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AIM - Corporate Governance lite?

1st November 2005

Speech to New York British Consultate

So what is corporate governance?

In the ten years since AIM was launched the development of corporate governance in the UK and the US has been rapid albeit sometimes reactive in nature following the financial scandals of the late 1980's and 1990's. In both the US and UK successive administrations have evolved their corporate governance regimes in varying ways, but ultimately with the aim of entrenching the principles of transparency, accountability, fairness and responsibility among its listed companies.

However, as corporate governance best practice increasingly spreads from its Anglo-American roots, so it has become a more difficult concept to define. The Organisation for Economic Co-operation and Development, which has developed its own international corporate governance standards, provides a definition of the term:

"Corporate governance involves a set of relationships between a company's management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and means of attaining those objectives."

Indeed, even between the US and the UK, there have been differences of approach. The introduction of the Sarbanes-Oxley Act in the US undertakes a strict prescriptive approach which differs from the "comply or explain" approach of the UK's Combined Code, which applies corporate governance principles to companies listed on the UK's primary market, the London Stock Exchange.

Significantly the Combined Code does not apply to AIM companies and AIM, as a market predominantly for small and mid-cap companies, therefore benefits from a more flexible and adaptable corporate governance regime. In light therefore of the cost implications to companies subject to the Combined Code and certainly SOX, AIM is becoming increasingly attractive to companies in the UK and across the corporate world.In practice however, there are certain corporate governance requirements which apply to all UK companies, I shall briefly review these before I go on to discuss the wider informal role of corporate governance in relation to AIM companies. Finally I shall touch on the future of corporate governance in a wider international context.

Existing statutory and regulatory corporate governance requirements

  • Statute - and in particular the Companies Act 1985 provides for English companies to adopt a wide range of governance requirements, by way of example:
    - Memorandum and Articles of Association: every company is obliged to have a memorandum and a set of articles of association which comprise the company's constitution of documents. The memorandum is concerned with the company's relationship with and dealings with outsiders, whereas the articles govern the internal workings of the company.
    - Dismissal and appointment of directors: directors can be appointed by a resolution of the company's members or the board and removed by a members' resolution.
    - Holding of general meetings and shareholder resolutions.
  • AIM rules: The Alternative Investment Market does have its own set of rules that contain a number of continuing obligations for companies whose securities are traded. These include announcements relating to changes in a company's financial position, sphere of activity and business performance as well as company and director transactions and interests and the preparation of a half yearly report and annual accounts. Recent changes now mean that cash shells face stricter entry requirements for listing and retaining listing on AIM.
  • Model Code: The Model Code forms part of the AIM Rules and the Continuing Obligations to which AIM listed companies are subject. It imposes restrictions on directors, senior managers and certain employees dealing in securities of a listed company beyond those imposed by the Companies Act.

Existing non-statutory corporate governance for AIM Companies

In the UK, non-statutory corporate governance is driven by the Combined Code, a set of main and supporting principles and provisions of good corporate governance. A company listed on the main London Stock Exchange is required by the listing rules of the Financial Services Authority to make a disclosure statement in relation to the Combined Code in its Annual Report and Accounts.

The current Combined Code evolved from the work of various parliamentary committees and reports on corporate governance. The original Combined Code was published in 1998 and updated in 2003 and 2005.

Despite not having to comply with the Combined Code, AIM companies will normally include a statement relating to corporate governance in its admission document. In the Pathfinder Prospectus of a company admitted to AIM in August 2005, one typical example, this time for a cash shell, stated as follows:

"The Board is committed to maintaining high standards of corporate governance and, insofar as is practicable given the company's size and nature, compliance with the Combined Code.The Company has adopted the Share Dealing Code for the directors and will take steps to ensure compliance by the directors with the terms of this Code.The directors will implement such corporate governance procedures and establish such committees of the Board as will be required, including audit and remuneration committees, for it to comply with the terms of the Combined Code upon completion of the first significant acquisition by the Company, insofar as is appropriate for a company of its size.

The directors have established financial controls and reporting procedures which are considered appropriate given the size and structure of the Company. These controls will be reviewed in light of significant acquisitions and adjusted accordingly".

