Select Committee on International Development Minutes of Evidence

Examination of Witnesses (Questions 614 - 639)




  614. Can I welcome you to the Committee, very wholeheartedly, this morning. I know that you have had to give up some very important work to come here, but we do need you here to tell us more about this subject of corruption. Mr Davis, first of all, could you introduce your colleagues today to us, and then I believe you would like to make a short statement?
  (Mr Davis) I think I can do it all in one, Chairman.

  615. Yes, indeed.
  (Mr Davis) Can I just say that we are very pleased to be here. I am sorry there was a little to'ing and fro'ing as to whether we could be here. I was in the United States last week and it is one of those wretched bits of communication that did not work, and I am sorry it is on this occasion, but we are very pleased indeed to be here. My introduction is going to be by way of introducing the experience we have before you, so you can direct your questions.

  616. Thank you very much.
  (Mr Davis) I am Roger Davis, a Senior Audit Partner in PricewaterhouseCoopers, and I think you will know that we are the largest auditing firm in the UK and probably in the world as well. I am also Head of Professional Affairs; that rather elaborate title means that I am responsible for working with Governments, the regulatory community, to develop the framework within which we, as accountants and auditors, operate. We are, as you probably know, a pretty highly regulated profession. So that is my main responsibility in the firm. I do bring many years' auditing experience of multinational clients. It may interest the Committee to know that I was Deputy Chairman of the Turnbull Committee in 1999. The Turnbull Committee produced the official guidance for companies, listed companies, that is, and most multinational companies are listed, listed companies, on what they should do to maintain a proper system of internal control, and all that was within the established UK Code on Corporate Governance, written by Sir Ronald Hampel and his Committee. So that is me. On my left I have Rick Helsby. On my right I have Ian Trumper. Rick is a Partner, Ian is a Director in what we call our Forensic Investigation Unit; they have a wealth of experience, particularly overseas and in some of the less developed countries, in actually investigating for Governments and for businesses what has gone wrong, why it has gone wrong, in the whole area of fraud and corruption. I think, Chairman, that is all I want to say. That is the experience you have in front of you, and we will be very happy to take whatever questions you would like to throw at us.

  617. Thank you very much. It is very important experience, and we welcome the opportunity to question how we deal with this question of corruption. We really want to ask, first of all, if we could pinpoint what you see as the role of the audit function and the broader accountancy function in stemming the tide of corruption in all its forms? What we mean by this is not just grand corruption, I want to ask you another question about that, grand corruption, but also petty corruption and the question of the tax treatment of petty corruption. Have you got any responsibility, in your audit, for saying, "This is money paid corruptly to other people"?
  (Mr Davis) I am afraid, Chairman, what I think it is necessary for me to do is just take one or two of your minutes in setting the scene as to what an audit is, what an audit does, is required to do, and then, within that context, to do my best to explain what the responsibilities are in this particular area. I hope that does not take up too much time, but please interrupt me if it does. The auditor in this country, and that goes for virtually every country in the world, the primary responsibility, given to us in this country by the United Kingdom Companies Acts, is to report to the shareholders that the accounts show a true and fair view of the financial position of the company; that is our prime, statutory duty. Within that, we have various other responsibilities which are set by auditing standards convention, and so on, and chief amongst those is to examine the system of internal control of the company. There are a number of reasons we have to do that. First, it is impossible to give an opinion on a set of accounts without understanding the controls that a company has. If you can imagine, any multinational company would have many, many millions of transactions every year, you would need a quarter of the population as auditors if we were to go and check them all, you cannot check all the transactions, you have to rely on the controls. So we have a very important role in looking at the internal controls, to assess the adequacy of them, so we know how far to delve down as a result of our audit. Secondly, the Turnbull Committee I mentioned has actually indirectly imposed a responsibility on auditors to report to the board of directors of a company, on their internal controls, before they make a public statement that they have reviewed the effectiveness of their controls, which is what that guidance requires. So I am sorry that is a long-winded way into your question. I will now focus down on your question. Internal control, as defined by the Turnbull Committee, this is the latest definition, is something that covers the effectiveness and efficiency of operations, reputational assurance and compliance with laws and regulations. The guidance on internal control requires that every listed company, and we are only talking about listed companies that all this applies to, number one, the board must itself ensure there is an adequate system of internal control covering those things; number two, every year, when it produces its annual report, it must say that it does have that system of internal control, and that it has reviewed its effectiveness; and, number three, the auditors, as I said, have to assure the board, before they make that statement, they have gone through due process. I am sorry that has taken up a little bit of time, but that is the background and the context. Clearly, if we are, as auditors, to report that the system of internal control is functioning correctly, which we do for the purposes of the audit, we have to look at all the procedures the company has, we have to test the procedures the company has, right round the world, and those procedures will include the procedures the company has designed to ensure, as I said, compliance with laws and regulations. Shall I just pause at that point, because I said it will go on a little bit, but it was important to set the scene in that context.

