§ 3.6 p.m.
§ Lord Brennan
rose to call attention to recent corporate failures and to the case for regulatory and other action to maintain public confidence in business and accountancy; and to move for Papers.
1356 The noble Lord said: My Lords, the heart of this debate is the human vice of greed. The levels of greed in the corporate sector have led to very severe hardship for ordinary people and to the loss of jobs, savings, homes and pensions. Such excesses in the corporate system can and should be dealt with by regulatory or other action.
What is the nature of the problem? Enron collapsed in probably the greatest corporate failure of our times leaving debt of 60 billion US dollars. It has put paid to one of the big five accounting firms employing more than 200,000 people world-wide. It is not an understatement to say that this is a seminal moment in the history of modern capitalism.
In the 1980s and 1990s we moved from an historical approach to business, where corporate effort was directed at firm structures, a steady hand on the tiller and a reasonable interest—but not obsessive interest—in profit. As we came towards the end of the century, we entered an era where the sole objective of much of business was ever-increasing annual profit. That difference in the ethos of business is the real explanation for the disaster of Enron.
This profit mania was worked under the rubric of shareholder value. The very objectives of decent shareholders—to make a reasonable return on their investment—became the millstone that the corporate structure in the case of Enron hung around its neck. It is simply impossible, year by year, evermore to increase your profit regardless of the world around you. But, by the turn of the century, many thought otherwise. Such a belief leads to failure. Enron was that failure.
It is not only an American failure. ICI has lost more than £400 million; Andersens employs 6,000 to 7,000 people in this country. The international ramifications of what has happened are very serious indeed. Asked by me, a friend in the financial world tried to explain what has happened in human terms in this way.
The executive, imbued with market fever, intent on making ever greater profits, becomes addicted to the task. The addiction is fed, perfectly reasonably, by the banks, which expect a return on their investment, and in this case the accountant—the "GP", who is there regularly to check on the presence or absence of serious symptoms—completely missed the problem, or chose not to diagnose it. So, in the end, the community—the "family", the "relatives" in the metaphor of the addict—entirely without expecting it, with no preparation at all, find that the addict has exploited his money and theirs to satisfy his addiction. So the problem can be translated into community terms. That is the aspect about which I propose to speak.
The first, and obvious, question to ask in this House is: could such a thing happen in our country? I regret to say that it already has. Within the last year or two, an independent insurance company collapsed in a sector of the financial world which is supposed to be the most heavily regulated in auditing terms. In response to the question, "Could it happen here?", Sir 1357 Howard Davies, chairman of the Financial Services Authority, in an article in the Guardian on 2nd February, frankly stated:The only honest answer is yes".How could it happen here? The Government, very sensibly, are intent on investigating, having set up in February a review of the role of auditors and an investigation of the independence and effectiveness of non-executive directors, helped as they will he by the new Financial Accounting Foundation, the independent regulator for accountants.
If it could happen here, how can we reform corporate systems in an attempt to ensure that it does not happen; and, if it does, that the impact is reduced to the bare minimum? I turn to the issue of company systems. Cadbury in 1992, Greenbury in 1995, Hampel in 1998, and the Government in 2002 have all investigated the same basic question: how can we make companies work honestly and fairly in the interests of the community?
I shall not anticipate many of your Lordships' contributions to the debate, but here are some of the obvious topics for debate. The audit committees of a company must be made to work. Off balance sheet accounting, the absence of employee share options and their value in accounts, the deep complexity of derivatives not fully explained, and an inconsistent treatment of revenue are all obvious factors which an audit committee could, and should, examine, along with company auditors.
Secondly, if it is felt that local authorities should have their auditors independently appointed by the Audit Commission—as now happens throughout the country—is it not reasonable that some similar system should operate in the private sector? I put the proposition forward. If it is wrong, I eagerly await the reasons why; but I hope that the concept behind it will not be ignored by those who seek to deal with this. The intent is that the auditing function can be separated from executive influence by the company.
I am pleased to note that Sir Howard Davies has set in progress this year several schemes or reviews to assist better control of company systems. There is already a very strict control of the auditors of financial institutions under the FSA. They propose to review their listing rules and I imagine that, in due course, they will establish appropriate disclosure rules, especially for the complexities of accounting which I have described. Above all, in company systems, let us ensure that the concept which I now understand to be commonly used in the City of "financial engineering" is never just that step ahead of the law, the regulator and the tax system.
If companies are to be audited, how can we make the auditors more effective in what they should do? Under our present statutory system, they are a watchdog for investors only in the sense that they determine, vis-à-vis the company and themselves, whether they can issue an auditing certificate of good accounting. But they have no separate duty, no separate obligation to individual shareholders, creditors or employees. That is a serious deficiency in the system.
1358 What should happen with auditors and the companies that they audit? Is it acceptable that you audit on Monday as an independent accountant and advise the company on Tuesday, as an accountant to that company, on its investment strategy? Most ordinary people would conclude that the conflict of interest is so obvious that it could hardly occur in the business world—and yet it does.
What should we think about the rotation of auditors? What should we think about auditors leaving their accounting firm to become a consultant or employee of a company, and their previous accounting firm continuing as the auditors? I invite the House to note with particular care the following stark reality. Out of the 250,000 accountants that we presently have—ever-increasing, always present in times past—no firm of auditors of any size has ever detected a corporate failure of any size by its auditing activity. That is simply amazing.
If we are to have effective auditors, the key principle upon which they must act in the future is surely the interests of the community affected by the affairs of the company that they are auditing, and not the interests of the company with which they are dealing.
Lastly, and most importantly, if such problems continue to occur—and human nature makes it inevitable—how can we seek to influence those in corporate life better to appreciate, and more enthusiastically to seek to avoid, the damage that they can cause to the community by their activities if reasonable activity descends, or ascends as the case may be, to excess? The answer to my rhetorical question must be better corporate governance, with responsible corporate behaviour in the community.
I put forward three propositions. Every company should be ethically governed and act responsibly towards the community in which it operates, whether nationally or internationally. We are not hidebound by a company law system created in the 19th century that treated the only relevant relationship as that between a company, its shareholders and its auditors. We have gone far beyond that in our multinational world.
The second proposition is to have the International Accounting Standards Board and its American counterpart seek to reach agreement.
Thirdly, many companies seek to act responsibly. I endorse their efforts and hope that feature will evermore be present in our national corporate life.
Milton Friedman, with remarkable and unacceptable candour, once answered a question about the basis of business thus: "What kind of society is not structured on greed?" I answer, not my kind of society. I adopt the wisdom of Lord Weinstock when in charge of the General Electric Company. He observed that profit was not a target but a residual—the end result of doing the right things in the right way. That is the expectation that we should have as a society of corporate activity serving the community. My Lords, I beg to move for Papers.
§ 3.21 p.m.
§ Lord Freeman
My Lords, I am sure the House is grateful to the noble Lord, Lord Brennan, for raising this issue. I congratulate him on his success in bringing it to your Lordships' attention. I declare an interest as a member of audit committees of a number of companies and a former partner, now consultant, of PricewaterhouseCoopers.
I wish to address my remarks to the responsibilities of directors—in particular, members of the audit committees of boards—in ensuring proper financial control and regulation of the companies they serve in the interests not just of shareholders but of society as a whole. I agree with the noble Lord, Lord Brennan, when he identifies the importance of the role of directors and audit committees in particular.
On 27th February the Secretary of State for Trade and Industry, Patricia Hewitt, announced the setting up of an independent review of the role and effectiveness of non-executive directors in the United Kingdom. That review is important and has been a long time coming. I am sure that your Lordships welcome the Secretary of State's announcement and hope that she will name the chairman of the committee as soon as possible, so that it can get under way.
The Secretary of State said that the independent review will examine the role and effectiveness of non-executive directors in the UK and will report to the Chancellor of the Exchequer and to the Secretary of State. The review will consider in particular strengthening the UK framework for how companies operate. I take that to mean that the review will look at how best to prevent a collapse such as that of Enron happening in this country. Sir Howard Davies asked whether that might possibly happen. The answer is, yes it could. Is it likely to happen? We can take steps by legislating and following the initial work of the Cadbury committee in 1992 for ensuring best practice to make certain that such a collapse is unlikely to happen.
The term "non-executive director" is misleading and I hope that we shall stop using it in this country. It creates the impression that the so-called non-executive director is a second-class director of a company; that he or she has fewer responsibilities than other members of the board. That is not true. A non-executive director is as much a director as the chairman, executive chairman or chief executive officer.
The term "non-executive director" conjures up a comfortable perk—as it was sometimes known to be a decade or more ago. In today's world, that is not the case. In our largest companies, the role of the so-called non-executive director is arduous and needs to be defined more clearly. The days when ex-politicians—let alone ex-accountants or distinguished members of the Bar Council such as the noble Lord, Lord Brennan—could be expected to join companies easily in the role of a non-executive director have gone. It is a demanding job and there is a shortage of competent people willing to take on the responsibilities involved.
1360 I hope that the review will recommend increased training and guidance for all directors but particularly members of board audit committees. That follows the lines of the excellent Myners report of last year. Its recommendations concerning the pension fund industry and the role and responsibilities of trustees have been accepted by the Government.
I am grateful to Paul Myners for reminding me that a recent poll showed that one-third of pension fund trustees in this country were unclear whether a fall in interest rates meant that bond values rose or fell—a disturbing fact but true.
As to the key aspects of training that will help to improve the climate of financial regulation, directors—particularly those who are independent of full-time management—should ask the right questions at the appropriate time. Directors should have explained to them their responsibilities under corporate law and the fact that they have a direct responsibility to shareholders—as do auditors. I am sure that the noble Lord, Lord Brennan, did not mean to imply that auditors are accountable only to the management of a company. By statute law, they report to the members of a company—the shareholders.
I pay tribute to the Institute of Directors, the Confederation of British Industry, the Institute of Chartered Accountants in England of Wales and many others for the steps they have taken to improve the training of directors. But there is a long way to go.
When the Secretary of State made her announcement on 27th February, she expressed the hope that the review's focus would be primarily on improving best practice. I hope that the review will consider changing our statute law—specifically, the basis of operation of audit committees. An audit committee is a sub-committee of a board and has responsibility for dealing directly with the auditors and internal auditors of a company. It must also satisfy itself on behalf of the board that the audit is independent and that proper steps have been taken by the auditors to ensure that a fair picture of the company's results is presented.
