Crunch costs
The credit crunch is likely to result in more regulation and increased litigation.
After the crisis, comes the litigation – and the regulation. The financial turmoil of 2008 will lead to tougher regulatory action, and a wave of law suits, this year, as governments and market authorities try to plug the gaps exposed by the market meltdown, and investors try to get at least some of their money back.
Life is going to get tougher from the boardroom down, with experts saying financial companies will come under tougher scrutiny across their operations: from the way the business is governed, to the way it archives its email.
Starting with the tone at the top, the depth of the current global economic crisis, and the fact that governments around the world have had to step in and use taxpayers’ money to limit the damage, has made corporate governance an incendiary issue. “The public, investors, shareholders and regulators will no longer tolerate corporate governance failures in 2009,” says Peter Giblin, visiting professor of corporate governance at CASS Business School, London, and president of Integrity Europe, a corporate governance advisory firm.
“Whereas a few years ago a company could ride out a corporate governance scandal, now the impact could be potentially catastrophic, with many companies going into administration. Tougher and more detailed regulations will be introduced, resulting in an inevitable increase in scrutiny,” Mr Giblin predicts. “In 2009 we will see a trend towards all senior management being judged more aggressively on their knowledge of and adherence to proper corporate governance standards and statutes.”
“Another area that will continue to grow in importance is the accountability of companies in monitoring the entire supply-chain. No longer will it be acceptable to plead ignorance to corporate governance failures at any point in the supply chain, for example, whether it be knowledge of the supplier of raw materials in Asia, the vendor of your product or the final customer’s intended use of the product.”
Regulation everywhere
Executive remuneration is one area where more regulation is likely, says Mr Giblin, pointing to growing pressure in the UK and Europe for companies to link rewards more closely to executive behaviour. Activist shareholders are already organising pay revolts, with large votes against remuneration policies likely at some companies. In the UK, City minister Lord Myners has said investors were too soft on pay and benefits before the credit crunch. Corporate governance lobby group PIRC has been calling on investors to vote down “excessive” remuneration at several businesses.
“I have no hesitation in calling the developing situation a regulatory minefield – and this is not an exaggeration,” says Neil Gerrard, head of the regulatory and litigation practice at DLA Piper. “We are operating in an unprecedented time of financial pressures and market volatility and the authorities are more determined than ever that everyone will play by the rules.”
For the financial sector, Simon Rawling, group managing director of London-based management consultancy PIPC, says the credit crisis has exposed global regulatory problems that need global solutions. “The last 12-months have proved that we lack any sort of joined-up global governance or regulatory structure,” he argues. “All we’ve seen to date is knee-jerk reactions from corporates to effectively shut-up shop” – by not lending to each other.
Mr Rawling predicts regulatory action on information and record storage, operational risk, and general corporate governance. “However, what we’re yet to understand, and what is needed more than ever before, is a set of compliance and regulation initiatives that are integrated across governments to effectively manage risk across global economies and global businesses,” he says.
Such a framework could emerge this year, and will be on the agenda when the G-20 leading nations meet in London in April. US and European banking chiefs are already working behind the scenes with central bankers and regulators to hammer out what that framework should look like. A private January meeting organised by the Bank for International Settlements was attended by banking luminaries such as Morgan Stanley chief executive John Mack, Citigroup chairman Sir Win Bischoff and Crédit Suisse chief Brady Dougan. Clearly, the finance industry is desperate to get its views across now, fearing that left to their own devices the G-20 diplomats will come up with something that they believe to be too onerous.
Reserving liquidity
The Basel Committee for Banking Supervision, which sets world banking regulations and measures of banks’ capital, has already indicated that it plans to changes its rules, forcing banks to hold a greater proportion of capital reserves in future, and to make higher provisions against bad debts. It also wants banks to hold more liquidity reserves.
Looking more widely, one trend to watch this year will be the extent to which new regulations and governance requirements directed at the financial sector spill over to affect general corporates. In the UK, for example, the Financial Reporting Council has cautioned against post-crunch changes to the Combined Code on Corporate Governance because they would apply to all listed companies, not just financial ones. FRC Chief Executive Paul Boyle used a recent speech to argue that the regulatory focus should be on whether financial firms had observed the existing standards, rather than whether those standards needed to change.