  618. Yes. Of course, this deals with the internal organisation of the company, as you have just described, which is important, of course, because fraud and bribery can take place within the company. But what we are, I think, most concerned with is the conduct of that company in relation to other companies and other persons in the society in the country in which it is working, and your answer is that you can only ensure that it is in compliance with the laws of that country.
  (Mr Davis) Indeed.

  619. So if the laws of that country forbid bribery, for example, and they are bribing officials in the Government, or in other large companies, is it your responsibility to identify that and report it?
  (Mr Davis) It is our responsibility, in the first place, to report it to the management of the parent company in this country. Invariably, not in every case but invariably, the board of the company will have policies on these matters and it will want assurance from the auditors that those policies have been complied with; they will be consistent policies throughout the group. There will be an X-plc way of doing things, if you like, in that, and the board will want our assurance that the X-plc way of doing things has been complied with. We have also professional standards, both national professional standards and international professional standards, external standards and not PricewaterhouseCoopers standards, which tell us what to do if we find a breach of a law or regulation, and the kind of thing that your Committee is discussing is clearly a breach of a law or regulation. Those standards, as they are presently written, and those are what we have to comply with, require us in the first instance to require the board to report that breach to the relevant authorities; they require the board to report the breach to the relevant authorities, not the auditors. Those standards at the moment explicitly say, because of reasons of client confidentiality, it is for the board and not the auditors. There are exceptions, like money laundering, and so forth, but that is the generality. If the board declines to report those breaches to the authorities then the standards require us to consider our position and take legal advice. Now, as a generality, if we are dealing with a company which is not prepared, as a generality, the term corporate governance has been mentioned quite a lot this morning, if we are dealing with a board which is not prepared to go by the normal rules of behaviour, ignores the request that we are making, ignores the recommendations we are making, we will part company with that company.

  620. You will simply end your audit contract?
  (Mr Davis) It sounds like marketing is not meant to be, ours is a very reputable name and companies seek our name; companies seek our name sometimes for the wrong reason. We have very, very strict procedures through which we go before we will accept our clients so our name is not used for the wrong reason. So, in our business, this situation does not often arise.

  621. From what you have just said, you do not actually have any responsibility to refer these matters to the police, except in the case of money laundering, I think you told me?
  (Mr Davis) Money laundering in the UK, there are very strict rules. I believe the rules at the moment are that, for money laundering in relation to drugs or in relation to terrorism, we have a statutory duty to report those matters, and we report suspicions, to the police direct, but that is the only exception.

  622. It seems to me though, if you end your contract of auditing when you find these practices and you cannot get the right reaction from the board, you simply withdraw, obviously because you want to preserve your own reputation in these matters. But would it not be better if you actually issued a report, either continue the audit and, in fact, qualify the audit, or, alternatively, make a statement to an authority that you are ending this contract because of the practices that you have found which are unacceptable?
  (Mr Davis) Frequently, when I say frequently, this does not actually happen very often but when it does happen we often do go through and complete our report and qualify the report, it will be probably quite a long report, qualified on lack of internal controls, the lack of willingness of the board to put the controls in, and so forth. We also have an obligation, under the UK Companies Act, if we resign as auditors, to put a statement on the file at Companies House, a public statement, setting out any reasons that creditors or shareholders ought to know, in connection with our resignation. And obviously we have to take legal advice on those statements, sometimes we have not completed our audit so we have not actually proved anything, but those statements will often say that there has been a breakdown in the mutual trust between an auditor and the board, and that kind of thing. Those who understand it will see some very severe warning signs in that kind of statement.

