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New Clause 4

Directors' Reports

.--(1) The directors' report of a public company laid before the company in general meeting after 31st December 1989 (not being a meeting adjourned from a date before that date) shall state, in addition to the matters required by Schedule 7 to the Companies Act 1985 (matters to be dealt with in directors' report), which, if any, of the directors at the end of relevant financial year were independent directors.

(2) The directors' report of a major public company laid before the company in general meeting after 31st December 1989 (not being a meeting adjourned from a date before that date) shall state, in addition to the matters required by subsection (1) above and by Schedule 7 to the Companies Act 1985 (matters to be dealt with in directors' report), if at the end of the relevant financial year fewer than three of the directors were independent directors, whether the directors propose that appointments of independent directors should be made.'.-- [Mr. John Garrett.]

Brought up, and read the First time.

Mr. John Garrett : I beg to move, That the clause be read a Second time.

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Mr. Deputy Speaker (Sir Paul Dean) : With thisit will be convenient to discuss the following : newclause 5-- Interpretation-- . In this Part--

"associate" and "associated company" have the meaning given by section 435 of the Insolvency Act 1986 ;

"audit committee" means a committee of the directors of a major public company appointed in accordance with the provisions of this Act ;

"directors' report" has the meaning given by section 235 of the Companies Act 1985 ;

"financial year" has the meaning given by section 224 of the Companies Act 1985 ;

"independent director" means a director who is not and in the previous five years has not been--

(a) an employee or the holder of any office (other than his office as independent director) or place of profit under the company. (

(b) an associate of any director or officer of the company. (

(c) an adviser retained by the company, or an associate or partner of such an adviser,

(d) a person or an associate of a person who has a notifiable interest in the company for purposes of Part VI of the Companies Act 1985, or

(e) a party to or otherwise materially interested in a substantial transaction or arrangement with the company ;

and in paragraphs (a) to (e) above, "company" includes any holding, subsidiary or associated company of the company ;

"major public company" means on any date a public company of which any issued share capital is listed on a recognised investment exchange as defined by the Financial Services Act 1986 and which in one or more of the three financial years ending on the last day of the financial year of the company immediately preceding that date satisfied two or more of the following conditions--

(a) the amount of the turnover of the company and its subsidiaries exceeded £200 million ;

(b) the balance sheet total (as defined in section 248(3) of the Companies Act 1985) of the company and its subsidiaries exceeded £100 million ;

(c) the average number of full-time employees of the company and its subsidiaries determined on a weekly basis in accordance with section 248(4) of the Companies Act 1985 exceeded two thousand.'. New clause 6-- Appointment of Audit Committee --

.--(1) Every notice calling an annual general meeting of a major public company to be held after 31st December 1989 (not being a meeting adjourned from a date before that date) shall, if no audit committee of the directors has been appointed in accordance with the provisions of this Act or if the appointment of such a committee has lapsed, include consideration of the appointment of an audit committee as a separate item of business to be transacted at that meeting.

(2) A major public company may by ordinary resolution require the directors to appoint an audit committee of the directors in accordance with the provisions of this Act notwithstanding any provision to the contrary or the absence of any necessary provision in the articles of the company.

(3) Where a major public company has resolved under the provisions of this Act to require the directors to appoint an audit committee, it shall be the duty of the directors of the company to make such an appointment within a period not exceeding six months after the date of the resolution.

(4) Subject to section 3 below, the conduct, the powers, duties and proceedings of an audit committee shall be governed by such regulations as the company may from time to time adopt by ordinary resolution and such regulations shall be part of the regulations of the company in the same manner and to the same extent as if they were regulations contained in duly adopted articles of association.

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(5) Section 380 of the Companies Act 1985 (registration etc, of resolutions and agreements) shall apply to any resolution passed by a major public company in accordance with the provisions of this section.'.

New clause 7-- Duties of Audit Committee--

. The duties of an audit committee shall include the following-- (

(a) to hold meetings with the auditors to consider any matters concerning the company of which notice has been given to the audit committee by the auditors and to report to the directors thereon ; and

(b) to report to the directors on any other matter which in the opinion of the audit committee requires the attention of the directors.'.

Mr. Garrett : New clauses 4 and 5 relate to companies having non- executive or independent directors, and new clauses 6 and 7 relate to the formation of those independent directors into audit committees.