The auditors look retrospectively, not prospectively, which is one reason for it not being surprising that it is difficult to find examples of auditors identifying the imminent or possible collapse of a company. Auditors often look at three, six or nine months of historical perspective—not into the future, which is the job of others.
We should encourage the independent committee to consider proposing in statute the responsibility of boards of directors, certainly of listed companies, to appoint a sub-committee—the audit committee—to discharge the responsibilities of financial regulation and oversight over the audit. That ought to be a statutory responsibility. At the moment, it is best practice. The code followed in recent years by listed companies in this country states that the annual report must include a statement if an audit committee has not been appointed. I believe that that should be a universal requirement.
1361 I believe that audit committees should have a majority of independent directors and a statutory right of independent access to the auditor of the company so that they can not only challenge but support the auditor when misgivings, wrongdoings or concerns are expressed or alleged.
I believe that the audit committee itself should have a responsibility to report in the company accounts directly to shareholders, and therefore directly to the wider community, about whether it is satisfied that the audit is independent. The noble Lord, Lord Brennan, drew attention to the fact that some auditors perform non-audit services and argued that that could in some ways impede independence because of the pressure that companies could bring to bear on the auditor. I believe that it should be the responsibility of the audit committee so to report. I also very much agree with the opinion of the Association of British Insurers, which has been circulated to some noble Lords, on that point.
We should be realistic in our expectations of boards of directors, audit committees, auditors and lawyers. We can, however, take steps in a future review of company law to place clearer and more specific responsibilities on audit committees.
§ Lord Brightman
My Lords, can the noble Lord tell the House when the office of non-executive director came into existence? When I took my examinations some 70 years ago, there was no such office as non-executive director.
§ Lord Freeman
My Lords, I very much agree with the thought that lies behind that intervention. The arrangement is not enshrined in company law, but it has become common currency to refer to directors who are not in full-time management as "non-executives". I believe that that is wrong and that it should cease.
§ 3.31 p.m.
§ Lord Sharman
My Lords, before beginning, I must first declare my interests. My business interests are as set out in the Register of Members' Interests, but my most relevant interest in relation to this topic is the fact that I am a former chairman of KPMG—one of the so-called big five—and continue as a paid adviser to that firm.
I must confess that I approach this Motion with a great deal of sadness. When I joined the accountancy profession 40 years ago, it was a profession held in high esteem. In those days, my girlfriends' mothers were quite keen on having a prospective chartered accountant as a son-in-law. That is not the case today; it is certainly not the case for Lady Sharman. Today, the accountancy profession faces the greatest crisis in its history. The reputation of Arthur Andersen, which has taken 90 years to build, lies in tatters, destroyed in 90 days. The indictment of a firm of accountants for obstructing the course of justice in the USA will, if sustained, leave a stain on the global accounting profession that will take many years to remove.
1362 As the noble Lord, Lord Brennan, said, the key factor in all this has been the collapse of Enron—the largest corporate failure in the history of the USA, if not the world, resulting in the loss of livelihood and pension for many thousands of people. I do not have the time to engage in a detailed analysis of how Enron developed, nor of how it failed. Suffice it to say that it was an unusual set of circumstances and that, as early as March 2001, Fortune magazine was pointing out the organisation's frailty. Clearly, however, it was a failure in corporate management—a house that is built on sand will not survive once the foundations start to move—which was compounded by a failure in corporate governance. Clearly the Enron board did not ask enough questions nor exercise enough control over the management.
Noble Lords who have sufficient time to look at Enron's financial statements—about six weeks should do—will see buried in the notes all sorts of disclosures. Although the situation could by no stretch of the imagination be said to have been hidden, it was very difficult to interpret. That was made possible by an auditing failure. At a minimum, the circumstances leading to the massive restatement of reported earnings, in late 2001, should have been identified and prevented. I believe that that was all made possible by poor regulation and inadequate accounting rules. This series of failures was compounded by what is alleged to be the wholesale destruction of evidence—the shredding—by the auditors, the very people who are supposed to be, as the noble Lord, Lord Brennan, said, the watchdogs. They are supposed to be the ones who exemplify independence, objectivity and probity. It is therefore little wonder that public confidence in them has taken a knock.
It is very convenient to remind ourselves that all this happened in the USA. However, that begs a question to which, as the noble Lord, Lord Brennan, said, Sir Howard Davies has given an honest answer: "Yes, it could happen here". There are, however, two key factors in the Enron affair that I do not think could he present here. First, our approach to accounting principles is highly beneficial, entailing principles based on substance rather than mere form and detailed rules. When one devises a set of rules, the first thing that others do is start spending a lot of time figuring out how to get round those rules.
The second factor—a key one in Enron's collapse—is companies' use of their own shares as security for borrowings and to fund their retirement programmes. The use of own shares as debt security is relatively uncommon in the USA, but it is almost unknown in this country. Moreover, in the United Kingdom, the use of own shares to fund retirement programmes is of course controlled by the MFR—minimum funding requirement—and is limited to 5 per cent of any pension plan.
As I said, however, let us make no mistake about the situation. When the Financial Times calls in a leader, as it did on 13th March 2002, for the potential "Fat Four"—a new term for your Lordships—to spin off their consultancy businesses and to be banned from doing non-audit work for audit clients, we have a deep 1363 crisis in public confidence. The issue is what we should be doing about it. Management is the first point. I know of no process other than good training to make incompetent management competent. I also know of no means other than counselling to make corrupt management not corrupt. So we have to rely on governance.
Many have said that the UK's corporate governance system, as it has developed, is thorough and should be seen as a role model for the rest of the world. I join those who have said that we probably have about reached the overdose level on corporate governance reviews—from Cadbury, through Hampel and Greenbury, to Turnbull. However, I agree with the noble Lord, Lord Freeman, that we really do have to examine the issue of the so-called non-executive director. We have to consider how many such appointments people can sensibly handle. We have to examine whether full-time executives can take more than one or two non- executive appointments, as they are called. We have to examine the desirability, or otherwise, of cross-directorships. I should also hope that the review will come up with something approaching a better definition and understanding of the role and responsibilities of so-called non-executive directors who do not spend all their time on a board.
We clearly need to look at auditor independence and regulation. I hope that the major firms and their professional bodies will understand the depth of this crisis. There needs to be much more transparency in their affairs. I am deeply disappointed that other major firms did not follow the example of KPMG and Ernst & Young in publishing audited financial statements. It is transparency that generates public confidence and an understanding of what these people are about. These firms each employ upwards of 10,000 people in the UK and have a significant role in our economy. Why should their financial statements not be audited and published to the same standard required of the public companies on which they report? There would he one benefit aside from the rest, which is that proper financial disclosure and segmental reporting would once and for all resolve the issue of whether auditing is used as a loss leader.
Progress has been made on regulation. Although I find it complex, with all the bodies involved, I think that there is a further step to consider. The key body is funded by the accounting companies themselves, but I think that the Government should consider taking over that funding which would get us away from the notion that he who pays the piper calls the tune.
A further step in transparency that should be considered is that the quality control reports carried out by the joint monitoring unit on those firms that audit public companies should he made public. I recommended that in my report, Holding to Account for the C&AG last year. There is no reason why that could not be extended to those firms that have a role in public companies.
I do not have time to comment on other issues such as the rotation of auditors. All our knowledge and experience leads us to believe that that will not work. 1364 It is better to focus on the rotation of audit personnel. Clearly we need to look at arrangements for former audit partners joining their clients, and to consider the role of the audit committee in determining what fees should be paid to accountants and auditors for other than audit services.
Before concluding, I wish to make the observation that it is difficult to be prescriptive because in regulated industries, in particular, large amounts of work flow from the audit function itself, such as reports for regulators and so on. They are not audit fees and are not disclosed as such.
In conclusion, it is clear that the auditing profession needs to take a very close look at itself in the light of the Enron affair. Let us not forget that it was not only the board of directors, management and auditors who were involved in that shambles. Investment bankers, lawyers and other advisers were clearly involved as well. We must not over-concentrate on any one of the villains in that piece. There is quite a large cast of characters to look at.
§ Lord Grocott
My Lords, I gently remind the House that there are three minutes in the gap. This is absolutely no criticism of anyone, but unless everyone keeps fairly close to the nine-minute limit, we shall have very little time for the wind-up speeches.
§ 3.42 p.m.
§ The Lord Bishop of Oxford
My Lords. I am grateful to the noble Lord, Lord Brennan, for this debate because it highlights certain crucial principles, which I believe are essential to the healthy functioning of our society. I would not presume to go into the detail of what kinds of regulatory and other action is necessary to maintain confidence in business and accounting, but there are a few fundamental points that are relevant to the issue.
First, there is the value of business and the business community to society as a whole. There was once an anti-business mood in this country. People believed that it was best to be born with a large estate, but if one did not have that good fortune, the second best thing was to make a lot of money quickly in order to buy one and then get out of business. In recent years attitudes to business have, quite rightly, been much more positive. It is vital that society feels good about its core activity. If people who work in business, or the rest of the community feel ill at ease with the work on which society depends, it sets up a tension that cannot be healthy. It matters that there is public confidence in business and accountancy.
I do not believe, any more than the noble Lord, Lord Brennan, does, that the business of business is simply to make money. Of course a business must be profitable, but I think that the mission statement of Dayton Hudson, the American retailing firm, is right when it says:The business of business is serving society, not just making money. Profit is our reward for serving society well. Indeed, profit is a means and measure of our service—not an end in itself".1365 The work of Charles Handy highlights the fact that most people who work in business do not want to work simply for the bottom line. They want to do something that they regard as worth while and which has meaning. Business is a worthwhile activity in principle. I always very much enjoy talking to groups of business people. There is a note of reality in the air, for if they do not succeed the company goes bust. That is very salutary for a mere talker.