  623. For the interests of transparency and so that the legal mechanism can be brought into action when we find fraud and bribery and money laundering, would it not be better if the law of this country required you to declare this?
  (Mr Davis) Money laundering, I have sort of dealt with, to declare that we have evidence of corruption. George Staple made a suggestion that perhaps the chief executive should be required, in an annual report, or the chairman in the annual report, to make a statement of, I cannot remember precisely what he said, but of the company's policies in relation to illegal acts of this kind, and the auditors should report on it. I do not think this is the specific answer to your question, but I wonder if we could come to it in sort of that direction. The first thing I would say about George Staple's suggestion is that I believe that we, as a profession, are edging up on it, it may not be going quite as fast as Mr Staple would like, we are edging up on it in a number of ways. I have mentioned the Turnbull Report. Every listed company in the land, for the first time, just about now, because it applied for the calendar year, the calendar year 2000, will have to report that it does have a system of internal controls in line with our guidance, and the auditors have to report on it. We are edging up on it, because I think somebody also mentioned the Company Law Review, I am also involved in that; the Company Law Review recommendations are being produced by an independent steering group, but they are suggesting much more social-type accountability by companies, and an audit role in that. So that is another way we are edging up on it. We are also edging up on it, my own firm is promoting, with companies, much extended reporting, both in terms of what is of value to shareholders but also to other stakeholders, on corporate responsibility. So everything is moving in the right direction; it might not be moving fast enough. Against that background, to come to your specific question, should the law require us to report specific items of corruption, I do not think I have any great difficulty, in principle, with that. I have two difficulties, in practice; one, will it be possible to sort of craft a law. We would have to act very, very carefully, as you would imagine, Chairman, on that, we only have qualified privilege; how far it would be possible to craft a law which adequately defined what we needed to report on. That is the first difficulty; these are very practical difficulties. And, secondly, I would not want to raise the expectation too high that somehow auditors can uncover all corruption, sometimes it is very, very difficult, even after the event it is sometimes difficult to prove that there was corruption, so I would not want to raise the barrier too high in the first place. But I think it is certainly something that can be looked at, yes.

  624. You see, BP has given us evidence that it does, in fact, permit, under its code of practice, within its companies, what it calls facilitation payments, which is, if you heard the evidence led this morning by Mr Raphael, he said that the facilitation payment, which is another word for bribery, is no different if it is a small amount than if it is a very large amount. And, therefore, BP is permitting bribery, in its work, in some countries, because it is the culture, they tell us, it is the way business is done, those arguments. And they get their accounts audited and they are not qualified. Equally, also, I understand, in some instances, those facilitation payments are actually claimed against UK taxation. Now, obviously, if BP tell us that, that that is what they are doing, and they have a British auditor, then that is something which is general practice, is it?
  (Mr Davis) The auditor in the UK does not have a duty at the moment, or indeed a right, under professional standards, to report, external to the company, anything that might be categorised as bribery, facilitation, whatever term you like to put on it, we simply do not have that right or the duty under professional standards and the law as it stands. We would certainly see it as our duty to tell the board. A number of people have mentioned the importance of corporate governance this morning, I would absolutely endorse that. If you have the right kind of board, good, independent directors with the gravitas necessary, and you put these things to them, that sort of gets dealt with, or at least there is a mature discussion in that boardroom of what is acceptable in that company or not. But at the moment that is as far as the duty goes.

  Chairman: That is the position; yes. Thank you. Mr Jones is going to continue the questioning.

