A decision by the Financial Conduct Authority (FCA) in which a listed company was fined £4,651,200 for failing to comply with the Listing Rules in relation to certain related party and other transactions is a reminder of the importance of having adequate systems and controls in place which are effectively implemented.

Background

Asia Resource Minerals plc (ARM), formerly Bumi plc, is one of the largest coal producers in Indonesia, a market position achieved through the acquisition of an 84.7% interest in PT Berau Coal Energy TbK (PT). ARM is incorporated in the UK with a

premium listing on the Official List and during the relevant period was in the FTSE 250. PT is listed on the Indonesian Stock Exchange.

On 24 September 2012 (approximately fifteen months after listing), ARM announced that it had become aware of allegations of potential financial and other irregularities in relation to its Indonesian operations.  Following this announcement, ARM conducted a review of the effectiveness of its internal controls, which included a review of its related party processes. From December 2012, ARM commenced a separate review of potential related party transactions that had been entered into by PT prior to the preparation of ARM’s Annual Financial Report for the year ended 31 December 2012 (AFR 2012). As a result of the review, ARM indicated to its financial advisers that it may have failed to comply with its obligations under the Listing Rules (LRs) and the Disclosure and Transparency Rules (DTRs) with regard to what might have been related party transactions. Subsequently, ARM’s financial advisers found that three related party transactions valued at just over £8,000,000 had occurred, of which ARM had been unaware, and notified the UK Listing Authority (UKLA) that there had been consequential breaches of the LRs.

The related party transactions were transactions other than in the ordinary course of business between PT and companies associated with a non-executive director of ARM, which were therefore related parties within LR 11.1.4R.

On 19 April 2013 ARM notified the UKLA that while it continued to review a number of items on the balance sheet of PT, including the potential related party transactions, it would be unable to publish its AFR 2012 within the time limit of four months of the year end specified by DTR 4.1.3R. Trading in ARM’s shares was suspended and ARM eventually published its AFR 2012 on 31 May 2013, in breach of DTR 4.1.3R.  

Breaches of the Listing Rules and Disclosure and Transparency Rules

  • ARM was fined by the FCA pursuant to section 91 of the Financial Services and Markets Act 2000, on the basis that it had, over a period of two years, breached the following LRs and DTRs:
  • LR 8.2.3R – ARM’s Sponsor should have been consulted in respect of the proposed related party transactions in order to assess the application of the LRs and the DTRs;
  • LR 11.1.11R – related party transactions with the same related party (and any of its associates) in any 12 month period should have been aggregated;
  • LR 11.1.10R – two of the three transactions were smaller related party transactions and therefore, after aggregation, ARM should have sought written confirmation from an independent adviser that the transactions were fair and reasonable as far as the shareholders of ARM were concerned and undertaken to include the transactions in the company’s next published annual accounts [note that LR 11.1.10R relating to smaller related party transactions has been subsequently amended and such transactions must now be announced];
  • Listing Principle 2 [now Listing Principle 1] – a listed company must take reasonable steps to establish and maintain adequate procedures, systems and controls to enable it to comply with the LRs. Guidance states:

“Principle 2 is intended to ensure that listed companies have adequate procedures, systems and controls to enable them to comply with their obligations under the LRs and DTRs. In particular, the FCA considers that listed companies should place

particular emphasis on ensuring that they have adequate procedures, systems and controls in relation to:

  1. identifying whether any obligations arise under LR 10 (Significant transactions) and LR 11 (Related party transactions); and
  2. the timely and accurate disclosure of information to the market.”
    • DTR 4.1.3R – annual report to be published within four months of the year end.

The FCA found that although ARM had a policy and procedures in relation to the treatment of related party transactions (RPT policy), ARM’s procedures, systems and controls in relation to related party transactions were inadequate in that ARM failed to:

  1. take reasonable steps to manage the increased risk of the occurrence of related party transactions given ARM’s structure and PT’s director relationships;
  2. establish adequate management oversight and control over PT; and
  3. implement the RPT policy at both ARM and PT level.