New clauses 4 and 5 represent a simple amendment in the tradition of something that goes back more than 10 years as the House has attempted to encourage public companies to appoint independent directors. I know that the late Sir Brandon Rhys Williams campaigned for this and that the hon. Member for Beaconsfield (Mr. Smith) moved the clauses relating to this in Committee. They advocated the appointment of such directors for many years. We think that it is right that that issue should be aired in this Bill at least one more time so that Conservative Members can join with us in trying to get this change through.

This issue has been current for a long time and, as proof, I have an article with me written by the late Sir Brandon Rhys Williams which appeared in the Investors Chronicle on 17 February 1978 entitled "Why companies need audit committees". At that time, Sir Brandon was making one of his numerous attempts to get such provisions enacted in company law.

New clause 4 requires a statement by a company as to whether it has independent directors and requires the directors' report of a major public company with fewer than three independent directors to state "whether the directors propose that appointments of independent directors"--

or more independent directors--

"should be made."

New clause 5 defines the companies to which that provision will apply as a major public company that satisfies three simple conditions--it has a turnover of more than £200 million, a balance sheet total of £100 million or over, and employs more than 2,000 people.

Sir Brandon's last act before his death was to introduce a Bill to this effect, which was passed unopposed on its Third Reading in the House, but which was regrettably blocked in another place by a hysterical campaign conducted by the Confederation of British Industry. At the time, I believed that that campaign was grossly over the top in its reaction to the threat to companies' independence and powers to carry out their proper duties by virtue of having the independent directors proposed by Sir Brandon. I still hold that view.

Mr. Campbell-Savours : This is a new proposition for some of us, and as we may wish to intervene later I wonder whether my hon. Friend could explain the relationship between the new directors and the executive directors.

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What would their relationship be on a day-to -day basis? Would they operate in terms of permanent accountability or timetable accountability?

Mr. Garrett : If my hon. Friend will allow me to proceed just a little further, most of his questions will be answered more or less satisfactorily.

This issue has been debated at great length for years. There is general consensus in the corporate community of the value of independent directors. The best run companies already have them and their numbers are increasing. A distinguished organisation PRONED--Promotion of Non-Executive Directors-- exists to encourage companies to take on independent directors and to promote the concept of such directors. It has said :

"The purpose of appointing non-executive directors is to provide the board with knowledge, expertise, judgment and balance, which may not be available if the board consists only of full-time executives."

PRONED was set up by the stock exchange, the Bank of England and the CBI. Therefore, it is an establishment body of impeccable credentials and its aim is simply to improve the governance of our public companies.

Non-executives can make a contribution to the long-term development of a company because of their specialist skills. They can take a detached view, and they can often see through any potential conflicts of interest on a board. In the United States, they form the majority of boards of large companies.

PRONED suggests that there should be three non-executive or independent directors in medium-sized companies. Of The Times top 1,000 companies, only about 10 per cent. have no independent directors and 60 per cent. have three or more. There is a proposed Bank of England code which will encourage companies to have independent directors.

8.15 pm

Hon. Members on both sides of the Committee were disappointed that the Government opposed the concept of enshrining the position of independent directors in statute. The then Minister referred to the desirability flowing from

"the contribution that those directors can make to the well-being of their companies".

He went on, I fear in an unintelligible passage, to say that the definition in the new clause did not encompass all the possible types of non-executive director. He said :

"There are degrees of executiveness We do not wish to place in company law rigid distinctions which are alien to the way in which British company law has developed."

However company law has developed, companies have developed in such a way. It seemed to Opposition and Conservative Members who have advocated the cause for more years than I that the new clauses would be a useful prompt to companies to take on and benefit from independent directors.

The Minister also denied that the passage of the new clauses would give more momentum--what we wanted--to the move towards more independent directors. He said :

"the new clauses would not advance that valuable trend."--[ Official Report, Standing Committee D, 8 June 1989 ; c. 275-6.]

He then announced that the Government would oppose the new clauses, but did not tell us how the Government proposed to advance that valuable trend. I had imagined that the Government would have wanted to encourage it.

On a purely non-partisan basis, we believe that companies are better governed by boards of directors that

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include outside, independent or non- executive directors with no axe to grind and with the ability to take a detached view of the long-term development of the companies.