Mr Jones

  625. You have almost answered this, but I was going to ask how easy it is to spot corrupt payments, because we had David Phillips, from the Crown Agents, tell us that he did not expect that anybody had a line in their accounts saying facilitation payments or bribes, but they might have something called petty disbursements. How is it possible to spot these?
  (Mr Davis) I am going to ask one of my colleagues, in fact, to speak, because they have more direct experience of this.
  (Mr Helsby) The short answer is, of course, extremely difficult. Most of the cases my team tend to deal with are those cases where it has come to the company's attention there has been some sort of economic irregularity or other, and they come to us and ask us to investigate thoroughly, that has victims and people who want to address their shareholder and stakeholder concerns; so we are dealing with the people who have got good corporate governance procedures in place and have come across instances where they are concerned about an irregularity. But in terms of, I think, the small-scale payments, which the Chairman has been referring to and which, in fact, you are referring to, it will be extremely difficult to find them in accounts, because by their very nature they are meant to be hidden; when they do come to companies' attention then very frequently they address these with us and we start investigating the full scale of them.

  626. So are you saying that you need somebody else to trigger you to say that there might be something?
  (Mr Helsby) Sure. So far as the work which I do and my colleagues do in the forensic investigations practice, which is nothing to do with our audit practice, of course, then where our colleagues from the audit practice, or the clients direct, come to us, having got issues around economic crime, fraud, or what have you, then they come to us and then they have usually got some evidence to come to us with, and we then work on that evidence. There may be a number of other instances, any number of other instances, where they have not got that evidence and which do not come to us. So, in answer to your question, it is very difficult, the cases we find are those where the corporates, or the NGOs, or what have you, have discovered the financial irregularity, and we spend time trying to quantify that, in order that stakeholder, shareholder concerns can be properly addressed and matters put right for the future, and, indeed, hopefully, the prosecution authorities instructed as well.

  627. But you do not turn a blind eye, if there is something in the accounts that looks a bit fishy, you actually try to get an answer as to why it looks fishy?
  (Mr Helsby) That is our job, yes. When addressed with these things, that is our job, to understand exactly what was the background to that transaction.

Mr Colman

  628. If I may press you a little bit further. You seem to be inferring what happens in terms of the internal audit has nothing to do with you, that you are only involved, if you like, in terms of the formal auditing of the books. We heard, when we took evidence from Unilever and from BP, and I think Balfour Beatty did the same, that they had a high level committee of the board which would look at these issues of corruption, of codes of practice, how these were followed through. Would PricewaterhouseCoopers, or any of the other major audit companies see themselves as, if you like, ex officio members of such internal committee arrangements, knowing what was going on, to ensure that the internal audit operation, where you would perhaps be able to look at how this line, petty disbursements, what was acceptable, was not acceptable; we have heard that, our evidence is, it is not acceptable, it is all bribery? Are you involved in these codes of practice, in the monitoring of them, in major multinationals, and being able to, in that way, if you like, supervise the internal audit as well as, in a sense, the external audit?
  (Mr Davis) The first point I would like to make is that the external audit and the internal audit operate very closely together, they may have different functions, we operate very closely—

  629. Perhaps I will call it the management audit, which goes on month by month?
  (Mr Davis) We will operate very closely together; the companies like us to do it, it saves them money, and it is much more efficient. So there is no question that somehow we are doing separate things, that would be rather silly. Internal audit and external audit tend to come together first at the beginning of the year when the audit plan for the following year is being set out. Usually, that will be under the auspices of an audit committee, but there may well be, as you say, another committee, an ethics committee, or whatever, and there are more of those actually that are now developing where we come together as well. And there will be a mutual discussion of plans, with the audit committee of independent directors, of how far external audit scope was going this year, how far internal audit scope was going this year, an assessment by both internal audit and external audit of where they saw the risks around the world, an assessment by management, who are likely to be at the same meeting, of where they see the risk. So there is a good brainstorm before the plans are actually hatched for the following year's audit. So, yes, it does come together very much now. We would also discuss, we are quite often asked, as a firm, although we have to be careful with our independence, we have to be careful that we do not operate as part of management, we are very frequently asked by boards these days, "We've got our code of ethics; how does that compare with what you would regard as best practice, do you think we should have something like this in the code of ethics?". The most frequent question an auditor gets from the board is, "What do your other clients do?", for all the good reasons, they want to learn from the experience.