While organisations watch anxiously to see whether the credit crunch will hit them with a further wave regulation, 2009 is a year in which many will finally get to grips with reforms aimed at fixing the last international financial scandal: the raft of corporate fraud and accounting scams that were exposed in 2002 and 2003, such as Enron, WorldCom, Parmalat and Ahold.
In Europe, for example, the combined EuroSox directives will finally start to take effect in 2009. This set of regulations brings together disparate directives already in place and harmonises them: the aim is to build trust in European auditing, financial reporting and corporate governance. Among the big changes: companies have to disclose their risk management activities in their annual report, including the principle elements of their risk management and internal control systems, and describe their approach to corporate governance. Management is also legally responsible for making sure that financial statements provide a “true picture” of the company’s situation.
“EuroSox places greater demand on an enterprise’s financial reporting – meaning more information must be stored, tracked, modelled and made available to relevant authorities as and when required,” says Lynn Collier, Solutions Director at Hitachi Data Systems. “The strain on the business will not only be the additional information being stored but also making sure it is secure and easily accessible so it can be reported on and audited as and when necessary.”
In Japan, listed companies will face their national version of such reforms in 2009, as J-Sox (the tag used to describe the country’s Financial Institution and Exchange Laws) takes hold. These regulations require the same sort of internal controls over financial reporting as the US Sarbanes-Oxley Act. Practice Standards set by the Japanese Business Accounting Council require companies to produce an audited assessment and report on their internal control over financial reporting. The rules apply to all Japanese public companies – and their overseas affiliates – from April 2008 and many are still in a rush to comply with and then embed the requirements. “Much of the impact in terms of effort to get compliant has been completed, but the integration of control to make it efficient as well as effective is still in progress in many organisations,” says ISACA International President Lynn Lawton.
Regulation isn’t always driven by crisis: in 2009, companies will also have to respond to significant compliance challenges that have been in the pipeline for a while. In Europe, insurers will have to monitor the developing Solvency II accord and 2009 will see the introduction of the EU’s controversial data retention directive for telecommunications and internet companies. In India, the government is introducing a new Companies Act in 2009, aimed at bringing the country’s business law and corporate governance rules up to international standards. In Hong Kong, important changes to the stock market’s listing rules took effect on January 1.
More regulation will not be the only consequence of the turmoil – litigation is expected to increase rapidly. “As the credit crunch bites all the chickens will come home to roost,” says Professor Alan Riley of The City Law School, London. “Flawed business models which may look fine in climbing markets are exposed in harsher economic times, and as a result all sides head to the courts or arbitrators.”
Ready to litigate
In the US, investors filed 210 federal securities class-action lawsuits in 2008, up 19 percent from 176 in 2007, according to figures compiled by Stanford Law School and Cornerstone Research. The total amount claimed was $856bn, up 27 percent from 2007 and the highest in six years. Nearly half of the year’s litigation was connected with investors’ losses from the credit meltdown. The Stanford figures show that a third of the finance companies in the Standard & Poor’s 500 index are targeted in new lawsuits. A record 12 complaints claim losses of $5bn or more.
“Given the financial crisis, litigation is, for some, an increasingly necessary option and all companies need to be prepared in order to meet obligations in terms of data disclosure,” says Tracey Stretton, legal consultant at Kroll Ontrack. “The next wave of litigation, which we’re likely to see a lot of in this year, is likely to be securities litigation – everyone is waiting for this ‘credit crunch litigation’.” Ms Stretton pointed to a policy shift in Europe away from public enforcement (such as formal investigations launched by bodies such as the European Commission) towards private enforcement, where parties sue each other for redress. There may therefore be an increase in anti-trust litigation as more follow on actions post-investigation and private stand-alone actions may be launched in future, she added.
One issue that will be under the spotlight is electronic communications and the electronic storage of information (ESI), such as emails and documents, Ms Stretton predicts. “The issues surrounding ESI have assumed a higher priority on the business agenda as the financial crisis threatens to trigger legal actions. With litigation and the amount of electronic data requested in discovery on the rise, and coupled with tightening corporate budgets and regulation, corporations cannot afford an ESI misstep,” she says.
Of course, all this regulatory activity will take place against a backdrop of global economic recession, when management would rather focus on corporate survival than corporate compliance. Just staying in business will be the biggest challenge many organisations face over the next twelve months.
