SPA AJIBADE & CO., Lagos, NIGERIA.
Audit Committee Chair - FRCN v Shareholders
-Debo Ogunmuyiwa1 and Yilji Dimka2 Corporate Finance & Capital Market July 28th 2016.
__________________________________________________________________ Introduction The Financial Reporting Council of Nigeriai (FRCN) recently issued rules which were made public on 15th March 2016. Specifically, rule 2(c) of the FRCN rules made pursuant to sections 7, 8, 30, 41, 42 and 44 of the FRCN Act No. 6 of 2011 is currently causing some disquiet amongst various shareholder groups and stakeholders. The rule relates to the qualifications of the person that can be appointed to chair the statutory audit committees of public companies and attest to annual reports, financial statements, accounts, financial report, returns and other documents of a financial nature in a public company. The rule prescribes that an individual must be a professional member of an accounting body established by an Act of the National Assembly in Nigeria before he may be appointed to chair an audit committee. Essentially, the intent of this rule imposes additional requirements to the position of an audit committee chairman over that provided under the Companies and Allied Matters Act 1990ii (CAMA), which currently allows a wider class of persons to occupy the position. The FRCN released the new rules in line with its powers to issue rules and guidelines for the purpose of implementing auditing and accounting standards.
1 Senior Associate, Corporate Finance & Capital Markets, SPA Ajibade & Co., Lagos, Nigeria. 2 Associate, Corporate Finance & Capital Markets, SPA Ajibade & Co., Lagos, Nigeria.
Further to this rule, the Nigerian Stock Exchange (NSE) released a circulariii which discusses the transitional concessions agreed with the FRCN in relation to the implementation of the rule.
Rule 2 of the FRCN rules provides that:
"a) Any professional providing assurance or certifying any part of an annual report, financial statements, accounts, financial report, returns and other documents of a financial nature, shall certify by indicating his or her name and FRC registration number;
b) Where such expert opinion, expressed by a professional, impacts on the financial report or return and/or is disclosed as a note in the annual report, financial report, accounts, returns and other document of a financial nature, the name of the professional, professional firm/entity and the FRC registration number of the person and firm vouching the integrity shall be disclosed in the note;
c) Any person attesting, as Chairman of Audit Committee, to annual report, financial statements, accounts, financial report, returns and other documents of a financial nature, shall be a professional member of an accounting body established by Act of the National Assembly in Nigeria" (emphasis supplied).
Implication of the Rule
The new rule 2(c) provides that a person must be a member of a certified professional accounting body in the Nigeria in order to qualify for an appointment as the chairman of an audit committee. Therefore, only a chartered accountant or any other individual who is a professional member of a recognised accounting body in Nigeria may chair the audit committee. By necessary implication, the individual must be a member of either the Institute of Chartered Accountants of Nigeria (ICAN), the Association of National Accountants of Nigeria (ANAN) or the Institute of Finance & Control of Nigeria (IFCN).
The rules also state that certifications that do not comply with the Council's pronouncement shall render the financial statements misleading. Non-compliance results in liability as provided for under the FRCN Act and FRC Guidelines/Regulations for Inspection and Monitoring of Reporting Entities 2014. In the event of non-compliance, the FRCN Act in its sections 64 and 65 provides that a notice shall be served on the company and the person preparing such financial statements and the company shall be required to restate and resubmit its financial statements to the FRCN and to any government department or authority requiring such statement and convene a general meeting on the restated financial statements within sixty (60) days. A failure to comply with the prescribed statement of accounting and financial reporting standards developed by the Council is an offence with a liability on conviction to a fine not exceeding N10,000,000.00 or an imprisonment for a term not exceeding 2 years or both. Also, the company will be required to restate the financial statement within thirty (30) days.iv
In the case of a public interest entity which fails to comply with the notice to restate financial statements within 60 daysv, it will be liable, on conviction to a fine not exceeding N20, 000,000.00 and be required to restate the said financial statements within 30 days thereafter.
