The European Commission has proposed forcing companies to disclose all financing done off the books as part of a four-point initiative to prevent accounting scandals such as the recent bankruptcy of Parmalat.

Under the new rules, publicly traded companies would have to provide full information about off-balance sheet arrangements, such as securities sales made through trusts. Certain financial instruments can involve special purpose entities located offshore that are not captured in the balance sheet.

The proposal also wants to establish that board members are collectively responsible for financial statements and key non-financial information. and that unlisted companies’ transactions with related parties should become more transparent.

Finally, the Commission proposes to make listed companies issue an annual corporate governance statement. The proposals are part of the Commission’s Company Law Action Plan, published in May 2003.

The broad objective of this push towards tighter corporate governance is to ease investor fears after major accounting discrepancies at Parmalat, the Italian foodmaker and also Dutch retailer Royal Ahold.

“Recent financial scandals show that investors and the public need more protection against cheats,” said internal market commissioner Frits Bolkestein. “Today's proposal will build confidence in EU capital markets and reduce malpractice.”

Investigations into alleged fraud at Parmalat, which has food operations around the world, began after the revelation in December 2003 of a €3.95 billion hole in the company accounts. Parmalat said it had the money temporarily marooned in the Cayman Islands, since deemed by a US bank to be non-existent.

It was discovered that the Italian food giant, which had operations on over 30 countries and employed over 35,000 staff, had used special-purpose entities to keep debt off of the books or make it look like equity.

At the end of the year the company was declared insolvent with debts of over €14 billion and its founder and former chief Calisto Tanzi arrested in a criminal probe into the billions of euros of missing money.

In order to prevent this from ever happening again, the EC proposals would establish that board members of limited companies are collectively responsible for financial and other key information that they publish. In addition, Member States must have appropriate sanctions and liability rules where board members do not comply with accounting rules.

For listed companies, disclosure requirements on transactions with all related parties such as family members and company managers already exist under International Accounting Standards (IAS). The proposed amendments would extend these to unlisted companies, though the amendments would apply only to significant transactions with related parties not carried out under normal commercial conditions.

Member States would be able to exempt small unlisted companies.

The Commission’s fundamental argument is that companies that perform well tend to be well-governed. It argues that investors need transparency on corporate governance to make informed investment decisions.

But the Commission has its work cut out. According to a Bloomberg news agency report, a survey conducted by consultant firm Hallvarsson & Hallvarsson reveals that more than half of Italy's biggest companies still don't give investors enough financial information on their corporate Web sites.

If the commission's proposal, which needs approval by EU governments and the European Parliament, is to achieve greater transparency across the 25-nation bloc, then it must overhaul this culture of sloppy corporate financial governance.

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