If the first point is the value of business, the second is its values. Just because business has value, it is all the more important to ensure that its activities reflect and are permeated by its core values. One of the encouraging features of business over recent decades is the number of companies that have adopted mission statements, ethical codes and statements of best practice. Of course, no doubt some are simply there to reassure shareholders when they look on the inside of the glossy front cover of the annual report. But even that is better than nothing, for as the Duc de Rochefoucauld said:Hypocrisy is the tribute that the vice pays to virtue".Other businesses, some of which are our most profitable, take these themes extremely seriously. They have not just been jotted down on the back of an envelope by the chairman during a boring part of a meeting, but are the result of a process of long consultation throughout the company and are subject to regular monitoring. My questions in relation to recent scandals would be as follows. What publicly stated principles did those companies have? How were those principles drawn up in the first place, and what steps were in place for monitoring them? I do not know the answers; I should be interested to hear them. My guess is that companies with such codes, agreed on after extensive consultation and subject to monitoring, need very little, if any, exterior regulation. My guess is also that such companies are among our most successful.
Clearly, however, some companies need regulation. Greed, compliance with a culture of conformity and cowardice are part of us all. In an article in the Telegraph last month, the most reverend Primate the Archbishop of Canterbury, pointed to the excesses of particular forms of capitalism and businesses that are less devoted to the production of goods and services that people need and want than to speculative buying and selling of things that no one can touch and which few understand. We need to be reminded of the danger that the pursuit of wealth turns into an end in itself as the need to see profits rise and rise becomes a temptation to excess and selfish irresponsibility. In relation to that temptation and perennial danger, regulation will always be necessary.
A few years ago the noble Lord, Lord Laing, and I co-operated to produce a booklet entitled The value of business and its values. As I have tried to suggest, the two halves of this sentence go together. They are integrally related and reinforce one another. Business has value and therefore it will want to be shaped and permeated by a set of values; and, vice versa, being shaped by a set of values will enhance a sense of the value of the work as a worthwhile human endeavour.
1366 The more perceptive were those who in the 1980s argued in favour of a market economy—some of whom came from all sides of this House. They argued that in order for a market economy to work properly it depends on, and is underpinned by, a set of values. Therefore, it is not just individual companies that need such values. To function appropriately, the whole market economy does so, too. For example, markets depend on contracts, but the efficacy of contracts depends on the assumption that they will he honoured. As the social thinker Durkheim said:Not everything in the contract is contractual".In short, if one makes a business agreement concerned with the exchange of goods or services, there is an unspoken moral assumption behind that agreement—agreements should be honoured.
Regulation, whether internal or external, is necessary, for two reasons. First, it stops rogue companies. The drive to excess will always take some people and some institutions close to the line and over it. Secondly, it reinforces good corporate practice. Regulation is necessary and more, or different regulation, may be needed to prevent the recurrence of recent scandals.
My main point is that, in the end, it is the ethos of a company more than anything else that matters. In this life, virtue does not always result in prosperity, but in the field of commerce it is more likely to do so. It will certainly help to avoid some of the financial collapses that we have seen recently.
§ 3.50 p.m.
§ Lord Haskel
My Lords, corporate failures have always been with us. They are part of an enterprise culture. Competition in the market sorts out the good from the bad.
My noble friend Lord Brennan is right to look at this matter rather more deeply and ask why some firms fail; not because they cannot compete in the market, but because of fraud or other unacceptable practices. As he said, it is a serious matter affecting people's jobs, pensions, savings and livelihoods. It is that kind of failure which affects the relationship between business and the public. The spectacular failures have usually led to some kind of inquiry. As other noble Lords have said, after Maxwell we had Cadbury, then Greenbury followed by Hampel.
All those inquiries concentrated on the role of the non-executive director. Certainly, non-executive directors are expected to watch out for and be alert to any situation which could endanger the business. But they are also expected to set and maintain the strong values referred to by the right reverend Prelate and to set high standards of corporate governance in all areas of the business. Some fulfil that role well, but obviously many do not. I am not sure what the forthcoming review by the DTI of the roles and responsibilities of non-executive directors will add, but, like the noble Lord, Lord Freeman, I hope that it will do something to provide non-executive directors with the skills and encouragement to do the job of governance better, especially on audit committees.
1367 The difficulty is that non-executive directors are largely dependent upon management for information about the business. If two or three executives decide to hide, distort or falsify information, there is little that a non-executive director can do except to use his or her intuition and then conduct an inquiry. Inquiries are impossible if auditors shred the records. Like the noble Lord, Lord Sharman, I found the shredding of documents by the auditors perhaps the most disturbing aspect of the whole Enron affair.
Auditors are in much the same position of dependence. If there is collusion in a business to hide or falsify information, it requires a lot more than a traditional audit to detect it. That explains the point made by the noble Lord, Lord Brennan, about major frauds not being detected by auditors. Indeed, the auditors may turn a blind eye to some irregularities. Although legally appointed by the shareholders, the auditors are selected by the directors with whom they want to maintain a good relationship, especially as the directors and managers can also retain them for other work, or even give them a job, as noble Lords have said. Recently, some accountancy firms have taken steps to avoid those conflicts of interest. Like other noble Lords, I welcome that.
What about more detailed accounting rules? Along with the rest of the European Union, we in Britain are committed to adopting international accounting standards fully by 2005, but that still leaves many jurisdictions where sloppy accounting and disclosure rules will apply.
If accountants and non-executive directors cannot stop these corporate failures, what about the regulators? We live in a complex economy and there are limits to regulation. I was in the United States when Enron went bust and was amazed to read in the newspapers that Enron was not really an energy company but a trading company, trading in the futures of 1,200 different products, many of which were totally unrelated to energy and a lot more risky. Yet Enron was regulated by the energy regulator, and those greater risks should probably have been better regulated by the banking regulator.
But if regulation is too tough, so-called investors can always operate outside the disclosure rules by spread betting, which in practice avoids both regulation and tax. So there are limits to regulation. Meanwhile, the banks have to ensure that their share analysts in the assets management arm do not promote the shares of companies with which their banking arm is doing business.
What is it about our business life in this country that has brought all this about? What is it that has created these difficult conflicts of interest? I put it down to the single-minded insistence on shareholder value and its narrow interpretation, as expressed in the share price. My noble friend Lord Brennan called it greed, yet most financial institutions, businessmen, managers and executives insist that the primary purpose of an enterprise is to deliver that narrow version of shareholder value. That takes precedence over 1368 everything. That is what justifies the dodgy deal that violates the code of practice; drives the cosy relationship between the auditors and directors with valuable share options; and makes it difficult for the non-executive director to argue for social responsibility if it stands in the way of the share price. I do not think that new rules for regulators, auditors, and non-executive directors will do a lot to change that. No, the solution lies in changing the culture of a company. The right reverend Prelate mentioned that.
There is nothing new here. As long ago as 1993, the RSA started an inquiry into Tomorrow's Company. It realised that the narrow view of shareholder interest brought only short-term success. The RSA stated:Only through deepened relationships with and between employees, customers, suppliers, investors and the community will companies anticipate, innovate and adapt fast enough, while maintaining public confidence.It defined a new kind of leadership to be put at the centre of all this, acknowledging that it takes entrepreneurship to start a business but adding that inclusive leadership and clear direction prolongs the success of a business by giving it lasting values. Slowly, companies are adopting that approach successfully. That is why some companies, such as Shell, are now auditing their environmental performance and their people performance as well as their financial performance.
Each company needs to develop its own inclusive approach; one which fits its needs. For some years, the centre for Tomorrow's Company has been quietly helping companies to do that. I welcome that. I believe that that bottom-up change of culture is the most practical way to raise public confidence in business and to avoid dramatic business failures.
§ 3.58 p.m.
§ Lord Hodgson of Astley Abbotts
My Lords, I, too, add my thanks to the noble Lord, Lord Brennan, for giving us the opportunity to discuss this important topic today. As one would expect from a distinguished lawyer, there was a powerfully argued case. He rightly drew our attention to the appalling personal consequences inter alia of these major collapses. However, rather than retread the Enron ground, I hope he will forgive me if I come at the issue from a slightly different angle.
I begin by declaring interests present and past. I am currently chairman of an investment bank in the City, and what is called a non-executive director—for the reasons referred to by my noble friend Lord Freeman I prefer to call myself an independent director—of three companies, one of which is listed on the Stock Exchange. Historically, I was a founder director of the Securities and Investment Board, the first City-wide regulatory authority, set up under the Financial Services Act, and until last December was director of the Securities and Futures Authority until it was swept away in the new structure.
I mention those organisations because I want to make clear that I am no Luddite as regards corporate governance. Indeed, a good many of my years within the City have been devoted, in a voluntary capacity, to 1369 raising standards and nailing popular misconceptions. For example, when I first went to work in the City 25 years ago, there used to be a widespread view that insider dealing was a victimless crime. That is far from being the case. Although perpetrator and victim never meet, and will never even know each other, the one has robbed the other as surely as if he had hit his victim over the head and taken his wallet—not as obvious and not as bloody, but just as certain.
Therefore, when people talk about the need to root out fraud, I am there with them. Fraud too, after all, is theft. But in making, and while making, such a condemnation we must be careful to distinguish between fraud and risk. We live in a litigious age. Every night on the television there are advertisements by legal firms inviting one to contact them if one wishes to make a claim.
Too often a risk that goes wrong can be seen as a fraud. None of us likes to believe that our judgment is fallible, so we seek someone to blame. That cannot be right. In commercial dealings there has to be what bankers like to call "the moral hazard", without which people do not take the trouble properly to assess what they are being offered and their own self-interests in accepting the offer.
I talked about popular misconceptions that have been nailed. One that has not been nailed is that regulation comes for free. Probably people feel that, because in many cases there is no charge to the taxpayer, there is no cost. But there is a cost.
I give a brief example from the City concerning the Financial Services Authority. The FSA is the top regulatory body that now controls every aspect of those of us who work in the City. Its budget will be £180 million. It will be paid for by the industry. But the external costs are not the whole cost. There are huge internal costs of complying with the regulations laid down by the FSA. The extent of these have been the subject of learned treatises by the London Business School, Warwick Business School and others. But they work out at roughly two to four times the cost of the external authorisation.
If we take the mid point, it is a cost to the City of around £720 million every year for the present regulatory structure—a short £0.75 billion. Who pays for that? Investors, pensioners, and savers pay, and maybe in the long run UK plc will pay if the sum becomes large enough. A balance has to be struck between too little regulation which drives people away because they fear malpractice in the market and too much regulation which drives them away because of the cost of doing business. If your Lordships feel that the City's position is unassailable I invite you to visit Frankfurt to see the German Government's plans for Finanzplatz Deutschland.