After the crisis, comes the litigation – and the regulation. The financial turmoil of 2008 will lead to tougher regulatory action, and a wave of law suits, this year, as governments and market authorities try to plug the gaps exposed by the market meltdown, and investors try to get at least some of their money back.
Life is going to get tougher from the boardroom down, with experts saying financial companies will come under tougher scrutiny across their operations: from the way the business is governed, to the way it archives its email.
Starting with the tone at the top, the depth of the current global economic crisis, and the fact that governments around the world have had to step in and use taxpayers’ money to limit the damage, has made corporate governance an incendiary issue. “The public, investors, shareholders and regulators will no longer tolerate corporate governance failures in 2009,” says Peter Giblin, visiting professor of corporate governance at CASS Business School, London, and president of Integrity Europe, a corporate governance advisory firm.
“Whereas a few years ago a company could ride out a corporate governance scandal, now the impact could be potentially catastrophic, with many companies going into administration. Tougher and more detailed regulations will be introduced, resulting in an inevitable increase in scrutiny,” Mr Giblin predicts. “In 2009 we will see a trend towards all senior management being judged more aggressively on their knowledge of and adherence to proper corporate governance standards and statutes.”
“Another area that will continue to grow in importance is the accountability of companies in monitoring the entire supply-chain. No longer will it be acceptable to plead ignorance to corporate governance failures at any point in the supply chain, for example, whether it be knowledge of the supplier of raw materials in Asia, the vendor of your product or the final customer’s intended use of the product.”
Regulation everywhere
Executive remuneration is one area where more regulation is likely, says Mr Giblin, pointing to growing pressure in the UK and Europe for companies to link rewards more closely to executive behaviour. Activist shareholders are already organising pay revolts, with large votes against remuneration policies likely at some companies. In the UK, City minister Lord Myners has said investors were too soft on pay and benefits before the credit crunch. Corporate governance lobby group PIRC has been calling on investors to vote down “excessive” remuneration at several businesses.
“I have no hesitation in calling the developing situation a regulatory minefield – and this is not an exaggeration,” says Neil Gerrard, head of the regulatory and litigation practice at DLA Piper. “We are operating in an unprecedented time of financial pressures and market volatility and the authorities are more determined than ever that everyone will play by the rules.”
For the financial sector, Simon Rawling, group managing director of London-based management consultancy PIPC, says the credit crisis has exposed global regulatory problems that need global solutions. “The last 12-months have proved that we lack any sort of joined-up global governance or regulatory structure,” he argues. “All we’ve seen to date is knee-jerk reactions from corporates to effectively shut-up shop” – by not lending to each other.
Mr Rawling predicts regulatory action on information and record storage, operational risk, and general corporate governance. “However, what we’re yet to understand, and what is needed more than ever before, is a set of compliance and regulation initiatives that are integrated across governments to effectively manage risk across global economies and global businesses,” he says.
Such a framework could emerge this year, and will be on the agenda when the G-20 leading nations meet in London in April. US and European banking chiefs are already working behind the scenes with central bankers and regulators to hammer out what that framework should look like. A private January meeting organised by the Bank for International Settlements was attended by banking luminaries such as Morgan Stanley chief executive John Mack, Citigroup chairman Sir Win Bischoff and Crédit Suisse chief Brady Dougan. Clearly, the finance industry is desperate to get its views across now, fearing that left to their own devices the G-20 diplomats will come up with something that they believe to be too onerous.
Reserving liquidity
The Basel Committee for Banking Supervision, which sets world banking regulations and measures of banks’ capital, has already indicated that it plans to changes its rules, forcing banks to hold a greater proportion of capital reserves in future, and to make higher provisions against bad debts. It also wants banks to hold more liquidity reserves.
Looking more widely, one trend to watch this year will be the extent to which new regulations and governance requirements directed at the financial sector spill over to affect general corporates. In the UK, for example, the Financial Reporting Council has cautioned against post-crunch changes to the Combined Code on Corporate Governance because they would apply to all listed companies, not just financial ones. FRC Chief Executive Paul Boyle used a recent speech to argue that the regulatory focus should be on whether financial firms had observed the existing standards, rather than whether those standards needed to change.