The new clauses relating to the audit committees follow from the new clauses relating to non-executive directors. The new clauses seek to establish a procedure for listed companies whereby the relationship with the auditor would be handled by a committee of the board. Such directors would not have a personal interest in the profitability of the company and in the manner in which it is reported, in comparison with executive directors, whose pay or bonuses are likely to have a significant profit- related element. Therefore, those directors would not have the same incentive, under any circumstances, to influence the auditors.

The typical specifications for an audit committee include that it should review financial statements prior to submission to the board for approval ; review external auditors' findings and any lack of co-operation encountered during audit with a view to erasing those problems ; review accounting policies for compliance with best practice ; review periodically the effectiveness of systems of accounting and control ; act as an advisory group to the board ; review the effectiveness of internal audit and its reports ; and discuss with the board and the auditors the significance of matters brought to light by audit and to make appropriate recommendations. The advantages available from an effective audit committee are most likely to be realised by board members who are non-executive officers of the company. Those officers should be senior, well qualified and experienced individuals who should feel uninhibited about expressing their views on important issues.

From the auditors' point of view, they would expect the detailed contents of management letters, any qualifications in the audit report, any matters involving disagreement with the views of the board or matters pertaining to the auditors' reappointment and remuneration to be discussed.

The case for audit committees derives directly from the argument for independent directors. Those committees help directors to fulfil their legal obligations as to the accuracy of financial statements. They give directors the opportunity to consider issues at greater length and strengthen the objectivity and credibility of financial reporting and the independence of the audit function. They are also an important adjunct to protecting the interests of shareholders and they bring an objective, outside view of the company's financial conduct.

Therefore, I am sure that these provisions will receive the support of hon. Members of all parties. Indeed, this measure has, in effect, already passed through the House with an unopposed Third Reading. I look forward to the Government's support if it comes to a Division. We should have a Division on this, because the House should have an opportunity of expressing its view on the matter and, if we reach that stage, I expect many Conservative Members to join the Opposition in the Lobby.

Mr. Tim Smith : I support the new clause, because it is identical to a new clause that I introduced in Committee. I support it also because the words of all the new clauses in this group are taken from the private Member's Bill which I introduced earlier this year. Those words, in turn, were taken from the Bill that was introduced last year by

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the late Sir Brandon Rhys Williams, which, as the hon. Member for Norwich, South (Mr. Garrett) has just reminded us, passed through the House unopposed.

However, I do not want to rehearse all the arguments in favour of the new clauses this evening, because we had a good debate in Committee. There was a consensus that independent directors and audit committees are a good thing. Indeed, that is why the CBI, the stock exchange and the Bank of England set up PRONED. The good news is contained in the figures that the hon. Member for Norwich, South gave the House about the proportion of The Times top 1,000 companies that now have one or more independent directors.

The question is, how do we make progress? The companies that do not have independent directors or audit committees almost certainly need them most. In such companies, the jobs of chairman and chief executive are rolled into one and one man often dominates the board--perhaps because he has a large shareholding in the company. Those are the companies that need these arrangements, but they are the companies that do not have them at present.

So, how are we to make progress? From experience of company law, I know that good and best practice has gradually developed to a point at which people have then said, "The time has now come when all companies should be required to do this. It is clearly the right way of going about things. We shall incorporate these things into company law." The example that I gave in Committee was the requirement to consolidate accounts. Many companies consolidated the accounts of their group companies years before the consolidation requirement was introduced in 1929. However, at that point consolidation was so widely the best practice that it was thought right to legislate. How are we to move forward from the present situation where 90 per cent. of companies have one or more independent directors to a position where every company has a number of non-executive directors and an audit committee?

The proposals in the new clauses are relatively modest. In the first instance, they will simply require a company to consider the matter and to give some information to shareholders. In answer to the question, "How are we to make progress?", I shall be interested to hear whether my hon. Friend the Minister agrees that these are good ways in which to proceed and good ways of conducting companies. I shall also be interested to hear how he proposes to encourage a higher take-up of this good practice so that we eventually have a universal provision of independent directors and audit committees. If the Department of Trade and Industry believes these arrangements to be good, how does it propose to promote them?