When I previously raised such uncomfortable questions the Minister in his response, quite fairly and properly said to me, "What about Barings bank?" That was 10 years ago. It was before the present regulation. But for the purposes of today's argument let me accept it as a "fair cop". But, interestingly, the total liabilities of Barings at the time of implosion were about £800 million.
1370 We are spending nearly that sum every year on regulation. Are we stopping a Barings a year? We shall never know. The trouble with the comment made by the noble Lord, Lord Brennan, about not stopping fraud is that the fraud you stop is never a fraud. That is one of the difficulties.
There are two much more significant points arising out of that comment about Barings. First, we must remember that in the end not a depositor, saver, creditor nor a customer lost a penny. ING bought the business—the market worked. The losers were the shareholders—the moral hazard again.
Secondly, with great respect to the noble Lord, Lord Brennan, and other noble Lords who have talked about the need for increased legal statutory regulation, we must not expect that the law will automatically provide a remedy to all these matters.
I was a member of the SFA's enforcement committee which considered the Barings case. It seemed to us on the committee that greed had clearly outrun judgment. Moreover, there was considerable public anger over the way jobs had been saved and, above all, the way that bonuses had been paid. We found our hands tied, not by the old pals act, but by the law. I had never heard of the legal doctrine of "vicarious liability". That principle states that if one asks a subordinate member of staff a question which one has reason to believe he will answer honestly, one is entitled to rely on his answer. However, it became clear that, despite the best legal advice, our powers to proceed and pursue were limited. Our sentences were seen to be inadequate. But even then one senior member of the Barings team was able successfully to attack his sentence and get it expunged, and even force us to pay his costs.
In this country we are in the process of settling down a huge volume of legal and quasi legal codes—the Financial Services and Markets Act and statutory instruments aplenty. There are the voluntary codes of Cadbury, Greenbury and Hampel to which many noble Lords have referred. The weight of responsibility on non-executive directors has already become very heavy. They are in danger of reacting by becoming box-tickers rather than by using their judgment, which should be their proper function, as was pointed out a few minutes ago by the noble Lord, Lord Haskel. Unfortunately, one can never be proved wrong as a box-ticker but one can be proved wrong in one's judgment.
Of course there is no room to be complacent. The recent collapse of Enron has clearly raised issues. The implications of that need to be considered carefully. That is why I welcome the noble Lord's debate today. But if every large corporate failure is to be accompanied by an unthinking legislative banging of stable doors behind apparently bolted horses we shall be doing no service to the UK economy or to our competitive position in the world.
§ Lord Brennan
My Lords, before the noble Lord sits down I shall use his last minute. I should be grateful if 1371 he could answer a simple question: what is the total size of the funds in the financial system against which £720 million has been spent to regulate it?
§ Lord Hodgson of Astley Abbotts
My Lords, it is minuscule. It is impossible to measure. Probably one-tenth of 1 per cent, depending of course on how one measures it and what one is including; for example, whether one is including foreign exchange transactions. It is hard to get the whole sum. It is an infinitesimal sum, but it is still a large sum.
§ 4.8 p.m.
§ Viscount Bledisloe
My Lords, I, too, thank the noble Lord, Lord Brennan, for initiating the debate. I speak in the debate because as a barrister I have been involved in a number of cases dealing with corporate collapses and with the attribution of responsibility. In particular, I have detailed knowledge of the Barings bank disaster, to which the noble Lord, Lord Hodgson, has just referred.
I agree almost entirely with the noble Lord's diagnosis of what went wrong at Barings. However, I must correct him on one point. It was the bondholders who suffered a grave loss and not the charity shareholders. I do not think that they can be dismissed as people who ought to have known when taking the risk.
The debate has been somewhat dominated by the Enron affair. So far we know little about the matter. However, it must be regarded as a somewhat unusual case. I think that the noble Lord, Lord Sharman, would agree that there are not many cases where auditors are found shredding documents. We must not extrapolate from Enron to the generality of business.
I have three particular points. First, we should not assume that whenever a company goes bust someone must be legally and morally at fault. As the noble Lord, Lord Haskel, said, it is in the nature of business that some enterprises will fail and that investment involves some degree of risk. Unfortunately, we in this country are now rapidly acquiring a culture of blame that says that because something undesirable has happened, someone must be held liable. That culture and concept is fundamentally misconceived and profoundly damaging. But that perhaps is a wider topic for another day.
My second point relates to the position of what are normally called non-executive directors. It may well be that "independent" is a better term, but there is a real distinction between those who are just directors and those who are also the leading managers of the company and involved in day-to-day management.
In many of the collapses, and certainly in the Barings case, the action or inaction of non-executive directors is wholly irrelevant. Barings was the result of failures of management. If management had applied to its business a reasonable understanding and an ordinary appreciation of risk and return, there would not have been that collapse. But there was nothing in 1372 the Barings case which a board of independent directors, or indeed an audit committee, should have seen or done.
Of course, it is desirable to have good non-executive directors or good independent directors, who have real independence, have an inquiring mind and an understanding of the business. But there is and must be a clear limit as to the extent of their role. Nothing in life can be successfully run by a committee on a day-to-day basis, whether it is a ship of the Royal Navy, an Arctic exploration or a commercial enterprise. If management is subjected to constant supervision and interference by non-executives, or if the auditors are second guessed by an audit committee, not only will enterprises of great pith and moment be sicklied o'er by the pale cloud of debate, but also responsibility will be diffused. Everyone will comfort himself by the fact that others are thinking about it whereas what is needed is a clear allocation of managerial responsibility so that someone knows that the buck stops with him and that it is his job to know whether the facts and figures of his department make commercial sense.
Thirdly, I refer to regulation. There may be, of course, some instances where a specific regulation would prevent a particular abuse, although as the noble Lord, Lord Sharman, said, one must remember that the ingenious and improper mind will rapidly find a way of avoiding or evading almost any regulation. However, on a much more general point, we must resist the siren call which says, "Something went wrong. We must make rules that ensure that it never happens again". "It must never happen again" is a sound but hopeless cry. One hears it after every rail disaster. Noble Lords stand at the Dispatch Box and say, "We must ensure that it never happens again", but we know as sure as eggs is eggs that it will because one cannot have rapidly moving vehicles, aeroplanes or trains without them occasionally crashing. One cannot have successful entrepreneurial businesses without occasionally a rogue or a fool making them go wrong. To go round saying that it must never happen again is to kid oneself and the public.
There are two great dangers in regulation and particularly in over-regulation. First, those involved in complying with the regulations spend their time ensuring that they have complied with the rules, filling in forms to ensure that the ratios tally with the requirements in the regulations. What they ought to be doing is looking at the fundamentals of the business and considering whether the reports and figures are consistent with the basic principles of commerce. Barings would never have happened if the fools on that board had ever said to themselves, "There is no such thing as a high rate of profit with no risk". Regulations will not teach them that simple lesson.
Secondly, the existence and the role of regulators creates a dangerous and false feeling of security. Time and again the managers in the Barings case have said, "Oh, we know that Singapore, and in particular the financial markets in Singapore, have very strict regulation by very strong regulators. Those regulators are happy and therefore we know that there could not 1373 be anything seriously wrong". Thus insidiously, regulation diffuses and dilutes responsibility from management where the buck should be and should stop.
In all these debates we must never forget the fundamental principle that a good business depends on proper control by a sound and sensible management, which understands the essential rules of sound commerce and applies them to its particular enterprise with a proper understanding of its risk. Pace the noble Lord, Lord Sharman, no rules or regulations can make the incompetent or dishonest into beings who are competent and honest.
I do not have time to deal with audits, but I venture to suggest to the noble Lord, Lord Brennan, that it is certainly not true that auditors never detect frauds and irregularities. When they detect them they are put right and one does not see that. It may be that when they are detected before they have got too far they cease to happen. The cases which emerge where auditors have not seen something are the rarity and not the regularity. The problem that auditors have when things go wrong is not that the audit rules are wrong, but that the relatively junior people who are, for reasons of cost, inevitably doing the donkey work, just fail to read the message which is inherent in the fact, perhaps because they have not the experience or the time within the cost to do so.
§ 4.17 p.m.
§ Lord Clinton-Davis
My Lords, the whole House will he tremendously indebted to my noble friend for initiating this important debate. We have heard from the world of business, of accountancy, of the clergy even, and from bankers and barristers, and I am the first solicitor to open my mouth. I believe that there will be another soon.
It is very important that the questions posed by the noble Lord, Lord Brennan, govern our attention this afternoon. Of course, we have been blighted by the Enron scandal. It is important that that should occupy our thoughts. But it is not the only issue, as the noble Lord and others have pointed out, that should be important to us. For example, the issue of auditor independence has been cited, and that is very important. The Law Society has given its full attention to the issue and it has also addressed the European Commission Competition Directorate. As a result of those activities the big eight were reduced to the big five as regards the world of accountancy.
It was considered at that time that conflicts of interest could arise, which could have deleterious effects on the issue of competition. Who is to say that the Law Society was wrong then? Is this not still a highly germane issue in the light of the Enron affair?
Solicitors, in particular, have to be conscious of the requirement for independence just as much as auditors do, but independence is viewed in different ways. It is vital that auditors should be able to provide objectivity in viewing the financial position of a client and, for that reason alone, the auditor should not enjoy—or be 1374 seen to be enjoying—a fiduciary duty to the client. As I understand it, this is not always the case in the United States.
A solicitor, on the other hand, has a very different relationship with a client, and I speak here of solicitors who have served on audit committees. Confidentiality to the client is a prime necessity. In other words, the auditor should never get into bed with the company, but the situation may be totally different for the solicitor, although I must stress that adherence to the law remains essential from his or her point of view.
The Enron affair has established a strong case for ensuring that auditors comply fully with a much stricter regulatory regime. They should play no part in misleading shareholders, nor, in my view, should they impair their independence by offering consultancy services that could have that effect.
The problem of consumers being vulnerable to unqualified advisers and fraudulent management companies is vitally important, and the Law Society is not alone in this regard. The National Association of Citizens Advice Bureaux has reported an increased number of inquiries from people who have simply failed to understand the terms of the agreements that they have signed with management companies dealing with accident claims. The Blackwell Committee and the Leggatt report have also covered vital matters.