While organisations watch anxiously to see whether the credit crunch will hit them with a further wave regulation, 2009 is a year in which many will finally get to grips with reforms aimed at fixing the last international financial scandal: the raft of corporate fraud and accounting scams that were exposed in 2002 and 2003, such as Enron, WorldCom, Parmalat and Ahold.
In Europe, for example, the combined EuroSox directives will finally start to take effect in 2009. This set of regulations brings together disparate directives already in place and harmonises them: the aim is to build trust in European auditing, financial reporting and corporate governance. Among the big changes: companies have to disclose their risk management activities in their annual report, including the principle elements of their risk management and internal control systems, and describe their approach to corporate governance. Management is also legally responsible for making sure that financial statements provide a “true picture” of the company’s situation.
“EuroSox places greater demand on an enterprise’s financial reporting – meaning more information must be stored, tracked, modelled and made available to relevant authorities as and when required,” says Lynn Collier, Solutions Director at Hitachi Data Systems. “The strain on the business will not only be the additional information being stored but also making sure it is secure and easily accessible so it can be reported on and audited as and when necessary.”
In Japan, listed companies will face their national version of such reforms in 2009, as J-Sox (the tag used to describe the country’s Financial Institution and Exchange Laws) takes hold. These regulations require the same sort of internal controls over financial reporting as the US Sarbanes-Oxley Act. Practice Standards set by the Japanese Business Accounting Council require companies to produce an audited assessment and report on their internal control over financial reporting. The rules apply to all Japanese public companies – and their overseas affiliates – from April 2008 and many are still in a rush to comply with and then embed the requirements. “Much of the impact in terms of effort to get compliant has been completed, but the integration of control to make it efficient as well as effective is still in progress in many organisations,” says ISACA International President Lynn Lawton.
Regulation isn’t always driven by crisis: in 2009, companies will also have to respond to significant compliance challenges that have been in the pipeline for a while. In Europe, insurers will have to monitor the developing Solvency II accord and 2009 will see the introduction of the EU’s controversial data retention directive for telecommunications and internet companies. In India, the government is introducing a new Companies Act in 2009, aimed at bringing the country’s business law and corporate governance rules up to international standards. In Hong Kong, important changes to the stock market’s listing rules took effect on January 1.
More regulation will not be the only consequence of the turmoil – litigation is expected to increase rapidly. “As the credit crunch bites all the chickens will come home to roost,” says Professor Alan Riley of The City Law School, London. “Flawed business models which may look fine in climbing markets are exposed in harsher economic times, and as a result all sides head to the courts or arbitrators.”
Ready to litigate
In the US, investors filed 210 federal securities class-action lawsuits in 2008, up 19 percent from 176 in 2007, according to figures compiled by Stanford Law School and Cornerstone Research. The total amount claimed was $856bn, up 27 percent from 2007 and the highest in six years. Nearly half of the year’s litigation was connected with investors’ losses from the credit meltdown. The Stanford figures show that a third of the finance companies in the Standard & Poor’s 500 index are targeted in new lawsuits. A record 12 complaints claim losses of $5bn or more.
“Given the financial crisis, litigation is, for some, an increasingly necessary option and all companies need to be prepared in order to meet obligations in terms of data disclosure,” says Tracey Stretton, legal consultant at Kroll Ontrack. “The next wave of litigation, which we’re likely to see a lot of in this year, is likely to be securities litigation – everyone is waiting for this ‘credit crunch litigation’.” Ms Stretton pointed to a policy shift in Europe away from public enforcement (such as formal investigations launched by bodies such as the European Commission) towards private enforcement, where parties sue each other for redress. There may therefore be an increase in anti-trust litigation as more follow on actions post-investigation and private stand-alone actions may be launched in future, she added.
One issue that will be under the spotlight is electronic communications and the electronic storage of information (ESI), such as emails and documents, Ms Stretton predicts. “The issues surrounding ESI have assumed a higher priority on the business agenda as the financial crisis threatens to trigger legal actions. With litigation and the amount of electronic data requested in discovery on the rise, and coupled with tightening corporate budgets and regulation, corporations cannot afford an ESI misstep,” she says.
Of course, all this regulatory activity will take place against a backdrop of global economic recession, when management would rather focus on corporate survival than corporate compliance. Just staying in business will be the biggest challenge many organisations face over the next twelve months.
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