Chris Horton Charles Mayo Jo Weston July 21 2015 Another failure by a listed company to maintain adequate systems and controls Simmons & Simmons LLP | Banking & Financial Services - United Kingdom Chris Horton, Charles Mayo, Jo Weston Banking & Financial Services IntroductionLarger fine for aggravated failingsFactsListing RulesFCA rulingIntroductionA listed holding company with insufficient control over a majority-owned foreign subsidiary (formed in and separately listed in Indonesia) was tripped up several times when that subsidiary entered into various related-party transactions without the listed holding company complying with the Listing Rules. The resulting fine imposed by the Financial Conduct Authority (FCA) – based on the value of the related-party transactions – enhances the trend in FCA enforcement actions for failure to comply with the systems and controls requirements in the Listing Principles (among other failures). These failings, and therefore the increased fine, have been treated as aggravated in light of previous enforcement action by the FCA against Exillon.The FCA has fined Asia Resource Minerals plc (formerly Bumi plc) (ARM) £4,651,200 (reduced from £6,644,641 for early settlement) for breaches of Listing Principle 2, Listing Rules 8.2.3R, 11.1.10R and 11.1.11R, and Disclosure and Transparency Rule 4.1.3R.ARM breached Listing Principle 2 by failing to take reasonable steps to establish and maintain adequate procedures, systems and controls for related-party transactions. These failures arose in circumstances where it was particularly important for ARM to have a robust related-party transaction policy due to the composition and nature of its group, which created a high risk of related-party transactions.Larger fine for aggravated failingsThis is a much larger fine than that imposed on Exillon Energy in 2012 for failing to have adequate procedures, systems and controls to enable it to comply with its related-party obligations. The larger fine appears to be due to the serious and systematic weaknesses in ARM's procedures and internal controls. The FCA also took into account, as an aggravating factor, the fact that ARM was aware of Exillon's enforcement notice and took steps to improve its related-party transaction procedures, but failed to carry them out sufficiently quickly and effectively.The case highlights, once again, that simply having a policy and procedures is not enough. The policy must be effectively implemented through proper training at both the holding company and subsidiary level.Systems and controls is clearly an area of focus for the FCA, as this is the fifth decision involving a breach of Listing Principle 2 (the others being Exillon Energy, Nestor Healthcare, Lamprell and Reckitt Benckiser).The non-compliant transactions which ARM admitted involved the subsidiary:making a loan with an interest rate below normal commercial terms;having a jet for use by the subsidiary's senior management mostly outside the ordinary course of business; andbuying a vessel with various related parties (which were associated with a non-executive director of ARM).The total value involved was $12.7 million (£8.054 million).The fine (before the early settlement reduction) of £4.651 million represents 75% of the value of these admitted related-party transactions plus 10% for aggravated failings. The fine is equivalent to 82.5% of the value of the related-party transactions admitted by ARM, before the early settlement reduction.FactsOn June 28 2011 ARM was listed on the premium segment of the Official List. It then had an 84.7% shareholding in an Indonesian-incorporated company, PT Berau Coal Energy Tbk (the subsidiary). Some ARM directors were nominated by founder shareholders of ARM. Certain directors of ARM and the subsidiary held board or senior management positions in companies in the same industry and other operations and financial interests in Indonesia with which the subsidiary could potentially enter into agreements.At listing, ARM had a related-party transaction policy designed to identify related-party transactions before ARM entered into them. Monitoring related-party transactions was a matter reserved for the ARM board (or a committee of it) and the board appointed a conflicts committee. Its duties included:establishing and maintaining a process for related parties and related-party transactions;ensuring that ARM was briefed on related-party issues; andwhere relevant, making recommendations to the board for authorisation of related-party transactions.However, the FCA notice identified various shortcomings in the implementation of the related-party transaction policy, including the following:The conflicts committee met infrequently;Training sessions on the policy were held, but key members of the subsidiary board failed to attend;Communication of the policy at the subsidiary level only took place several months after listing and the training was inadequate; andManagement oversight of the subsidiary through representation on its board effectively did not occur until March 2013.There was also an inadequate flow of information from the subsidiary to ARM until ARM became aware of alleged financial irregularities in its