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Commercial Question

OFR and Acceptance

updated on 28 February 2006

Question

What does the abolition of the Operating and Financial Review (OFR) mean for companies?

Answer

Just eight months after introducing a requirement for all quoted companies (ie, companies whose shares are not traded on AIM or OFEX) to prepare and publish an Operating and Financial Review (OFR), Chancellor Gordon Brown announced that the requirement to publish an OFR would be abolished. This was part of the government's drive to reverse the effects of "gold plating" of EU regulations (ie, the implementation of regulations in a more onerous or heavy-handed manner than actually required). Abolition of those parts of the Companies Act 1985 that contained the obligation on companies to prepare an OFR took effect on 12 January 2006.

Announcement of the abolition received a great deal of publicity. However, in the accompanying fanfare, little mention was made of the fact that quoted companies are still required to include a 'business review' as part of the Directors' Report in order to comply with the minimum requirements of the EU Modernisation Directive. The directive will apply to all quoted companies and larger businesses (those with a turnover in excess of £22.8 million) from 1 April 2006. Certain provisions are relaxed for medium-sized companies, while small companies are exempt from the requirements.

The idea behind the requirement to produce an OFR was to provide an analysis of (i) the development and performance of a business during the relevant financial year and its position at the end of that year, and (ii) the main trends and factors underlying its current and future development, performance and position. Essentially, the OFR was an enhanced and more prescriptive version of the business review.

This means that although the gold-plating elements of the OFR have been abolished, certain requirements remain. In essence, the business review must be a balanced and comprehensive analysis of the development and performance of a company during, and of its position at the end of, the relevant financial year. It must be prepared on a basis that is consistent with the size and complexity of the business.

In order to provide readers of the business review with a clear understanding of the development, performance or position of the company's business, the business review must also include an analysis using key financial performance indicators and, where appropriate, analysis using other key performance indicators (ie, factors that can be used to measure effectively the development, performance or position of the company). These factors may include information relating to environmental and employee matters.

A Directors' Report must now also contain a description of the principal risks and uncertainties facing the company, and the company's auditors must also state in their report whether, in their opinion, the information given in the report for the relevant financial year is consistent with the relevant accounts.

The Financial Reporting Council (the UK independent regulator for corporate reporting and governance) remains of the view that preparation of an OFR should be best practice for quoted companies. However, as the OFR is no longer mandatory, the Accounting Standards Board withdrew Reporting Standard 1 and, on 26 January 2006, replaced it with a Reporting Statement on Operating and Financial Reviews, representing a best practice guide for quoted companies and all other companies producing a document equivalent to an OFR. The board has confirmed that it is keen for all quoted companies to produce an OFR on a voluntary basis.

Abolition of the OFR has also impacted on the Company Law Reform Bill. The government has subsequently invited views from interested parties on considerations to be taken into account by ministers in framing amendments to the bill to ensure that the relevant legislative requirements will lead to effective narrative reporting.

It is possible that rather than reducing the burden of reporting on companies, abolition of the OFR has in fact increased it. As the nature of their obligations appears to have become more subjective, directors and companies remain uncertain as to the extent of their obligations under the business review. The consultation invited on the bill may produce further guidance and clarification but, in the meantime, the situation is far from clear. The difficulty for directors is that failure to comply with the requirements relating to the preparation of the business review is a criminal offence that could result in a criminal conviction and the imposition of a fine.

Justine Howard is a professional support lawyer in the Corporate Department at Pinsent Masons.