What is especially wrong with accident claim companies is the way in which many of them go about their business. No one has referred to this tonight. For such organisations, the lay client is a burdensome necessity. They are often extremely aggressive, and frequently persuade the client to settle the case on terms that are distinctly disadvantageous to the client. That they do this is, in my submission, entirely beyond doubt.
I turn to the question of tribunals. Unqualified advisers frequently provide inadequate advice and representation in these circumstances, and the client is often persuaded to settle on terms that could, frankly, be considerably improved. I hope that the Government will soon confront these, and other, issues, which are central to the way in which tribunals on personal injury cases are dealt with.
I shall conclude by asking my right honourable friend what I hope are some relevant questions. Will the Government take steps to ensure that qualified lawyers can carry out advice work in contemplation of proceedings before courts or tribunals? As an alternative to that, will the Government require claims management companies and unqualified advisers to stick to a code which would stop sharp practice? I hope that the Government will do their best to ensure that the customer should approve only those who adhere to such basic standards.
The elements of a standards code might well include: a cooling-off period; some indemnity insurance; suitable consumer redress when appropriate; transparency about what the consumer has to pay: a ban on doorstepping potential clients; and a ban on paying claims management staff only on a commission basis. I hope that these questions have been relevant to 1375 the debate. I regret that no one seems to have tackled these important issues. This debate is not only about auditors, or about the Enron affair. It is about a wide variety of matters that are equally important.
§ 4.26 p.m.
§ Lord Clement-Jones
My Lords, I would like to declare an interest as a solicitor, and also as the former company secretary of a major FTSE 100 company. I congratulate the noble Lord, Lord Brennan on instituting a timely debate, and on a thoughtful, if rather bleak, speech.
I am tempted, unusually, into this area because I believe that, following the events of this year, we have reached a watershed in corporate governance. We have had crises of confidence in corporate governance in the past—I remember particularly well the Robert Maxwell case. I am sure that the Mirror pension scheme is engraved on the hearts not only of many professionals but of many of those affected by the case. There have been attempts to deal with corporate governance in a voluntary way. Many of your Lordships have talked about Cadbury, Greenbury, Hampel, Turnbull—the mantra goes on—and the combined code. There has been a succession of governance and risk management tools to give investors assurance about the governance and risk management of their companies.
Those attempts were worthy, and it is only with some reluctance that I have concluded that the current role of the non-executive director is no longer viable for major PLCs. In the past, we have relied on the non-executive director—sometimes a retired professional or executive, often a busy current full-time executive—to fulfil the role of watchdog on behalf of the shareholders. In reality, however, despite attempts to boost their role through the various codes, that is a quite impossible task, except, perhaps, after a crisis has happened. We have audit committees and remuneration committees, the membership of which is often entirely made up of non-executives, yet abuses have occurred. In fact, it is noticeable how newsworthy it is when a remuneration committee really works and takes a robust line on remuneration, as it has in the Vodafone case, with Penny Hughes in charge of the remuneration committee.
The other frequently cited role of non-executive directors is that of their relationship to shareholders and investors. Chief executives, however, regard that as a major part of their role, as the share price is key to the perception of a company, to the measurement of performance and, indeed, to the chief executive's bonus. Non-executives can and do have a major impact on the social responsibility aspects of a company. But the question that needs to be asked is whether that is more than skin deep.
The fact is, as the noble Lord, Lord Haskel, pointed out, that executive directors are far better informed than non-executives will ever be. It is no longer tenable that non-executives should have the same legal duties as executive directors. I agreed with a great deal of 1376 what the noble Lord, Lord Freeman, had to say, but on that aspect I part company with him. Someone being paid to do, say, one day a month for a major company is hardly in a position to argue with the full-time executives of that major company. Often they are appointed precisely because they will not do so. However, companies get the professional advisers that they deserve.
Though I am happy to discuss future governance of the accounting profession, I do not believe that that is at the root of this problem. Unless the governance of a company is strong, the professional advisers will inevitably see their main route to retaining influence as serving the interests of the executive management team of the company. That is professional and human nature.
How many auditors will actually spill any beans at all to the non-executive audit committee when the executive directors are asked to leave the boardroom, or express doubts about any aspect of the company's financial controls? Therefore I welcome in particular the Secretary of State's announcement on reviewing the role of the non-executive director. I am pleased also that the Secretary of State wants to see more active institutional shareholders following the Myners review.
We already have two types of director who should have different legal duties. We should rapidly move towards a fully effective two-tier board system for our major companies. A supervisory board should be charged with the duty of ethical and financial quality control and governance. That board should be accountable to shareholders for that aspect of the company. The members of the board should be properly remunerated; they should be serviced by staff; and they should he fully supported by legal and financial expertise. There is a good case to have the internal audit function reporting to that supervisory board.
On the other hand, the management board should be responsible for commercial strategy, trading and financial performance. In the words of Patience Wheatcroft, the City editor of The Times, who conducted an effective, sceptical campaign about the role of non-executive directors, the executive directors should walk the plank if they do not perform.
I am a reluctant convert to that structure for a company. I believe that currently non-executives can play a valuable strategic advisory role to boards. But that is as far as it goes. I do not believe that the appointment even of a designated senior non-executive director will do the trick in governance terms.
In summary, I do not believe that we can carry on tinkering about with a bit more corporate governance here and a bit more corporate governance there. If we are genuine about ensuring proper governance, protecting shareholders' interests, managing risks and so on, we need to think more radically. A two-tier governance system deriving inspiration from continental models, but being far more proactive and with responsibilities far more carefully defined, is the best way forward.
§ 4.33 p.m.
§ Lord Barnett
My Lords, I begin by declaring an interest as an accountant and, some time ago, being the chairman of a moderately sized accountancy body of the kind that was eaten for breakfast, or morning tea, by KPMG. I admit willingly that I have never shredded a single paper. I should also declare an interest in that I am a non-executive chairman of two companies and have been a non-executive chairman and director of others in the past.
I thank my noble friend Lord Brennan for introducing this important debate at this time. We all know that the Enron affair damaged both company boards and the accountancy profession rather more than many of the other failures and serious problems did in the past, for reasons of which we are all aware.
Many major investigations have already taken place by the DTI and the US Congress, and Paul Volcker was brought in by Andersens a bit late to look at what could be done for them. I noted what my noble friend Lord Brennan called "profit mania". I am not too sure about that. Greed certainly could have been one of the causes of the Enron disaster—money is often the root of all evil and that was certainly a problem in which the directors and indeed the auditors seemed to be involved.
That said, it would be nice if, as the right reverend Prelate the Bishop of Oxford said, we could have a moral value on the boards of companies. However, the code of most of the companies with which I have been involved has been to increase their profits. I do not apologise for that; I understand that that is one of their major functions. I would love it if we could all have moral values, not only boards of companies, but we do not.
I hope, as a member of a company board, that boards take proper account of what is legally sensible and right and what is good corporate governance. But I do not know enough yet about the causes of the Enron affair to be able to advocate more regulation of a statutory kind. It is far too early to say and we should not rush into that kind of legislation. And I do not necessarily go along with the noble Viscount, Lord Bledisloe, that regulation is positively damaging to corporate bodies. Some action will be needed, not necessarily with statutory regulation, but such action could be taken now before we need to take legal action.
It should be recognised, and I hope it is, that directors of most companies—certainly the ones of which I am aware—and most accountants are perfectly honourable men and women who should not be condemned along with what happened to Enron or Andersens. I am sure that all the accountants in Andersens, other than those directly involved in the issue, are perfectly decent, honourable people. So we have to be careful about who we find guilty in these affairs. We must not allow the Enron affair to besmirch the whole of the accounting profession. Many companies I know would not be happy to have the name of Andersens as their auditors—they may like KPMG, but I shall come to that.
1378 Clearly, changes are needed. Some FTSE 100 companies and even more, have already appointed internal audit bodies. Those bodies need to be truly independent of the board and the auditors of the company. That is crucial. Otherwise neither the directors nor non-executive directors would know, as somebody said, how to deal with the problems that arise. It may not stop all the fraud and corruption that takes place, but I like to think that it would go a long way towards dealing with some of it. If there is, as there seems to have been in the Enron affair, collusion between a chief executive and the auditors, enormous problems could be created even for a properly appointed internal audit committee.
Much has been said in this debate about non-executive directors. Somebody even referred to them as "so-called" non-executive directors. I can say that a non-executive director is someone who is not an executive. That certainly applied in my case and applies in most. But much attention has been focused on them. The very first question a non-executive director should ask on being appointed is: "Do we have a properly appointed independent internal audit system?". That is crucial because they cannot do the job if they do not have such a body.
After asking that question—and asking if there is proper insurance for directors, of course—we need to know how non-executives are appointed. The noble Lord, Lord Freeman—I have a lot of regard for him℄said that he did not believe that they were now appointed in the way that they were in the past. Again I declare an interest; most of my appointments as non-executive director arose from contacts and connections I had, some no doubt because I was a Peer of the realm and a former Cabinet Minister. It could be that I was appointed on every occasion precisely because I am such a wholly competent person. I would like to think so, but I doubt if that was the reason—at the start anyway. Later, that may have been found to be so. There is no doubt that Peers and former Cabinet Ministers are appointed because of their connections and are not always the most competent of people.
Another person often appointed is the senior auditor of a practice who retires, perhaps early, to take a non-executive directorship. That kind of conflict of interest is clearly serious and it needs to be examined very carefully. There has been talk of a one-year delay between retirement and appointment. Though many of them will do an excellent job, I am not sure about that; it needs to be looked at. We have to ask ourselves whether statutory regulation would help at present. I doubt it.
The other point that has been made throughout the debate, and elsewhere, is whether auditors should do non-audit work. The definition of consultancy is a somewhat difficult one. Much of it stems from the audit work done by a sensible partner who is doing a good job. Should due diligence on an acquisition be given out to someone else to do? There are all kinds of other areas, such as tax work and investment decisions, that are required by a partner and by the company. They will invariably arise in talking with the 1379 partner: a perfectly decent, objective, serious partner. All of that could not be cut out, and we need to look very carefully at what is done in that direction.