  630. But do you advise, where you have that formal arrangement, that this sort of area of facilitation payments, or bribes, is not acceptable, and that you wish to unpack, if you like, this line which says petty disbursement and that this is not acceptable, and would you perhaps be able to tell us to which particular companies you have given such advice?
  (Mr Davis) We do not think it is our role, as auditors, to pass what I might call moral judgements on what is acceptable or not; what we will do is, if somebody says, "What do other clients do in this area?" we will tell them. To pick up a point I think the Chairman made, we will never ever turn a blind eye to anything that we see; so we will insist that there is a code of practice, we will want to know that that has been rigorously looked at by the whole board. Of course, as auditors, our starting-point is that you do not want to be involved in anything of this kind, that is the natural thing, in fact, but we would not see it as our job, as auditors, to insist that a client had a sort of zero tolerance, that is not condoning it, it is not our job, that is a judgement of the management of the company.

  Chairman: Now, Ann Clwyd, can you lead us on corporate transparency.

Ann Clwyd

  631. Mr Davis, if one of the firms that you audit was accused of corruption in another country and the matter was before the courts, is this not a matter that ought to be reported to the shareholders in the annual report?
  (Mr Davis) If it was in the courts, it quite probably would be, for the very simple reason that there may be a major cost to that company coming up in whatever penalties are imposed, and that is financial information of great importance to the shareholders. So any legal action which is being taken against a company would be looked at extremely closely by the auditor for the effects that is likely to have on the financial position of the company.

  632. Have you any examples, where you have actually prevailed on a company that did not want to reveal information of that kind to reveal it subsequently, against their will?
  (Mr Davis) I cannot immediately call to mind any examples in the area directly of corruption, in the terms the Committee would think of it. I can think of many examples where companies are being sued for questionable business practice, making a cartel, or something like that, where obviously there is a natural reluctance to disclose it, because companies would say that you disclose your hand in your negotiating position, I am sorry, it is simple, we put our foot down and say that has to be disclosed.

  633. What I am after, I think, is a definition of transparency, because witnesses have said, in evidence to us, that there is a need for greater corporate transparency, and I wondered if there were international accounting standards, and, if so, are they widely applied, or does local practice, regulation and expectation often take precedence over the international accounting standard?
  (Mr Davis) Ms Clwyd, an enormous amount of effort is now going into international accounting standards; it was actually stimulated by the profession, several years ago. We thought it was essential that, as I say, finance is the language of business, it must be an international language. There is an immense amount of effort going into international accounting standards, with a view to, just as you say, more transparency. Now the starting-point in that is not so much transparency in terms of, if you like, the business mores, it is transparency in what the basic finances are. I think it is well known, quite a lot of people say, that the Asian crisis was stimulated, or helped along, because there was not transparency in the published financial accounts for a number of Asian countries. I think there may be an element of truth in that. You have to realise that in many Asian countries there has not been the same kind of need for transparency, this sounds odd, but many Asian economies are effectively controlled by large families, the large families did not need the transparent information that a very liquid capital market, like London and New York, did, where the ownership and the management of the companies is completely separated. So the first bit of work that is going on, and it is very, very active now, is to bring the whole of the world up to the standards of Anglo-American transparency, just in basic accounting; if that is the profit, that is a profit under a set of internationally established rules. There is also a lot of work going into international auditing standards, because there is no point in having one standard for accounting unless the auditors are working to one standard; so that is happening as well. Where the work, I would say, it is born but it is still in its infancy, is on the kinds of areas we have been talking about, what is actually disclosable in terms of an exceptional, unusual, business transaction; and the work has started but it is not nearly as advanced as getting the basic accounts right in the first place.