Mr. Jim Cousins (Newcastle upon Tyne, Central) : I follow the hon. Member for Beaconsfield (Mr. Smith) in thinking that these amendments are relatively modest and moderate, yet the Government's argument on this point in Committee was obscure to say the least.

In Committee on 8 June, the then Minister stated :

"The basis of argument is that by putting the matter into statute and having a separate category of independent directors, we would make it more difficult for the general movement towards more non-executive directors to take place."--[ Official Report, Standing Committee D, 8 June 1989 ; c. 282.]

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That argument is extremely perverse and hard to follow. It invites us to believe that if one brings a new category of people into existence, one is making it harder for that new category of people to come into existence. Plainly, the argument does not make sense. I believe that the Minister was forced into such a contorted argument because he had no other arguments at his disposal on that occasion. As the hon. Member for Beaconsfield has rightly said, there was an effective consensus in Committee--although perhaps it was not always expressed in votes--that these provisions would be a desirable development and one that fitted with the general movements in the markets at large.

This may very well be one of the last opportunities on which we can deal with this matter in this way. Since the Standing Committee met in June and July, there have been further reports, revelations and a further air of unfortunate uncertainty about the conduct of people in the City, especially --but not only--in relation to takeover bids. The market pressure to produce a better system of director responsibility and accountability, not simply to the shareholders but to the markets at large, is almost irresistible.

We must agree to some kind of modest proposal which is self-acting in its mechanisms and simply asks people to occupy a certain role and to carry it out properly. None of the new clauses asks for complex regulatory mechanisms. If this matter cannot be dealt with at this juncture in the development of our financial and industrial markets by putting into place simple, modest and self-acting proposals, the only other alternative at a later date will be to accede to the growing demand for precise, externally imposed regulatory mechanisms which would not suit the needs of the time so well. It would be much better and in the interests of all parties if we could achieve a self-acting, self-regulating system by inviting new categories of people to come into existence, with a new remit and a sense of their own role when carrying out these wider responsibilities.

The stock exchange is asking us to move in precisely that direction. I noted with interest the report of the Listed Companies Advisory Committee, which was contained in the last annual report of the stock exchange. It carefully noted the need to produce a guideline for directors on investor relations which would remind directors of their wider responsibilities, not only to shareholders in that specific company, but to the investing community at large. The document outlined the legal framework that already exists and the responsibilities of directors.

This year the stock exchange has also supported the production of a new booklet entitled "Takeover Bids--A Guide for Directors", which states

"Understanding their legal and regulatory responsibilities is essential if directors are to take rational and defensible decisions in takeover bid situations, and to communicate them effectively." Obviously, that is not going as far as to underwrite our new clauses, but its meaning is clear. The financial markets and those experts in them are concerned about the lack of accountability and direction that has been shown by some directors in some key matters of grave public concern that have brought our financial markets into disrepute.

This is a modest opportunity to set in being a new category of actors on the industrial and financial scene,

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with new responsibilities and a wider remit in the spirit of the recommendations of the Listed Companies Advisory Committee. Our opportunity to do that now is precious. If we do not take it and do not put in place this modest and limited system, we shall be faced later with almost unstoppable pressure for much more complex external regulatory mechanisms such as are in place elsewhere and such as produced the Financial Services Act 1986. It must be in the interests of both sides of the House to support the new clause and to head off that track. It would be unfortunate if, after a few more years of DTI inspectors' reports and of calamities such as Eagle Trust Holdings and the unfortunate image left by the Ferranti business, we were faced further down the road with irreversible pressure to put in place something as complicated in its own way as that Act proved to be.

Mr. Nelson : I, too, support the new clause strongly. My support follows on from my sponsorship of the private Member's Bill of the late Sir Brandon Rhys Williams and from my speeches in Committee in which I supported this measure. If the Government feel unable to accept the new clause--I hope that even now my hon. Friend will consider it sympathetically and change his mind--I shall certainly vote for it.

8.30 pm

This is an idea whose time has come--in fact, it came a long time ago. Something must be done now and if this measure does not pass tonight, it will, nevertheless, come. It is necessary and the only question is how many more scandals and abuses of shareholders' funds need to occur before the House is prepared to recognise in statute the need to separate some of the responsibilities and to accord to a non-executive element of boards of directors the duty objectively to assess the reports of accountants and to determine whether the affairs and liabilities of the company are being deployed in a wholly proper way.