The problem of accountancy is the sheer size of it. They are now called the "fat four"—and I am not making any comment about the size of the noble Lord, Lord Sharman, but the "fat four" practices of which he is now, I understand, only a consultant. The problem has grown with the size of private companies, mergers, and so on.
It has happened and is happening in the accountancy profession. I checked with someone who was the senior partner of a modest-sized accountancy practice in the UK which merged with Andersen some years ago. They were a so-called alliance of separate partnerships. I asked him today what kind of a partnership it was, because it does vary. To my amazement, he said, "a federal partnership". We spoke about that at Question Time yesterday, and so I will not go into it again. I understand that Andersen itself is an alliance of small partnerships. We should not rush into statutory regulation before we know exactly where we are going and what has happened.
The Association of British Insurers represents, it is said, some 20 per cent of the stock market and so is not a small organisation. The investment fund managers, instead of writing letters to the Prime Minister and printing them in The Times, should think more carefully about what they are doing in their job as investment managers.
With that, I leave it, my Lords, as my time seems to be more than up.
§ 4.43 p.m.
§ Lord Griffiths of Fforestfach
My Lords, I thank, as others have done, the noble Lord, Lord Brennan, for introducing this subject, which is very timely. I also declare my interests which are set out in the register. In particular, the membership of the boards of two companies in America, boards of which I have been a member for 10 years and both of which have been audited by Andersen over that period. I must say that the service we have had from them has been of the highest possible standard of integrity.
The subject of today's debate is of enormous importance to anyone who values the market economy. The collapse of Enron, as has been said, especially by the noble Lord, Lord Sharman, is different from the collapse of almost any other company that I can think of. Its failure on such a massive scale, with such repercussions, casts a cloud over all of us who have any association with business. It has undermined the credibility of the business world. The notion of one of the major five auditing firms in the world shredding documents when in difficulty is so appalling, and so impossible to justify on any ethical basis, that it calls integrity into question on a massive scale. Accountants, lawyers, independent directors, regulators—we all stand indicted because of that.
There are three questions that I find myself asking. First, the numbers which are being thrown up and which reflect the value of a company are being called 1380 into question. Secondly, the validation of those numbers by an external firm is being called into question. Thirdly, the competence of independent directors is being called into question.
I have no desire whatever to be complacent. I agree with what the noble Lord, Lord Barnett, has said about increased regulation. Perhaps I may say one or two things, however, before making some positive suggestions.
First, an economy which had no failures would, in my judgment, be an economy which was inefficient. It would not be an economy in which companies were taking risks and innovating. What seems to have happened at Enron is a disgrace. Nevertheless, when it started and for the first 10 or 12 years, it made tremendous innovations which have benefited consumers. Secondly, there is no regulatory system in the world which can ever outlaw fraud. If there was fraud in the Enron situation, it is something which, however much we try to change regulations, we shall never outlaw. Thirdly, Enron is not typical of corporations in either this country or in the United States. The remarkable thing is that it is such an exception. There are so many companies, as has been said by the noble Lord, Lord Barnett, in which the non-executive directors and the management are very decent, honourable people, who have very high ideals in business.
It has been said that we should think twice before embarking on regulation. Every extra piece of regulation that we impose on a company will involve a cost. The question we have to ask is: do the benefits justify the cost that we will be imposing?
§ Lord Clinton-Davis
My Lords, the Labour Government in particular caused a number of reports to be made on the aberrant activities of companies and, in that regard, every report had a recommendation.
Does the noble Lord totally ignore that? Is that something which counts for nothing?
§ Lord Griffiths of Fforestfach
My Lords, I am not suggesting that such a report is not valuable. What I am suggesting is that we already have, as has been said by the noble Lord, Lord Hodgson, an enormous amount of regulation with which companies have to comply. Before we increase regulation as a result of Enron, we would do ourselves well to ask what benefits we can realistically expect from such regulation. That is the simple point that I was making.
The other point I make is in relation to what was said, initially by the noble Lord, Lord Brennan, and then by the noble Lord, Lord Haskel; namely, that we live in a society which is entirely driven by greed and that, as a result, the concept of shareholder value is not a good one. From my perspective of sitting on company boards, shareholder value is necessary as an objective simply in order to survive. When a country the size of China is entering the WTO and exporting their products here, shareholder value is necessary. If we do not pay attention to shareholder value, we will not be in business tomorrow.
1381 In order to achieve that shareholder value, one has to do much more than simply go after profit. Profit is the result of producing a service or a product which people want. It is that which is the value.
I turn to the subject of accountancy and also non-executive directors. In relation to accountancy, many have mentioned possible reforms of the auditing process in order to make it more effective. Mention has also been made of re-tendering of audit work; audit firms not doing consulting; companies not hiring finance staff who were formerly employed by their audit company; non-executive directors appointing auditors, and so on. However, a number of speakers have said, "Let's go easy in this respect".
I believe that Enron has created a crisis of great proportion. In such a crisis, we need very simple rules. The last thing we want is a lot of complexity. If we want to rest ore public confidence, first—this is where I would be in favour of increased regulation—we must have simple rules stating: that every board must have a beauty contest every so many years in order to look at its audit work; and that an audit company cannot undertake consulting for that company. If you start trying to trim, it seems to me that you cannot restore public confidence.
Secondly, when it comes to financial reporting, transparency in terms of the numbers is absolutely critical. I am no accountant, but, although they may be legal, certain current practices also seem to me to be misleading. Let us take, for example, the question of off-balance sheet liabilities. This is really a call to the accounting profession. I believe myself to be reasonably intelligent, but I find the footnotes to some accounts totally impenetrable. In my view, the annual accounts of a company should be providing not just the professional investor but also the average investor with sufficient information to make an informed decision. Financial reporting has a long way to go in that respect.
A few years ago, Warren Buffett said that three questions should be asked by an audit committee of its auditor. First, if the auditors had prepared the accounts, would they basically be different from the way that the company prepared them? Secondly, if the auditors were an investor, would the information provided have been sufficient to make an informed judgment about that company? Thirdly, if the auditor were the CEO, would the internal audit system of the company, as suggested by the noble Lord, Lord Barnett, be something that was up to scratch? There is a further problem for the audit profession; namely, where do you find good auditors? If it is more attractive to be proactive running companies, or to operate in other areas—investment banking, and so on—there is a real problem about getting high quality people who can examine others, such as the directors of a company like Enron.
Finally, although there is little time in which to say anything, I should like to make one comment. We have seen many reforms of corporate governance in this country. It seems to me that we could have more of those reforms. The Government could play more of a 1382 role in the process and we could limit the role of non-executive directors, but the values of non-executive directors lie at the heart of the issue. You need a CEO and a chairman who have integrity; management that has integrity; and, indeed, a board that has integrity. You cannot regulate in that respect, but you can try to create an ethos within the business community that those are the shared values that apply. If we go down that route, I believe that that will prove to be the way to inspire public confidence.
§ 4.53 p.m.
§ Lord Newby
My Lords, like other noble Lords, I congratulate the noble Lord, Lord Brennan, on introducing this extremely timely debate. In speaking this afternoon, I declare an interest as chairman of a company that seeks to advise other companies about how they should exercise their corporate social responsibility.
The noble Lord, Lord Brennan, talked about the basic human emotion of greed, which drove many of the people at Enron, and in many of the other companies to which he referred, to disaster. I should like to add two other basic human emotions; namely, ambition and pride, which, when mixed with greed, produce a particularly heavy cocktail at the heart of running a big company.
I should like to begin by discussing the role of the accountancy profession. This role is especially important because it is central to the management of all businesses. The effect of Enron has been to undermine confidence in the profession not only in the United States but more generally. Certainly, with allegations of the shredding of documents in the United Kingdom, the industry in this country cannot afford to be complacent; nor will the fact that accountants in this country have to form an overall judgment about the state of a company, rather than simply following set rules, be completely reassuring to many investors.
Post-Enron, things simply cannot continue as before. I share the view of the industry that a knee-jerk response that simply accepted all the possible areas of reform would be inappropriate. But during the course of this afternoon's debate we have heard a number of suggestions that should now be seriously considered. Let us start with the role of the auditor. A number of suggestions have been made in terms of a rotation of auditors. I would not wish to go as far as to have a formal shift or change in the audit company on a regular basis; indeed, where that has been tried in Brazil and Italy, it has not worked. However, there is an argument for having a more frequent rotation of audit staff.
I certainly agree with those speakers who made the point that the practice of former audit partners joining companies that they previously audited—and doing so within a short period of their working in the audit company—either as members of the board or in an advisory capacity, must stop. There is a question over how long a moratorium might be; for example, should it be a year or two years? In my view, it should be at 1383 least two years and there may be an argument for a longer period. Clearly there is an issue about the extent to which non-audit work should be undertaken by auditors. However, I agree here with my noble friend Lord Sharman. It is very difficult to prescribe in the area. It is necessary for the audit committee to keep a very close watch on the process, rather than setting very precise limits. I also agree with my noble friend's suggestion that government should take over the funding of the Accountancy Foundation.
We also had a long discussion on the role of non-executives. Like other noble Lords, I welcome the setting up of the Hewitt review. The suggestion of my noble friend Lord Clement-Jones of a two-tier board for large companies needs to be considered. That is one dramatic way of being able to shift current practice. However, even with that structure in place, it would be very difficult for those on the supervisory board, unless they are very assiduous, always to get underneath exactly what the executive board is doing. I certainly agree with the suggestion that there should be a limitation on the number of cross-directorships that arise, and on the number of non-executive directorships that any individual should hold.
Enron has demonstrated the need for many such changes. It also demonstrated the fact that complicated, sophisticated companies look to areas of weakness in order to undertake areas of corporate practice that they could not manage at home. The partnerships in Enron that caused many of the problems were undertaken offshore because those concerned could not have got away with those activities in the United States. Therefore, the whole question of extending best practice in terms of accountancy, tax rules and international standards to countries that do not currently adopt such standards should remain high on the agenda of this Government, and on that of international bodies.
Although today's debate has naturally concentrated on the accountancy profession post-Enron, I hope that the House will forgive me if I refer briefly to another area where public confidence in business is currently taking a battering. I refer to the split capital investment trust sector. This sector has grown over the past decade and a half—from nothing to a series of over 120 funds with assets of over £13 billion. However, in recent weeks a dozen splits announced that they were in default of their banking covenants. It is estimated that between 20 and 40 other funds are at risk, with possible assets between them ranging from £4 billion to £5 billion.