In order to provide companies with ample time to comply with the rule, the FRCN and NSE have made a concessionary arrangement which exempts sitting chairmen of audit committees from complying with the requirement. This concession is however available for the current financial year only and it is only available to entities or their subsidiaries that are currently not involved in any litigation against the FRCN, and/or where neither of its directors have been suspended by the FRCN.
The audit committee is one of a number of statutory committees required to be constituted by a public company. Its functions inter alia include ascertaining whether the accounting and reporting policies of the company are in accordance with legal and ethical requirements, review of the scope and planning of audit requirements; make recommendations on the appointment, removal and
remuneration of the external auditors and authorizing internal investigations by the internal auditors.vi
Various shareholder groups have kicked against the rule requiring the chairman of the audit committee of a public company to be a member of an accounting body, citing a number of reasons. The arguments in favour and against the rule are highlighted below.
Firstly, CAMA the principal legislation relating to the formation and activities of companies is silent on the qualifications to be held by a person to be appointed as a chairman of an audit committee except such a person is disqualified under the provisions of CAMA. By virtue of the provisions of section 359 (4) of CAMA, the audit committee shall consist of an equal number of directors and representatives of shareholders subject to a maximum of six members who shall examine the auditor's report and make recommendations thereon at the annual general meeting. CAMA only sets out the procedure through which a member of the committee is to be appointed, providing that any member may nominate a shareholder as a member of the audit committee by giving notice in writing of such nomination to the secretary, at least twenty-one days prior to the annual general meeting.vii Shareholder groups insist that under the provisions of CAMA, a shareholder need not possess any accounting qualification to sit as chairman of audit committee, as is now required by the FRCN rule, arguing further that no such requirement was attached as a pre-condition to purchase shares.
The Securities and Exchange Commission's (SEC) Code of Corporate Governance for Public Companies ("SEC Corporate Governance Code") also makes prescriptions relating to the composition of the audit committee. The SEC's Code of Corporate Governanance is applicable to all public companies and compliance with its provisions is mandatory.viii It requires at least one member of the committee to be "financially literate."ix All other members of the committee are required to have basic financial literacy and should be able to read financial statements. At least one member is expected to have knowledge of accounting or financial management.x In the event that it becomes necessary, the committee may obtain external professional advice.xi Essentially, all that is required by SEC's Corporate Governance Code is that members of the audit committee should be able to read
and understand basic financial statements, and should be capable of making valuable contributions to the committee.
Secondly, it may also be argued that the rule which is a subsidiary legislation contravenes the provisions of CAMA and that the rule being made pursuant to legislation, i.e. FRCN Act, may not be used to amend the provisions of a primary legislation (CAMA). Although a subsidiary legislation when validly made has effect and force as the principal or enabling Act (see Trade Bank Plc v Lagos Island Local Government Council),xii it is well established that subsidiary legislations are inferior to and may be repealed by a primary legislation. A subsidiary legislation must keep within the bounds of the authority conferred by the enabling statute and any abuse of that power will render the legislation void [see A. G. Bendel State v A. G. Federation & 22 Ors.].xiii By necessary implication, this newly prescribed rule of the FRCN is susceptible to being pronounced void if found to be ultra vires the powers of the FRCN.
On the other hand, it may be argued that by virtue of the wide rule making powersxiv granted to the FRCN by the FRCN Act, it is within its rights to make and implement the rule. FRCN as a body is equally set up by an Act of the National Assembly. Several of its provisions also grant it powers to make rules and regulations relating to financial reporting in Nigeria. Therefore, it may be safe to argue that such rules made by the FRCN should stand.