I also congratulate my hon. Friend the Minister on his appointment. I urge on him in the strongest possible terms the importance that I and many others attach to the new clause. This measure went through the House without objection ; the Government did not roll in people to vote it down. Because of a cluster of Lords in another place, it was eventually defeated on a despicable day and in an appalling way. However, we do not support it for those nostalgic reasons. We support it because it has been shown intrinsically necessary to have on a board of directors an element who can scrutinise affairs at arm's length and separately assess whether the liabilities and assets of the company are being used with integrity or deployed to an excessive degree. This element can also assess whether, as so often happens, a dominant chief executive or chairman who may appoint all the other members of the board is abusing his position of patronage. No one would say that this has not happened or will not happen again. I join my hon. Friend the Member for Beaconsfield (Mr. Smith) in welcoming the extent to which so many companies have non-executive directors and the success of organisations such as Promotion of Non-Executive Directors, but the very companies that need effective non-executive directors are those that refuse to have them. They are the companies that use such directors' names on the list of directors instead of giving them an effective role of second guessing or inquiring into the policy decisions and finances of the companies concerned.

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I suspect that my hon. Friend will refuse to accept the new clauses--I suppose that it would be impossible for him, as a newcomer, to move against the system, which has been in place for a long time in the Department. The system has won : it has put the House down time after time by ordering Ministers to resist this necessary measure--and I do not know why. The House of Commons, which is sovereign, has often said that this is a necessary measure, but, due to a gross error of judgment by Ministers of both parties, they have been persuaded not to proceed along the lines adopted in other countries.

I have great personal respect for my hon. Friend the

Under-Secretary. I suppose that Ministers are still not persuaded to move from a purist view of the common responsibility of directors in a unitary board structure. None of those common responsibilities will be affected or undermined by superimposing on a unitary board structure certain additional responsibilities or overt

responsibilities that directors must be seen to be carrying out. They are responsibilities that all directors should carry out already, but this measure will concentrate their minds because non-executive directors will know that they have a statutory responsibility to report to the annual general meeting. They will have a similar responsibility to hear from the accountants if they are worried, for instance, about the extent to which they are lending to another company and about other financial arrangements that may appear slightly suspect.

How many scandals and personal abuses of corporate money would have remained uncovered but for the existence of non-executive directors? Various examples have been mentioned and Blue Arrow may be one of them.

The problem arises in the many companies in which an individual controls the show and is unwilling to have on his board--and if he has them, to use them as an audit committee--some non-executive directors. If we maintain our unitary board structure and do not pursue a continental style of supervisory and executive boards--there is much to be said for maintaining what has proved good in the past--I believe strongly that the time has come for, and circumstances have shown the necessity of, having non-executive directors within the unitary board structure. Urging people to accept this voluntarily will not work in the companies that we most want to accept it.

Pressures exerted by people like myself and others in the House and the City on the stock exchange to make it a listing requirement of public limited companies to have an audit committee and non-executive directors have not been accepted. As so often, that is the trouble with our system of self-regulation : moves are made after events have pre-empted them. In other countries it is a listing requirement for major companies on the exchange, so why not here? Why does not our stock exchange council do exactly the same, at least for the plcs? Large private companies to which the same obligation should extend will remain, but if the plcs refuse it, there will still be problems. As long as a massive amount of personal and financial patronage rests with a few corporate individuals in this country, recent experience should have shown us that there is a strong case for a departure from the reluctance, conservatism and innate resistance on the part of the DTI's advisers to Ministers to allow a change that was universally accepted in the House on a previous occasion and that received enough support in Committee to enable the matter to be considered again tonight.

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I respect my hon. Friend very much and I beg him, even if he cannot accept these measures, to throw away his notes and to speak to us from the heart telling us why he resists them and whether he will keep the door open for such a change. It would be a grave personal error of judgment, as well as a massive political one for our party, so to set ourselves against this provision that future events will be a hostage to fortune. I am not prepared to be a part of that. I have made my position clear and, like my hon. Friend the Member for Beaconsfield, I shall be consistent and support the new clause.