The sector has been characterised by a high degree of cross-holdings between one firm and another, creating a pyramid of values that was bound to collapse given a significant market downturn. That downturn has now occurred, leading to a systemic collapse of at least part of the sector. Those who are losing out are not only institutional investors, but tens of thousands of small investors who invested in splits believing them to be low-risk vehicles for long-term savings. They did so in part because the funds were 1384 marketed as low risk and recommended by their managers as a means for saving for school fees or retirement, for example.
I hope that your Lordships will forgive me for quoting from a letter that I received yesterday from a couple who invested their life savings in a split trust that has now defaulted. They write:Our investment was made in the knowledge that there was a risk of a fall in capital commensurate with such a higher than market dividend, but the thought of a total loss was never thought of, and our perusal of the literature received from the management Co. never suggested such a possibility".A number of serious allegations have been made against the sector that need a quick and authoritative answer. First, did the pervasive extent of cross-holdings amount to collusion and a reckless disregard for investors' funds? Secondly, were directors in breach of their Companies Act duties to act in the interests of shareholders by putting their own interest first as recipients of extremely high bonuses based on fees earned by their companies? Thirdly, how extensive was the mis-selling of splits to small investors, some of whom have now lost their entire investment? Fourthly, is there a case for compensation for those investors? Finally, will the splits now waive all their fees while the crisis is sorted out?
The Financial Services Authority is currently undertaking an investigation into the management of split level trusts. Given that they are publicly listed companies quoted on the Stock Exchange, with boards of directors at least nominally independent of the fund managers, there is a major question about the responsibility of the Department of Trade and Industry. I should be most grateful if the Minister would say whether the DTI intends to launch its own investigation or to leave the whole issue to the FSA.
Turning from that specific area back to the main issue, several noble Lords have discussed the need for the development of a more ethical corporate culture and practice, in which some of the practices undertaken by Enron and its accountants would simply never have been contemplated by the board or executives. I strongly agree, but I fear that to rely solely on the good nature of senior executives in every case to see off the triple vices of greed, ambition and pride is to wish for the moon.
Our current regulatory framework, complex and expensive though it may often appear, is necessary to keep those three vices at bay. It must be kept under constant review. To take the point made by the noble Viscount, Lord Bledisloe, it may not be possible to stop every financial or other man-made disaster happening, but it is surely only sensible to try.
§ 5.3 p.m.
§ Baroness Noakes
My Lords, perhaps I may first declare some interests. I am a chartered accountant and a member of the council of the Institute of Chartered Accountants in England and Wales—indeed, I am a former president of the institute. I was a partner of KPMG until 2000 but have no on-going interest to declare in that regard. However, I should say that I have a number of friends who are currently 1385 partners in KPMG or other members of the "fat four". I am also what I am learning to call an independent director of a number of companies and in that capacity am a member or chairman of audit committees.
Like other noble Lords, I thank the noble Lord, Lord Brennan, for introducing this important debate. Noble Lords who have spoken today have contributed much wisdom and practical experience and we have had an excellent debate. In particular, I welcomed hearing the right reverend Prelate the Bishop of Oxford contributing to a debate on business affairs, and I agree with him about the importance of the issue of values. I sincerely hope that they can exist within a framework of shareholder value.
The issue of Enron has clearly been the driver for this debate—it was the largest corporate failure in the history of the United States. We may never know the truth behind what led to the Enron collapse. Some strands, including inadequate accounting rules and action or inaction by auditors, are identifiable, but it seems certain that behind those failures were directors determined to flout the rules for their own purposes.
Indeed, if we consider major corporate failures the world over, directors must be first in the firing line. The most notorious cases in this country in recent years, such as Maxwell and Polly Peck, involved one or more directors—executive directors, management—set on breaking the rules. Those directors have often been dominant personalities whose apparent commercial success made it more difficult to challenge them.
But not all corporate failures are linked to fraud in the boardroom. If I think back to my first year of accounting training, the biggest corporate failure, which shocked the business community in 1971 was that of Rolls-Royce. That did not involve overbearing or fraudulent directors but directors making a major commercial misjudgement.
I mention that not to diminish the importance of the collapse of Enron but to remind your Lordships—as have other noble Lords—that corporate failure is a natural consequence of the capitalist system on which our economy is based. Capitalism has fuelled our economic growth and that of other Western economies. Global economic prosperity rests on it. But capitalism involves risk taking. Capital markets, shareholders and management all accept that risks sometimes turn out badly. Some business enterprises will fail. Last year alone, there were more than 30,000 liquidations and bankruptcies in this country. Business failure is an unfortunate fact of business life.
One reason that our economy has been successful has been its relatively light regulatory burdens. Of course, our business community always complains about the level of regulatory burdens—and rightly so. Especially since 1977, regulatory burdens have been rising—the British Chambers of Commerce estimates their total cost at £15 billion. But our economy is still relatively flexible, which has meant that we have a greater ability to withstand global slowdown.
It is important to remember the underlying virtue of the flexibility of our economy when we consider what responses are needed to corporate failure. It may be 1386 tempting to think of ratcheting up regulatory systems as a response to Enron, but I sound a note of caution. Increasing regulatory burdens could drive business out of this country or prevent inward investment from coming here. As my noble friend Lord Hodgson pointed out, regulation carries costs for business.
We know that other regulatory burdens on business in this country are coming. There is the so-called enterprise Bill, which will increase regulatory burdens, and at some point during the life of this Parliament, the company law review will increase the regulatory framework for companies.
Today is not the time to debate the substance of those issues, but it is time to debate how we approach the regulation of business. We must be careful that we do not simply respond to corporate failure by massively increasing the rules and regulations surrounding business. We must ensure that the benefits of any additional regulation outweigh the costs. We must ensure that we do not strangle the spirit of entrepreneurship, which is important to our economic success.
We should also remember that major corporate failures can result as much from government action as from the actions of directors or auditors. The most shocking corporate failure in this country in recent months was the assassination of Railtrack by Mr Stephen Byers, who is, remarkably, still Secretary of State for Transport, Local Government and the Regions. When the Government address the issue of corporate failure, they should consider carefully whether they come to the task with clean hands.
The Government have announced several actions in specific response to the Enron case. First, there is the review of non-executive directors announced by the Secretary of State for Trade and Industry, which has been welcomed by many noble Lords. On these Benches, we welcome such a review in principle. Although the announcement of the review made it sound as if some action was involved, there is still, I understand, no chairman or person to take forward the review. The person whose name was mooted in the newspapers, Sir Peter Davis, appears not to have wanted to take up the challenge. Perhaps, that is not surprising, given the succession of reviews—Cadbury, Hampel, Greenbury and the like—that have already covered the area. What is the status of the review of non-executive directors? Who will lead it? What are the terms of reference? When will it report back?
The second review announced by the Secretary of State for Trade and Industry was a review of audit and accounting issues. It is to be taken forward with the various regulators in the field. What are the terms of reference for that review? When will it report? I would also like the Minister to say whether the proceedings of both reviews will be open to the public. Will they take evidence in public? Will they cast far and wide for contributions? Will the reviews be open and transparent?
The reviews will touch on issues that are central to business life and the existence of a successful business community in this country. Their recommendations 1387 could have far-reaching implications for business. It must be made clear that a broad spectrum of business interests can contribute to it fully and openly.
The accountancy firm at the heart of the Enron scandal, Andersen, has close links with the Government. It worked closely with the Labour Party before the 1997 election and was rewarded with the rapid settlement of long-running litigation undertaken by the previous Government against it over the quality of its work on De Lorean, another corporate failure, albeit less spectacular than Enron. The Secretary of State was director of research for what was then Andersen's consulting arm.
What are the Government doing about Andersen's Enron role in the UK? I am aware that the majority of the issues relate to the US offices of Enron and Andersen, but Andersen's UK office was singled out for special mention by the US authorities when the US firm was recently charged with criminal acts relating to the destruction of evidence. What is the Government's current approach to work done by Andersen? Are there any contracts in progress or any contracts for work for which Andersen are bidding? What do the Government intend to do if there are any such contracts?
Many issues are raised by the Enron failure. I hope that the Government will be prepared to face all those issues, even those close to home. I hope also that the Government will not fall into the trap of creating more regulatory burdens on business—that includes auditors—without being sure that those burdens are outweighed by the benefits to our economy.
§ 5.14 p.m.
§ Lord McIntosh of Haringey
My Lords, my noble friend Lord Brennan is to be congratulated on the timeliness and importance of the Motion and on having attracted such a range of expert contributions. As has been suggested by several speakers, that has happened because, although Enron is not mentioned in the Motion, attention has been wonderfully concentrated by the largest, most serious corporate failure in the history of capitalism. Perhaps it is going a little too far to call it that; but certainly several speakers have questioned things that should have been questioned before but may not have been.
We start in the knowledge that company failures, as has been said, are a normal part of business life. They can result from misjudgments in corporate strategy, from an inability to adapt to changing market conditions, or from simple bad luck. They can also result from weak systems of control within companies, from failure to apply those controls rigorously, from human weakness—greed, ambition and pride—and, in a significant number of cases, from dishonesty and fraud on the part of the employees and managers of a company.
As has been made clear by the Enron case, they can arise also from failures in accountancy, Whether they are failings in external or internal audit, all those things can and do happen. I doubt whether the noble 1388 Lord, Lord Brennan, was right to say that no company was ever saved by its auditors. I suspect that the companies that are saved by their auditors do not come to public notice, and the fraud does not bring the company down. The poet said:Treason doth never prosper, what's the reason?For if it prosper, none dare call it treason".We must accept that no amount of regulation by Government could prevent all failures occurring. On that, if on little else, I agree with the noble Baroness, Lady Noakes. Certainly, we could not expect to provide benefits to consumers or the economy by propping up failing companies. As has been said, taking risks, with all the rewards that it brings, is at the heart of the free market. However, we take seriously the failures that raise issues relating to regulation or public confidence, and I shall set out some of the things that have been done in the past 10 years or so and some of the things that are being done now and will be done in the future.