As noted above, whether or not a rule issued by the FRCN may override earlier statues which are not in consonance is clearly settled. In the current instance however, questions may be raised as to whether the new rule in actual fact contradicts the provisions of CAMA. A contrary argument may be advanced that new rule merely builds upon the requirements as set out in CAMA. However, and as stated above, a subsidiary legislation must keep within the bounds of the authority conferred by the enabling statute in order to survive a challenge to its validity. (see Barclays Bank of Nig. v Ashiru).xv
Thirdly, it may also be argued that the rule seeks to impose a certain class of persons on companies by requiring that the statutory audit committees are chaired by accountants. It is arguable that such an imposition is in contravention of the constitutional right of freedom of associationxvi as it imposes an unanticipated
obligation on shareholders who did not contemplate membership of an accounting body at the time of purchasing shares in a company. Typically, non-executive directors are nominated to the board by shareholders whose interests they represent. It is usually the case that the chair of an audit committee is a nonexecutive director. The shareholders of a company should be able to freely appoint the type and caliber of persons they wish to appoint to the board. The requirement that such persons must come from a particular profession may be viewed as a fetter on such freedoms.
Again this argument may easily be countered based on the fact that the chairmanship of an audit committee is not the first position within a public company which a relevant regulator restricts to a certain class of professionals. The role of the Company Secretary in a private or public company is reserved for members of the Institute of Chartered Secretaries, legal practitioners, members of the Institute of Chartered Accountants or persons who have held the office of the secretary of a public company for at least three of the five years preceding appointment in the public company. In the same vein, this requirement may be justified on the ground that the function of chairing an audit committee in a public company should be left to professionals that are best suited to effectively discharge the function.
Furthermore, another rationale in support of the rule is that it was issued in furtherance of a need to protect the interest of the public, hence its applicability to public companies only. The dispersed ownership of public companies puts it in the public realm thereby bringing about the need for effective regulation of its management in the financial reporting process. The rule is said to ensure that the audit process is overseen by competent persons, who are expected to improve the quality of the financial reporting process. Thus the rule could be seen as protecting the interests of shareholders.
Another criticism against this policy is that it would put undue burden on public companies to secure one or more professional members of an accounting body on their audit committees. This will take up time in sourcing for suitable candidates, and resources in hiring and retaining such candidates. Statutory committees are constituted by shareholders, executive directors, non-executive directors and
independent directors. Where neither of these is a professional member of an accounting body, these concerns will surface.
Again advocates of experience argue that the measure blindly adopts the need for a certification without taking into consideration the individuals' competence, character and personality, citing examples of individuals who are not members of an accounting body but have the requisite skill and experience to effectively chair the audit committee. This argument though plausible can be countered as the same may be said for various professions. A certification provides the basis upon which an individual may be said to have acquired certain knowledge and skill set. This at least raises a presumption that the individual in question is sufficiently knowledgeable in the relevant field with any further experience acquired only seen as an addition.
CAMA prescribes that the auditors' report which is to be laid before the members of the company at a general meeting is to be made to an audit committee established by a company.xvii The audit committee is to be composed of an equal number of directors and representatives of shareholders, subject to a maximum of six members who shall be responsible for examining the auditor's report and making recommendations to the annual general meeting. Members of an audit committee are not remunerated and are subject to re-election annually.xviii
It is interesting to note that the Exposure draft of the National Code of Corporate Governance by the FRCN for the private sector, released in January 2016 mirrors the provisions of the CAMA on the issue save for the requirement for every public company to constitute a board audit committee in addition to the statutory audit committee.xix The draft however does not require the chairperson of the audit committee to be a qualified accountant as set out in the new circular issued by the FRCN. It simply requires that all members of the committee be financially literate and be able to read and interpret financial statements. It also requires that at least one member is to be an expert and have current knowledge in accounting and financial management.
With respect to the chairmanship of the board committee, the draft simply requires that the chairman of the board committee must be a non-executive director. In the
case of the statutory board committee, the chairperson is to be a non-executive director or an independent shareholder.
It would have been tidier if the FRCN had ensured the inclusion of the provisions of rule 2C in the proposed National Code of Corporate Governance, thereby embedding the requirement in the proposed National Code and forestalling future claims for interpretation of the relevant rules as to applicability.