Indonesian operations.On September 24 2012 ARM announced that it had become aware of allegations concerning potential financial and other irregularities in its Indonesian operations.In October 2012 ARM commenced a review of the effectiveness of its internal controls, which included a review of related-party processes. As part of its preparation for the annual financial report for the year ending December 31 2012, it carried out a separate review of historic potential related-party transactions entered into by the subsidiary and investigated some transactions where the ultimate counterparty or beneficiary was unclear.On March 17 2013 ARM informed its advisers that it might have failed to comply with its obligations under the Listing Rules and Disclosure and Transparency Rules regarding related-party transactions.On April 19 2013 ARM notified the UK Listing Authority that it would be unable to publish its annual financial report while it continued to review certain items on the subsidiary's balance sheet, including a review of historic potential related-party transactions.On April 22 2013 ARM's shares were suspended.On May 31 2013 ARM published its financial results.On July 22 2013 ARM's shares returned to trading once ARM confirmed that it was in compliance with Listing Principles 2 and 4.In a letter dated May 23 2013, ARM's financial advisers notified the UK Listing Authority that three transactions (which had taken place between June 28 2011 and July 19 2013) were related-party transactions and that the rules had been breached.Listing RulesThe relevant provisions of the Listing Rules were those in force at June 28 2011:Listing Principle 2 requires a listed company to take reasonable steps to establish and maintain adequate procedures, systems and controls to comply with its obligations under the Listing Rules.Listing Rule 7.2.2G highlights areas on which the FCA thinks companies should place particular emphasis, including identifying any obligations under Listing Rule 11.Listing Rule 11 applies when a company with a premium listing of equity shares enters into a transaction with a related party. Under this rule, the company may have to send an explanatory circular to its shareholders, obtain shareholder approval and notify a regulatory information service of such a transaction.Listing Rule 11.1.11R requires transactions or arrangements to be entered into with the same related party (and any of its associates) during any 12-month period to be aggregated if the transaction or arrangement has not been approved by shareholders.Listing Rule 8.2.3R(2) requires a company with a premium listing of equity shares proposing to enter into a transaction which is or could be a related-party transaction to obtain the guidance of a sponsor to assess the potential application of the Listing Rules and the Disclosure and Transparency Rules.FCA rulingThe FCA ruled that there had been a breach of Listing Principle 2, as ARM had failed to:take reasonable steps to manage the increased risk of the occurrence of related-party transactions, given ARM's structure and its subsidiary director relationships;establish adequate management oversight and control over the subsidiary in a timely manner; andimplement the related-party transaction policy at both the ARM and subsidiary level.The FCA noted:"it is not sufficient to have well-drafted policies and committees with detailed terms of reference at a holding company level where those policies are not effectively communicated, implemented and monitored at subsidiary level, where the underlying business of the group is conducted."The FCA also concluded that ARM's breaches were particularly serious, given the number of red flags that should have put it on notice at an earlier stage that its related-party transaction policy was not being implemented effectively. These red flags included recommendations from its internal audit function and advice from its external auditors, which identified that limited or incomplete information was available in relation to certain transactions.The FCA also ruled that the following rules had been breached:Listing Rule 11.1.10R, as ARM failed to provide the FCA with written details of the admitted related-party transactions and written confirmation from an independent adviser that the terms of those transactions were fair and reasonable, and had not undertaken to include details of those transactions in its next published annual accounts;Listing Rule 11.1.11R, as ARM had failed to aggregate transactions which were with the same related party;Listing Rule 8.2.3R, as before entering into the various related-party transactions, ARM had failed to obtain guidance from a sponsor in order to assess the application of the Listing Rules and the Disclosure and Transparency Rules; andDisclosure and Transparency Rule 4.1.3R, as ARM had failed to publish its 2012 annual financial report within four months of the financial year end.For further information on this topic please contact Chris Horton, Charles Mayo or Jo Weston at Simmons & Simmons LLP by telephone (+44 20 7628 2020) or email ([email protected], [email protected] or [email protected]). 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