Mr. Campbell-Savours : The speech of the hon. Member for Chichester (Mr. Nelson) reminded me of debates in the Committee stage of the Financial Services Bill, when he put the case for a number of new clauses and amendments as eloquently as he has spoken this evening. He and I joined together and conspired behind closed doors to try to see those amendments through the Committee. I do not mean that in any distasteful way. The proceedings on that Bill are clearly replicated by the proceedings on this Bill, whose Committee stage I was unfortunately unable to attend, although that was my fault, and I regret it.

The issue that the Minister should tackle tonight is the one that I had to address as a member of that Standing Committee in 1986. When the Financial Services Bill was put before the Committee, Conservative Members were eager to accept the principle of self-regulation, and I understand why. Early in the debates on the Financial Services Bill most of the argument took place between Labour Members who questioned whether self-regulation could work. By the end of the Committee proceedings, I was one of those hon. Members who, following discussions with various institutions in the City, had accepted the proposition that self-regulation would work and I was willing to give way on statutory requirements, which we had begun by vigorously pursuing. I thought that if it were possible to introduce a system of self- regulation which people were motivated to ensure worked because thereby statutory controls would be avoided, that would secure the same objective. The arguments are similar this evening.

We have two propositions before us. There are those who say let the law take its course and let those directors who default be found and prosecuted, and there are people who say let us have a system based on some form of self-regulation whereby people within the company, with an arm's- length relationship with it, are able to monitor, check and observe its activities, particularly its financial arrangements. It is clear that these audit committees would work on an arm's-length arrangement, rather than its being exclusively the responsibility of management reporting directly to the main board.

I view this proposal in the same light as the debates on self-regulation during the Financial Services Bill Committee in 1986. The Minister should view them that way, because the alternative is clear.

I have brought a number of cases of fraud companies--sometimes large companies--to the attention of the House. I have wondered how it would be possible to check on them without setting up a huge statutory authority which could meddle in the affairs of companies in a way that right hon. and hon. Members on both sides of the House would find unacceptable. These proposals would provide a mechanism that could secure that objective.

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The hon. Member for Richmond and Barnes (Mr. Hanley) has drawn my attention to a document that encapsulates my point very clearly--a report by Peat, Marwick McLintock on the audit committee. The introduction says that, in recent years, the presentation of financial information by commercial organisations has been subject to increasingly stringent standards of accountability. This trend has been accompanied by a few highly publicised instances of fraud and corporate failure which have focused attention on the stewardship responsibilities of the boards of directors, particularly in relation to the fair presentation of financial information and the accounting controls of the business. The board of directors is legally responsible for ensuring that the financial statements give a true and fair view, yet the board's detailed involvement in the preparation of those accounts may be minimal.

These people are reputable and know all about these matters. I presume that they have been campaigning on them for years and have consulted widely, as did members of the Committee. The board's detailed involvement in the preparation of those accounts may be minimal, however, as the financial management usually prepares the annual accounts. The board may often rely on an external auditor's expertise to ensure that no material misstatements exist. These people understand the problem and they are making a proposition. They know it works and, as the hon. Member for Chichester said, in other countries such arrangements are already standard practice. I support the view that he advanced that, if companies want to be listed, they should be required to comply with the arrangements, if only to safeguard the interests of shareholders in companies where large shareholdings may be held by individual directors whose power and influence on the affairs of the company is therefore draconian. Surely inside those boards one needs a committee or some independent directors who can report and give a more arm's-length, independent view of what is happening.

8.45 pm

I do not want to undermine my case, but I shall draw the House's attention to one independent directorate with whom I have had some dealings in the past few months which is well known to the hon. Member for Beaconsfield (Mr. Smith). The Observer newspaper has a board of independent directors which was set up prior to the takeover by Lonrho, but I feel sure that what we are advocating is not similar to that arrangement. It was a way to try to reassure the public, journalists, readers and others that the company would not be unreasonably manipulated by Mr. Tiny Rowland and his cohorts in Cheapside. Unfortunately, that board of independent directors did not do its job properly and the newspaper has been manipulated, which is why its circulation has fallen so dramatically and why it will probably be out of business in no time. That is something that the journalists on that newspaper have to sort out and it is to be hoped that Mr. Tiny Rowland will divest himself of control of that newspaper. That is not the kind of independent board of directors that we are looking for. We want a body with teeth, which has an arm's-length relationship, and which will report and consider the financial affairs of a company independently.

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