CNV3-I1-9-Intellectual Property

The most technology-based businesses have their valuable corporate and commercial assets in IP. Today the value of a business is no longer determined by physical stock and assets they have been in the past, but rather by the value, management, effective control and extent of the commercial exploitation of its IP assets. The governance of IP presents new challenges for directors of the corporations. IP assets may do more than just affect the financial strength of a corporation; they may determine it. As per data sources for many modern technology-based companies IP may constitute more than 70 per cent of its saleable assets.

Good Governance[1] is the optimum state of the governance that maximises the social goods, whose characteristics include legitimacy, transparency, accountability, responsiveness, efficiency participation, integrity and justice etc. However, in corporate governance guidelines for companies, the term ‘Intellectual Property’ does not feature. But it is perhaps the single most important and valuable aspect of any technology company. The mismanagement of IP assets creates massive commercial risks for shareholders and directors alike. In instances where a company does not have the luxury of having an expert IP counsel on board, it is imperative that the directors are guided by the expert advice of outside IP counsel. Important IP considerations such as transfer pricing, exchange control regulations, appropriate valuations and IP due diligence are often not addressed properly before commercial transactions are entered into. IP laws differ from country to country. Corporate governance needs to respond to society’s rising expectations of directors and boards as the impact of the global intellectual property ecosystem is felt. The question is, how can a responsible corporate culture of IP transparency be stimulated to connect corporate communication with the desires of all stakeholders?

Today the lack of true and fair[2] information in companies annual reports about their IP assets makes it difficult for shareholders and other stakeholders to assess directors’ stewardship of those assets and this is an important corporate governance issue today. Hence, IP reporting in alignment with the key corporate governance principles of transparency and disclosure is a must.

IP rights are complex intangible legally recognised exclusive rights that play an integral role in modern corporate value creation. An important question that more and more stakeholders are asking is whether the accounting treatment of intangibles under current accounting standards provides a ‘true and fair view’ of a company’s financial position. The inter-relationship between corporate governance, IP assets and traditional financial accounts will be of interest to those in civil, common law and other international jurisdictions where IP rights are growing as an asset class. It is a fact that the traditional financial reporting system is ill-equipped to deal with IP. The balance sheet is often unable to adequately capture internally-generated IPs, which is regarded as an off-balance sheet and therefore invisible to stakeholders. Hence, accountants must comply with the International Accounting Standard (IAS) 38 for intangibles.

There are a few concerns about IP reporting. The first one is the key patents in early-stage are treated as an off-balance sheet asset that may later have to be disclosed in an annual report when they expire due to the detrimental impact on profitability. Secondly, depreciation of IP assets, which conversely often increase in value over time. The third one is the difficulty in re-valuing IP assets under the accounting standards. The IP information gap is problematic from a corporate governance point of view as shareholders’ needs for corporate IP asset information is not being met. As a result, corporate disclosure of more relevant, accurate and timely information regarding a company’s patents, trademarks, copyright and other IP rights is needed to separate intangible’s financial data through cross verification with corporate disclosure.

In good corporate governance, the company should include IP value story in connection with the company’s business strategy to provide the basis for a standard analysis. This is the first step in assessing whether the company’s directors are managing the IP assets in the interest of the company. Although companies required to do so publish annual reports that are richer in content wherein important IP information remains clearly distinguishable. The Association of Chartered Certified Accountants (ACCA), the global body for professional accountants, having surveyed 500 annual report users in three common law jurisdictions (the UK, USA and Canada) maintains that investors are the foremost audience of the annual report and that their needs must be placed at the heart of future developments in corporate reporting.

Good corporate governance requires additional narrative disclosure of ‘true and fair’ IP information to supplement the traditional financial accounts. The lack of IP asset transparency across companies, (small and large), negatively impacts lenders and financiers, who rely on accounts and annual reports to evaluate the creditworthiness of the company. As such the company valuation is heavily influenced by norms in the relevant business sector e.g. IT, fashion etc. because the balance sheet is only really useful for companies that have a trading history. In addition to narrative IP value story, increasing and improving the use of ‘notes’ to the accounts would assist to provide relevantly IP asset information and support innovation.

Hence, it makes sense that Finance Directors become better integrated into R&D, IP and business strategy. It is crucial for the Finance Director to identify and record IP assets, even if they are off-balance sheet items, as they will undoubtedly become more important and valuable to the enterprise as it matures. To ensure the integrity of the accounts, the financial value of IP assets should be traced back to the day the company came into existence to counteract the negative impact of off-balance sheet IP assets.

It known that traditional financial accounts on their own, struggle to provide a true and fair view of an IP-rich enterprise. In terms of future corporate governance and accounting policy, company directors should consider recording off-balance sheet early-stage IP asset financial information from the date of incorporation to ensure traceability and integrity of financial accounting information which is, currently not a requirement of IAS 38. These records support the contextual narrative IP asset information to provide a true and a fair view of the financial position of an enterprise.

Corporate governance also means protecting your technology and information[3]. Not a day passes without news of a data breach or cyber-attack on a company’s operations or a nation’s critical information infrastructure. Indeed, data security and operational risk are the top two concerns of public company directors according to the 2012 Law. Disaster recovery, e-discovery and company reputation also rank high among top issues keeping directors up at night. Directors’ duty of care includes protecting technology and information. In an effort to fulfil the duty of care to protect these vital assets, some boards have formed committees focusing on protection and strategic use of intellectual property and technology. Very few of these committees, however, specifically address the risks associated with data and the need to keep it secure.

The emergence of IP rich companies is the new corporate governance challenge[4]. This is because IP is largely invisible, not only in the financial accounts but also more generally in corporate law theory and the legal framework.  In the modern era, all companies, large and small, have intellectual property (IP) rights, sometimes across multiple jurisdictions.  They are corporate IP owners.  At the same time, the shift to intangibles and IP assets as the major driver of value in business in today’s competitive business environment.

Key corporate governance principles of transparency and disclosure are being more rigorously applied to corporate ownership of monopolistic IP rights that protect innovation and creativity.  In the US, SEC disclosure law Regulation S-K requires disclosure of the importance, duration and effect of all patents, trademarks, licences, franchises and concessions that a company holds.  IP rich companies need to ensure they reflect on disclosure and transparency rules and take into account the growing magnitude of their corporate intangibles, IP assets and IP business models that potentially generate future wealth for their shareholders and potential investors.

In 2017 the UK implemented the EU Non-Financial Disclosure Directive, which requires large and listed companies to include additional disclosures of non-financial information (like IP) in their annual reports, similar to the disclosure requirements in the Strategic Report.  These new company law requirements potentially increase the reporting of non-financial information, better business and IP strategy reporting through the mandatory requirement to report the company’s business model.

In conclusion, IP rights have evolved over the years to add significantly to corporate value and hence corporate governance needs to respond to society’s rising expectations of directors and boards.  Companies need to tell us how their corporate investment in IP generation and exploitation contributes to the bottom line of the company. The regulators need to ensure boards of directors are accountable for IP management and strategy decisions, an important underside of the intangible economy.