UK Court Finds Shareholder Was Prejudiced by Inadequate Accounting for Executive Compensation

A shareholder was unfairly prejudiced within the meaning of the UK Companies Act by the failure of a company’s financial statement to adequately disclose executive compensation. Although the UK High Court of Justice found that there was no deliberate plan to conceal the truth from the shareholder, it was readily understandable that the improper accounting should cause her to lose all confidence in the competence and integrity of the board of directors. Any conscientious director should have questioned the company’s auditor about the omission of any mention of certain payments in the accounts, said the court. Moreover, the fact that the shareholder could have questioned the accounting at the annual meeting was not determinative, held the court, since transparency demands that the unvarnished truth be revealed by the financial statements, and not hidden and left to the shareholder to ask questions at a shareholders' meeting, still less to engage the services of a forensic accountant. (In re Sunrise Radio Limited, UK EWHC, 2893, Nov. 13, 2009.)

But the court rejected the claim that a general lack of transparency in the financial statements was unfairly prejudicial to the shareholder, noting that the real problem was that the company’s accounts were unconsolidated, so that the real picture of what was happening in the group could only be ascertained by looking at all the accounts of the subsidiaries. Apart from the inadequate disclosure of directors' remuneration, said the court, the accounts were properly prepared.

The company was not required to file consolidated accounts at the time, as that requirement did not apply either to small or medium sized groups. Thus, the absence of the full picture in the accounts was attributable to the legislature, reasoned the court, and not to any wrongful conduct on the part of those responsible for the accounts in question.

The court found that certain aspects of compensation were hidden among "administrative expenses". The court agreed with the conclusion of the shareholder’s accountancy expert that the directors had adopted a very careless attitude to their responsibilities. While it would be wrong to expect individual directors to be on top of the detail of the accounting requirements of successive Companies Acts and allied regulations, said the court, it is their duty to read the accounts carefully before approval them and query anything that strikes them as odd, or questionable.

Any conscientious director should have noticed the omission of any mention of certain payments in the accounts, said the court, and should have observed the contrast with the remainder of the directors' remuneration, and the disclosure in previous years of charges by related parties. It followed that a conscientious director would have queried why there was nothing about the relevant charges in the accounts, especially as the disclosed directors' remuneration was much lower in consequence.

The obvious person to raise the query with was the company’s auditor, noted the court, who was ``clearly embarrassed’’ when the deficiencies in the accounts were drawn to his attention, and did not seek to defend the accounting treatment. Had any director raised a query with the auditor at the time, emphasized the court, it is inconceivable that the accounts would have gone out in the form in which they did, with no note at all revealing the payments.

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