds to believe that the company will be a going-concern.

Compliance

Announcements from 1 September 2006 relating to quarter/half-year financial statements must include the Directors’ “negative assurance” statement. The Listing Manual does not specify any particular format or requisite element of the “negative assurance” statement.

In general, the “negative assurance” statements included in listed companies’ financial statements are usually rigorously plagiarized from the wording of the Listing Rule 705(4) itself for instance:

“Pursuant To Rule 705(4) Of The Listing Manual, the Board of Directors do hereby confirm that to the best of their knowledge, nothing has come to their attention which may render the unaudited interim results of the Group, for the half year ending xxxx, to be false or misleading.”

There are no outright penalties imposed on directors if they do sign off on interim statements that are later proved to be false or misleading. This contrasts with the case under the Companies Act where failure by any director to provide a “true and fair” view of audited accounts is an offence punishable with a fine of up to $10,000 or to imprisonment of up to 2 years.

Standard of Care in giving Negative Assurance

What then should a director do in order to assure himself that the “Negative Assurance” can be properly given?

Firstly, a “Negative Assurance” is a statement of what the director does not know as opposed to a statement as to what the director knows (positive assurance). In this case, the director states that nothing has come to his attention in the interim financial results which may render such results to be false or misleading.

In the author’s view, it is not meaningful to split hairs on whether there is a lower or different standard of care just because a negative, rather than a positive, assurance is given. Embedded within the figures in a financial report lies the crucial information about where the company has been and where it is headed. This has to be truthfully presented to the investing public. Taking the cue from the penal provisions in sections 199 — 200 of the Securities and Futures Act which prohibit the making of false or misleading representations to induce the public to subscribe for shares or to deal in securities, the director must dispel any hint that he does not care whether the statement or information is true or false, or that he knows or ought reasonably to have known that the statement or information is false or misleading in a material particular, or that he has acted recklessly in giving the statement.

Practical Tips

The “Negative Assurance” expresses the subjective belief of the director that nothing in the interim financial results renders the results to be false or misleading. If a director is able to estab21lish that he exercised due care, he will likely have a good defence for signing off on an interim statement that is later found to be false or misleading.

Section 157C of the Companies Act provides a useful starting point on the aids which a director may rely on before giving a “Negative Assurance”. Section 157C provides that a director may, when exercising powers or performing duties as a director, rely on reports, statements, financial data and other information prepared or supplied, and on professional or expert advice given, by:

• a reliable and competent employee

• a professional adviser or an expert

• any other director or any committee of directors upon which the director did not serve

However, this reliance on employees, professionals or other directors or committees is only warranted if the director:

• acts in good faith

• makes proper inquiry where the need for inquiry is indicated by the circumstances

• has no knowledge that such reliance is unwarranted

The author suggests that directors adopt a simple P.A.C.T. with themselves before signing off on the “Negative Assurance:

P — Professional Experts

A — Audit Committee

C — Chief Financial Officer

T — Training

P — Professional Experts

Although Listing Rule 705(4) provides that directors will not be expected to commission an audit of the interim financial statements in giving the “Negative Assurance” confirmation, directors may nevertheless wish to engage auditors to perform either an interim or a limited review on the financial results to enable them to make their confirmation.

This is likely to be most reassuring form of due diligence undertaken by a director, as obviously a professional will be better equipped to recognise creative accounting and cooked books, and advise the director accordingly.

A — Audit Committee

The company’s Audit Committee will usually comprise of non-executive and/or independent directors who have accounting or related financial management experience. Apart from reviewing the formal audit results, the Audit Committee is also responsible for ensuring the integrity of the financial statements of the company and any formal announcements relating to the company’s financial performance. The Audit Committee will also be in the best position to advise on the adequacy of the company’s internal financial controls, operational and compliance controls, and risk management policies and systems.

It will therefore be prudent for a director, if he does not already sit on the Audit Committee, to confer with the Audit Committee and source out any irregularities or potential issues prior to giving the “Negative Assurance”.

C — Chief Financial Officer

Working closely with the company’s CFO will be the next in the line of defence. The CFO has the overall responsibility for the company’s financial situation, and has (or should have) his ear to the ground as to the company’s financial situation. The director should regularly discuss and review all management accounts with the CFO, and have a sound grasp of the company’s financial performance, position and prospects.

Such preparatory work paves the groundwork for the director to review any interim financial statements with adequate background information and knowledge to know if anything is amiss and to raise any relevant queries to the management before giving the “Negative Assurance”.

T — Training

While the director may not be an expert in financial accounting, he should be familiar with the company’s accounting policies and financial controls in place within the company. The director should also be equipped with some basic investigation skills to identify warning signs and red flags on the most obvious kinds of accounting anomalies such as phantom clients and improper revenue recognition.

A director should therefore strive to receive relevant technical training in the areas of accounting and identification of fraudulent financial reporting. This is borne out by Guideline 1.6 of the Code of Corporate Governance 2005, which encourages every director to receive training from time to time on discharging his duties. Having a trained eye will assist the director in making proper inquiry where the need for inquiry is indicated by the circumstances, as required by Section 157C(2) of the Companies Act.

Conclusion

The “Negative Assurance” rule should be viewed in a positive light. The existing legal framework already obliges a director to exercise reasonable diligence in discharge of work and to be accountable for the success of the company. The “Negative Assurance” rule only requires the director to be explicit in taking on financial accountability. This can be properly discharged if the director demonstrates that he has acted in good faith and has made due inquiry whenever warranted by the circumstances.