The FCA made a number of comments, including:

  • Failure to obtain guidance from Sponsor – ARM failed to obtain the guidance of a Sponsor in  order to assess the application of the LRs and DTRs. As LR 8.2.3R states, a company must obtain the guidance of a Sponsor when it proposes to enter into any transaction which is or may be a related party transaction. ARM breached LR 8.2.3R both in relation to the related party transactions which were retrospectively identified as such by ARM’s financial advisers and in relation to those transactions which were retrospectively determined not to be related party transactions.
  • Inadequate implementation of  RPT policy – ARM should have been aware of the need to have a robust RPT policy from the outset of listing and to ensure that this was implemented within both ARM and PT. This was particularly important because PT is an Indonesian company with Indonesian senior management who were unfamiliar with UK listing requirements. The RPT policy required effective implementation but ARM’s implementation of its RPT policy was inadequate.
  • Director relationships – directors of both ARM and PT had senior management or board positions in other companies in Indonesia within the same industry with which PT might potentially enter into agreements, which made the likelihood of a related party transaction more acute. It should therefore have been understood at a senior level within ARM that the nature of the group created a high risk of related party transactions.
  • Management oversight of PT– management oversight of PT through representation on its board effectively did not happen until fifteen months after the requirement had been agreed by ARM and twenty one months after listing.
  • Lack of knowledge at PT – there was a lack of skill, knowledge and organisation within senior management at PT.
  • Related Party List – ARM’s RPT policy involved the maintenance of a comprehensive Related Party List, which set out ARM’s related parties. During the preparation of the AFR 2012, ARM became aware that the Related Party List was not complete as PT had not provided the necessary information. 
  • Committee met infrequently – prior to listing, the Board of ARM established a Conflicts Committee, whose duties included ensuring that any related party transaction entered into was, to the extent applicable, compliant with Chapter 11 of the LRs. However, the Conflicts Committee met infrequently and lacked disclosure from PT management.
  • Training sessions not attended by PT board – ARM prepared materials for a workshop for the directors and other senior management at PT to be held shortly prior to listing. It included training on the LRs, Listing Principle 2, financial reporting under DTR 4, related party transactions and the application of the class tests. However, the initial training sessions were not attended by certain key members of the PT board.
  • No training for other employees– ARM did not appear to have provided any training for employees of PT below director or senior management level in relation to the RPT policy.
  • Executive Committee (Exco) concerns not addressed quickly and effectively – the implementation of the RPT policy within PT was explicitly referenced as a “particular matter of concern” at the Exco meeting in July 2012. Specific potential related party transactions were discussed at subsequent meetings, however, the FCA considered that the expressed concern was not addressed sufficiently quickly and effectively.
  • Red flags – on a number of occasions, ARM was or should have been put on notice that its RPT policy was not effective. Red flags included recommendations from internal audit, external auditor enquiries and concerns, a retrospective related party transaction referral and a relevant Final Notice published by the FCA in relation to Exillon Energy plc. The Final Notice imposed a penalty for breaches of the LRs in relation to related party transactions and was circulated internally to senior management. Whilst the FCA considered that ARM took steps to improve its procedures in consequence, the FCA considered that these were not carried out sufficiently quickly and effectively and regarded this as an aggravating factor when determining the appropriate financial penalty.

Steps taken by ARM ARM took steps to address its failings in relation to its Listing Principle 2, LR and DTR obligations, including:

  • ARM made changes to the senior management and boards of ARM and PT and its subsidiaries;
  • ARM implemented a wide scale training programme at ATM and PT in relation to the RPT policy;
  • the oversight and control of the Conflicts Committee was strengthened;
  • the Exco was formalised to be more effective; and
  • ARM implemented and supported an improved culture within PT and its subsidiaries.

Financial Penalty

The amount that ARM was fined was linked by the FCA to the size of the relevant transactions. As ARM agreed to settle at an early stage it qualified for a 30% reduction in the financial penalty, reducing the financial penalty of £6,644,641 to £4,651,200.

Comment

The FCA’s decision serves as a reminder of the following:

  • Related party transaction policies must not only be well drafted but must also be well implemented and effectively maintained by management.
  • Regular training is key to ensure that all relevant individuals are aware of the how the company must comply with the LRs.  This is of particular importance in cases where a listed company has a subsidiary in a foreign jurisdiction where senior management is unfamiliar with the LRs.
  • Consideration should be given to maintaining a list of related parties, if practicable, although this is not required by the LRs. If this is a requirement of the company’s  RTP policy then a list must be maintained.
  • The guidance of a Sponsor is a requirement of the LRs when a proposed transaction is or may be a related party transaction.