Be that as it may, it appears that the FRCN merely sought to improve the quality of the financial reporting process by issuing the rule. Thus, it is expected that persons entrusted or saddled with the responsibility of chairing audit committees should naturally be financially literate and well-versed in accounting in order to ensure a standard of quality through the audit process.
The importance of accounting and the audit process to any going concern cannot be overemphasised. Corporate failures have been synonymous with weak corporate governance and accounting irregularities. The Enron scandal which led to the breakup of Arthur Andersen remains fresh in the memory of the corporate world. The 2008 financial crisis is also in some quarters blamed on the misapplication of accounting standards.xx Businesses run on numbers which must be accurately recorded to ensure that a factual picture of the true state of affairs of the business is presented. Strong corporate governance culture in an organisation encourages success and business sustainability by ensuring that adequate checks and balances are put in place. It therefore follows that persons saddled with the responsibility of effecting audit functions are capable of doing so by virtue of their expertise and experience and in view of the fundamental nature of that role.
Wherever the pendulum in support of or against the qualification prescription by the newly introduced rule swings, the level of public discontent with the rule suggests that a challenge could be made in due course before a court of law, where a pronouncement would be made on the legality or otherwise of the rule.
For further information on this topic please contact Yilji Dimka or Debo Ogunmuyiwa at S. P. A. Ajibade & Co. by telephone (+234 1 472 9890), fax (+234 1 4605092) or email (email@example.com) or (firstname.lastname@example.org).
i The Financial Reporting Council is an agency established by the Financial Reporting Council Act 2011 to succeed the Nigerian Accounting Standards Board. It is a federal government Parastatal under the supervision of the Federal Ministry of Industry, Trade and Investment, responsible for, among other things, developing and publishing accounting and financial reporting standards to be observed in the preparation of financial statements of public entities in Nigeria; and for related matters. ii Companies and Allied Matters Act Cap C21 Laws of the Federation 2004. iii The Nigerian Stock Exchange circular titled "Transitional Concessions Agreed between the Nigerian Stock Exchange and the Financial Reporting Council of Nigeria of Nigeria regarding Rules 1 & 2 of the FRC's Rules", reference no: NSE/LARD/LRD/CIR5/16/30/29. iv Section 65 (1) (3) Financial Reporting Council Act No. 6 of 2011. v Section 65(2) the Financial Reporting Council Act No. 6 of 2011. vi Section 359 (3) Companies and Allied Matters Act Cap C 21, Laws of the Federation, 2004. vii Section 359 (5) Companies and Allied Matters Act Cap C 21, Laws of the Federation, 2004. viii Following an amendment to the SEC Code of Corporate Governance 2003 on 12th May 2014, compliance with its provisions is now mandatory. ix Article 30(1) SEC Code of Corporate Governance 2003. x Article 30(2) SEC Code of Corporate Governance 2003. xi Article 30(3) SEC Code of Corporate Governance 2003. xii  3 NWLR (pt. 806) 11 p. 27. xiii  3 NCLR 1 S.C. xiv Section 8(2), 30 & 53(2) of the Financial Reporting Council Act No. 6 of 2011 grant the FRCN wide powers to make and issue rules, procedures and policies and guidelines in furtherance of its mandate. xv  6 7 S.C 99. xvi Section 40 Constitution of the Federal Republic of Nigeria. xvii Section 359 (3) Companies and Allied Matters Act Cap C 21, Laws of the Federation, 2004.
xviii Section 359 (4) Companies and Allied Matters Act Cap C 21, Laws of the Federation, 2004 xix See, paragraph 8.14.2 of the exposure draft of the FRCN, Private Sector National Code of Corporate Governance 2016 xx The Role of Accounting in the Financial Crises by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday, March 2, 2012 last accessed at https://corpgov.law.harvard.edu/2012/03/02/the-role-of-accounting-in-thefinancial-crisis/ on 4th May 2014.