CFOs face increased liability risk
Being a CFO has traditionally been regarded as a top- end job. But changes in legislation mean that CFOs now face personal liability under the Companies Act, significantly decreasing the attractiveness of the job. RISKSA examines the issues.
The Companies Act of 2008, the Consumer Protection Act and the Protection of Personal Information Bill have all raised the bar for chief financial officers in that the risk of personal litigation against company directors and officers is more prevalent than ever before.
The Companies Act, which now governs all corporate entities in South Africa, adopts a stakeholder approach as opposed to a shareholder approach, with the term ‘ stakeholder’ now encompassing a much wider group including, among others, employees, creditors and the environment.
One of the key issues raised by the new act is that of director liability and the perception that directors now have greater personal liability. “The new Companies Act has, to a large extent, decriminalised transgressions, but it has also codified the old common- law duties of directors,” says Larey van der Westhuizen, managing director of Statucor, the company secretarial and corporate governance arm of the BDO Group.
“Their duty is now towards the company, with most of their liabilities being for losses that the company has suffered. The new act has also introduced solvency and liquidity tests as a replacement for the old capital maintenance rule.”
Van der Westhuizen says there is a need to determine who is a prescribed officer in an organisation. This is a new term introduced by the act, which applies to people who are in executive positions, but who are not directors, yet have the same duties and liabilities as directors.
Increase in reported fraud
According to the third KPMG Fraud Barometer study, South Africa has the highest number of reported fraud cases on the African continent. The study shows that there has been an increase in the number of fraud cases being reported.
“In South Africa, foreign investors and South African companies investing on the African continent are increasingly conscious of multinational and national anti- fraud
legislation. They understand that not playing by the rules can have a significant impact on market capitalisation and are therefore more accountable when it comes to fraud and corruption,” says Petrus Marais, KPMG’s global leader of forensics.
“We also see a number of enforcement agencies, such as the National Prosecuting Authority of South Africa, working hard to bring perpetrators to justice. Prosecution is increasing but still remains low compared to reported cases. We do note improvement, but also understand that it may take more time.”
Tertia Barrett, head of sales and marketing at CQS Technology Holdings, says fraud is not limited to larger corporations but has also mushroomed in smaller companies. “The Companies Act changed the requirements stating which companies need to be audited. So, smaller companies no longer need to be audited. Although this move was intended to reduce the cost of doing business in South Africa, it has opened the door for fraudulent activity,” she says.
“A chief financial officer ( CFO) can now be held personally liable for fraud because he signs off on all financial statements. So, it’s a catch 22 situation – not all companies need to be audited and the CFO now risks personal liability,” Barrett explains.
Barrett says accountancy training is still too basic with insufficient focus on internal auditing and fraud prevention tactics. The South African Institute of Chartered Accountants ( SAICA) has stepped in to provide training. “Reducing the risk of fraud outweighs the cost of the training,” Barrett says.
Regulation and compliance a concern
Research by accounting firm, Ernst and Young, shows that the percentage of board members with a finance background has increased significantly over the past 12 years.
In 2002, for example, just eight per cent of board members at some of the world’s largest companies were either current or former
CFOs. By 2012, that figure had climbed to 12 per cent. In 2002, just 19 per cent of audit committee chairs were experienced CFOs. By 2012, this had risen to 41 per cent.
One of the main reasons for the change is changing regulatory requirements in different countries. Graham Stockoe, Ernst and Young’s Africa Private Equity leader, says: “For CFOs of African companies, we expect more focus on regulation and compliance as this area rapidly evolves with continued focus on how the CFO and their financial team can add value to investment professionals and the firm’s portfolio companies. However, Ernst and Young found that 45 per cent of CFOs across the world put regulation and compliance at the top of their list of concerns for 2014. They ( CFO) also said the increased regulatory demands had put a strain on their firms’ resources and had limited their ability to focus on key priorities. As a result of regulatory changes, 83 per cent of CFOs expect to see an increase in costs.
Are CCs on the way out?
The act raises the question whether there is any benefit in keeping close corporations ( CC). “I don’t think there is any benefit in keeping CCs and my advice would be to convert them to private companies,” Van der Westhuizen says. “The same rules apply to both, but in a CC all members have the liabilities of a director; it is not possible to be an owner in a CC without also being regarded as involved in management. A company provides that opportunity by separating shareholders from directors. Also, a CC always has 100 per cent of interest issued, and the only way to acquire an interest in an established CC is by acquiring it from an existing member. A company can issue more shares and raise capital by doing so.”
On the subject of the Memorandum of Incorporation, Van der Westhuizen explained the importance of preparing this correctly. “This is effectively the document in which a company tailor- makes the corporate governance principles and rules that will apply to them by altering the default terms of the act capable of amendment. In doing so a company makes use of the opportunities and benefits provided by the new act ensuring that it suits their specific needs. It is essential that this document is precise and that it includes the correct terminology to avoid problems down the line.”
Barrett says purpose- written software can provide a solution. “Software with a built- in audit trail and drill- down functionality can allow a CFO to interrogate every figure on a financial statement,” she says. Liability insurance can indemnify directors and officers against claims
for which they are legally liable, as a result of an innocent act, omission or error in judgment. This type of insurance can cover CFOs’ costs in the following instances: Civil or criminal defence costs Legal representation expenses
• A written demand ( whether or not for monetary compensation)
• A formal administrative or regulatory proceeding or an arbitration proceeding
• Misrepresentation or mismanagement
• Breach of fiduciary duty
• Unfair trade practices
• Consumer protection contraventions
• Breach of franchise agreements
• Copyright, patent or trademark infringement
• Wrongful interference with a contract
• Arbitration services incurred in attempting to resolve a dispute that could potentially give rise to a claim.