We must get the balance right between regulation and encouraging enterprise. We must make the United Kingdom an attractive place in which to do business, and we must consider the issue in the wider sense. The noble Lord, Lord Hodgson of Astley Abbotts, gave some importance to the cost to business of regulation, although even he admitted, under questioning, that the cost was infinitesimal in the context of the turnover of the financial services business.
§ Lord Hodgson of Astley Abbotts
My Lords, the question is whether other markets charge the same. If not, there is a competitive disadvantage. If the Minister deals in shares, he will see that there is £5 compliance charge on each of his contract notes. That is a considerable sum.
§ Lord McIntosh of Haringey
My Lords, that is not the question. The question is what is necessary to make this country a safe and successful financial market. I shall not give way to any other interventions; I simply do not have the time.
What has been done in the past 10 years? We have improved accounting and auditing requirements. The Companies Act 1989 paved the way for the creation of the Financial Reporting Council and the Accounting Standards Board. There is a stronger requirement to consolidate special purpose vehicles. There is the use of substance over form to determine the extent of consolidated accounts, which makes it more difficult than it may be in some other countries to keep liabilities off the balance sheet. That was certainly the issue at Enron. The Financial Reporting Review Panel, chaired until a couple of years ago by the present Attorney-General, has played a role in this.
1389 As my noble friend Lord Brennan pointed out, of course it is important that the United Kingdom and the United States should reach agreement on accounting standards. However, as we move towards international accounting standards by 2005, it is also important to ensure that we should move to the best accounting standards and not sacrifice any of the virtues that we have now.
Financial services regulation has been addressed with the establishment of the Financial Services Authority, which took on its full powers last December. We now enjoy the benefits of a single regulator which sees the importance of market confidence at its core. Furthermore, we now have an opportunity, if not to eliminate the risk of failure—that cannot be done—at least to probe more fully and penalise more harshly any contraventions of the standards now being put into place by the FSA.
Improvements have been made in corporate governance, perhaps less dramatic than in some other areas. The combined code has proved a valuable account of best practice. Its influence has been recognised outside this country. We have also had the Turnbull report which addressed the subject of risk assessment. As I shall make clear, there is still a great deal more to be done on corporate governance and, indeed, on the issue of audit committee responsibilities, a matter raised by my noble friend Lord Brennan. However, we have not been entirely idle in this area.
In terms of accounting regulation, a commitment was made in 1997 in our business manifesto that new arrangements should be introduced for oversight of the self-regulatory functions of leading accountancy bodies. The new Accountancy Foundation, chaired by my noble friend Lord Borrie, and the various bodies related to it, are now active and are asking many or the questions which have been put in our debate this afternoon.
I turn now to what is being done and what will be done in the future to address these concerns. I refer first to the Company Law Review, whose final report after a three-year exercise was published in an enormous volume last July. The review looked at the whole framework of company law and corporate governance and made wide-ranging recommendations. However, it did not go as far as some of the views that have been expressed in our debate. It recommended that there should he a statutory statement of directors' general duties, to provide greater clarity about the rules governing directors' decision-making. It also made recommendations about transparency, including a statutory operating and financial review for large companies, and improved arrangements for company disclosure and shareholder voting.
Many of those recommendations will require legislation. We are consulting on that now and we are actively preparing major draft legislation in response. It will be published for consultation purposes. We are determined that our company law should be fit for the demands of the 21st century.
1390 Questions were asked about what is being clone about concerns raised by the accountancy profession and the role of the Accountancy Foundation. In this area, too, progress is being made. The Ethics Standards Board is looking at the professional rules on auditor independence, while the Auditing Practices Board is considering the relationship between auditors, audit committees, company management and shareholders. We shall have to see whether the role of the audit committee should be strengthened, as well as enhanced independence for that committee.
The noble Lords, Lord Sharman and Lord Newby, have suggested that the Government should fund the Accountancy Foundation. In due course we shall be carrying out a review, probably after five years. Certainly the question of government funding has not been ruled out, although as far as I am aware, it has not particularly been asked for.
Both the noble Lord, Lord Griffiths, and my noble friend Lord Barnett referred to the issue of auditors and non-audit work. I think that there is a distinction to be made with regard to non-audit 'work which falls naturally to auditors and thus does not raise any issues of auditor independence. However, over the years there has certainly been a history of non-audit work presently undertaken by auditors which could raise reasonable concerns about independence. In particular, it raises concerns about whether the profitability of non-audit work can affect the independence of the audit work itself. That, after all, is what we are concerned with here; this is a debate about corporate governance rather than consultancy.
I shall interrupt myself to say a few words about offshore financial centres, a point raised by the noble Lord, Lord Newby. This is an ongoing problem and has been so for many years. However, we are working closely with the Crown dependencies and the overseas territories, putting considerable pressure on them with regard to the issue of money laundering. All the UK dependent territories have sent letters of commitment to the OECD Harmful Tax Competition Initiative and we are continuing to hold talks on that.
Perhaps I may turn to the developing role of the Financial Services Authority. An issue which has been raised is that of the review of the listing rules, which will give an opportunity to consult on the issues raised by the collapse of Enron as they affect listed companies. However, I do not think that we should prejudge the outcome of that review. It may be sensible for the FSA to take the opportunity to address the issue of auditor rotation or the employment by major companies of senior staff from their auditors before a form of "cooling off" period has elapsed. That suggestion received a mixed response this afternoon.
Two issues which are the responsibility of the Financial Services Authority are ones of which I have become aware only by reading the press today. The first is the news of what I believe is called the "Plumber" case, concerning the use of spread betting in flotations, which clearly raises issues of market abuse. Since the provisions covering market abuse came into effect only last December, it will be interesting to see how they work out in practice.
1391 The second issue is that of split level investment trusts, raised by the noble Lord, Lord Newby. I have to say that I think that this is a matter for the FSA rather than for company law reform. Even if the business vehicle used is corporate, it would still come within the remit of the FSA. However, if having concluded its investigations the FSA was to make recommendations to the Government, we would take those recommendations very seriously indeed.
The noble Lord, Lord Hodgson of Astley Abbotts, was right to say that insider dealing, which undoubtedly is still going on, is not a victimless crime. That is why the Financial Services and Markets Act 2000 introduced the civil market abuse regime, to which I have already referred. That regime complements existing insider dealing and other criminal legislation, so that the market abuse offences of misuse of inside information, giving false or misleading impressions or market distortion can now be tackled in ways that were not possible in the past. The FSA can also investigate and prosecute insider dealing offences under the Criminal Justice Act 1993.
Questions were asked about what is being done about corporate governance and non-executive directors. A number of speakers, including the noble Lords, Lord Freeman and Lord Clement-Jones, and even the noble Baroness, Lady Noakes, have welcomed the announcement of a review of the role and effectiveness of non-executive directors. Clearly they have an enormously important part to play.
I am afraid that I do not agree with the noble Lord, Lord Freeman, who suggested that what had been a comfortable perk in the past is in many cases not a comfortable perk now.
I am not saying that it ought to be a comfortable perk—I agree with the noble Lord, Lord Clement-Jones, that being a non-executive director and doing the job properly can be, in many ways, an impossible task—but if you look at the lists which have been published, with mugshots and all, in the Sunday press recently, you realise that all the old abuses are still going on. There are still far too many people who are serving on 10, 12, 15 boards, to which they clearly cannot do justice; there are still far too many people serving on each other's remuneration committees, and no doubt helping each other out when they get into difficulty; and there are far too many examples of what is far less than best practice in the appointment of non-executive directors. The review will look at best practice and ask whether best practice works—because if best practice does not work, something more serious will have to be done.
The noble Lord, Lord Barnett, among others, raised the issue of the role of institutional shareholders. The Myners review, on which we are still consulting, was enormously helpful in that regard. But there is still a good way to go in establishing the role of non-executive directors. We should be cautious about thinking that non-executive directors—even if much more effective than they are at present—are a simple way of reducing corporate failure.
1392 Over the past 10 years I have found great difficulty in debating these matters. The difficulty I find is that whenever something goes badly wrong, the business community—particularly, the financial services community—says, "Oh well, this was a one-off. It will not happen again. Surely we have procedures in place to make sure that this kind of thing cannot go wrong. You cannot find a way to deal with fraud". People said it about Maxwell; they said it about Barings; they have said it about so many examples. No doubt there are people who are starting to say it about Enron—although they are being a little more cautious now than they were.
On the other hand, it is true that much of what I have said about government action to deal with corporate failure is, to an extent, shutting the stable door after the horse has escaped. You have to attack the abuses that you see—the ones which have identified themselves. It is difficult to find a pattern of failure behind them and to attack that pattern.
That is the value of Patricia Hewitt's recent announcement about the setting up of the group within government which will be chaired by Melanie Johnson and Ruth Kelly. The group will ensure that the relevant questions are being addressed in a coherent and considered way and that the overall response is adequate.
Some of the things that have happened before will happen again, and some things that have not yet happened will happen for the first time. Reading articles in this morning's papers about split capital investment trusts and the use of spread betting in flotations made me think that we shall have to run very fast to keep up with those who are determined to distort markets.
I should love to agree with the noble Lord, Lord Griffiths, that what we need is simplicity of rules. I wish I thought it were true. But the combination of the many important measures I have described in the course of the previous 19 minutes are relevant and will be helpful in dealing with the problem. I am grateful to all those who have taken part in the debate.
§ 5.34 p.m.
§ Lord Brennan
My Lords, there are three short messages. The first is that we must maintain public confidence in business and accountancy. I am sure that the honest-to-goodness businessmen and accountants, who are the vast majority, will seek to do that. The public want just profit, not profit mania, which I carefully define as a disease first diagnosed during the "South Sea bubble" episode—that is, the expectation of ever-increasing profits wholly unrelated to reality.
The second message is that values instilled into corporate life will support the public confidence that we think is so important. I thank the right reverend Prelate for emphasising that.
The last message is that the objective of all this is to make people in our society feel that the financial system is safe in so far as it can reasonably be made to be so.
1393 I thank all noble Lords—in particular the noble Lord. Lord Clement-Jones, for encouraging me to hone my forensic skills so as to make the unpalatable appear anything other than bleak—for their diverse and informed contributions, which I hope have produced a worthwhile debate. I beg leave to withdraw the Motion for papers.
Motion for Papers, by leave, withdrawn.