A cynic could say that this language means nothing and justifies the health warning that on appears on the front of all AIM circulars - however, this could also be seen as a reflection of the adaptability of the AIM market - which can cater for the entrepreneurial company that wants to avoid excessive regulation in its early stages and build up its corporate governance as it develops.

The QCA Guidelines

The Combined Code, however, does not apply to companies quoted on AIM and there is no formal alternative for the 3,016 companies listed on the UK's secondary market. To fill this void, in July 2005, and in recognition of both the growing market capitalisation of AIM companies and the desire of institutions to invest in AIM companies, the Quoted Companies Alliance (QCA) - the representative body for small and mid-cap quoted companies (formerly known as Cisco) - published its first corporate governance guidelines for AIM companies.

The QCA guidelines include a Code of Best Practice and some relatively straightforward principles which are intended set a minimum standard as well as recommendations for AIM companies to report corporate governance matters.

The Guidelines provide that:

  • as with the Combined Code, the roles of Chairman and CEO should not be held by the same person - if they are, however, the Board should provide clear explanations of the procedure which would protect against potential concentrations of power;
  • a company should have at least two independent non-executive directors (one of these can be the Chairman) which is less onerous than the Combined Code's requirement for a majority of independent non-executive directors;
  • the Board should be provided with the appropriate information in order to discharge its duties;
  • all directors should be submitted to re-election at regular intervals subject to continued satisfactory performance - which is not onerous for UK companies that have mandatory re-election by members every three years in any event;
  • on an annual basis, internal controls are to be reviewed - these reviews concern material controls including financial, operational, compliance controls and risk management systems;
  • there should be a formal schedule of matters reserved for the Board;
  • companies should establish audit, remuneration and nomination committees with the Audit and Remuneration Committee, each requiring a minimum of two members who should be independent, non-executive directors; and
  • there should be dialogue with shareholders to establish a mutual understanding of the Company's objectives.

The Guidelines also address the reporting of corporate governance matters and makes recommendations that AIM companies:

  • should publish a Corporate Governance Statement every year stating its good governance practice on its website or in its Annual Report and Accounts;
  • should describe in this statement how it is adhering to each of the QCA Guidelines or if the Company is not complying with the Guidelines, then it should explain how "good governance" procedures and standards are being achieved over and above the basic QCA guidelines; and
  • should include in its company reports basic disclosures such as a statement of board operations and the identity of its directors.

It is important to emphasise that this is a voluntary code and it will be interesting to see to what extent it is followed by AIM companies over the coming months and to what extent the institutions expect compliance.

So how does corporate governance impact on small to mid cap companies?

The establishment of the Sarbanes-Oxley Act in 2002 provided a prescriptive regulatory system that makes no distinction between a billion dollar large-cap company and a small-cap company. This some would argue is making it more difficult for smaller companies to compete and grow in the regulatory environment in the United States.

Neal Wolkoff, Chairman and CEO of the American Stock Exchange, voiced his concerns in this regard in August of this year in a Wall Street journal article, stating that:

"A regulatory system that discourages such companies from participating in public markets is of vital concern for our Exchange and our listed companies".In the same article Mr Wolkoff went on to say that smaller companies have argued that the costs of compliance have outweighed their benefits. The problem with SOX has been that corporate governance is ultimately driven by the dominance of institutional investors, whose presence is not generally found in small-cap and micro-cap stocks where ownership emanates from entrepreneurs who founded the companies, their families and public shareholders.

The SEC has taken steps to address the issues of Section 404 by creating an Advisory Committee to examine the impact of SOX and other laws on smaller companies, but the reality following Mr Wolkoff's survey of Amex-listed CEO's was that auditing costs have trebled or even quadrupled. One CEO surveyed even said that they could no longer retain the services of one of the big four auditing firms as those "four" were concentrating on larger companies. Amex has seen more than a dozen small companies de-list from the Exchange and deregister their securities because of the high costs of compliance. Compare this with the recent growth of AIM where in the first six months of 2005, the market experienced 320 new admissions - the same as the total number of companies floated in 2001 and 2002 combined - raising a total of

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