  634. So the answer really is that there are not any international accounting standards; you are attempting to obtain them, but at the moment they apply in some parts of the world and not in others?
  (Mr Davis) What I would like to see, and I think the UK actually has a leadership position in this, in terms of expanding the scope of corporate reporting, as I said, I think, to the Chairman earlier, what I would like to see is us moving in steps. The present position is not satisfactory, the present accounting is not satisfactory, the present accounting looks back, it just looks at the historical transactions, they do not give you an idea of the value of the company to the shareholders, or to the other stakeholders in the company. What I would like to see, what my firm would like to see, what we are encouraging, and I think this is the way we are moving, is a progressive and quite rapid move to much wider corporate reporting, in a much more structured way than it is at the moment, and audit it, so that companies' policies, this is, first of all, that you get a clearer feel of companies' strategies then you get a clearer feel of their policies, including their social policies, and so forth. But you have got to go through that stage first, I think, and when you have gone through that stage you can look at, well, how do deviations from those policies get reported.

  635. Can I just ask you, because you operate, I think, in Eastern Europe, do you not?
  (Mr Davis) Yes, we do.

  636. In many Eastern European countries, for instance, in the former Soviet Union, where corruption is a problem, and a growing problem; now if you are actually operating as auditors in that environment, where there are different expectations, how do you work?
  (Mr Davis) With some difficulty. It is my firm's policy that if we are going to put my firm's name on a set of accounts then, as far as possible, those accounts have to be up to the best international standards. Now I qualify with "as far as possible", and this is a big problem for us, for this reason, and I am not talking about the Soviet Union at the moment, but I can think of a number of other countries where the local regulatory authorities, whether it is government or some kind of securities regulator, simply will not allow us to produce accounts that come to the acceptable standards.

Mr Worthington

  637. Can you say where they are?
  (Mr Davis) I can identify, there is a lot in Asia. I think, if I were to name countries, I would want to check exactly where we are at the moment, because we are in negotiations with quite a lot of these countries at the moment, and I think to mention a country I would probably find that it is one where we have now settled the problem, but there are quite a lot who say, "Those are the rules for accounting in this country." We have had instances where the problem we have is that some of those countries will say, "If you want to practise here, you will practise according to the rules of the country." Now we are pushing back at that all the time, in fact, and I think we are being quite successful. People do say, "Well, we're an accounting firm; why aren't we solving it?"; it is quite difficult to solve it on your own. What we do need is the support of the international securities regulators, we need pressure from people like the World Bank, IOSCO, the International Organisation for Securities Regulators, and so forth. So, initially, that is why the accounting firms now, and I do not want to go off at too much of a tangent, we have developed something called the International Forum on Accounting Development, this was an initiative of the big five accounting firms, it has regulators, it has stock exchanges on it, that is a forum we have developed to bring much more pressure on those countries that will not fall into line, and it is starting to work.

  Chairman: I think we should go on now, to operating in corrupt environments.

Mr Worthington

  638. It is directly following on from what Mr Davis was saying. I am puzzled about this. You are saying that there are countries where you are not allowed to operate to decent accountancy standards, that the regulating bodies do not exist, but you have not withdrawn from any country, as far as I understand it?
  (Mr Davis) It is an option that really is not available to us. I will make two points on that, I think. First, what is in the public interest, that we stay in there and try to get the thing changed, or just come out? Secondly, our multinational clients, if they are investing there, they need us there. Now if we come out they have to come out, and what is that actually doing for the economy of the country. So it is not an easy call.
  (Mr Helsby) Can I make an observation on this one, which may be helpful to you, and I think actually it supports very much what Roger Davis has been saying. One of the clients I am acting for at the moment is in an African country and he has suffered a fraud, and I can tell you more about those circumstances. But, so far as it relates directly to what Roger Davis is saying, I did ask that client, "Why on earth is a multinational, with billions of pounds of turnover, in this corrupt environment?", what were they doing there, because they had suffered a relatively small fraud, about a quarter of a million dollars, on a company with a turnover of about $1.5 million, tiny in comparison with a multi-billion-dollar turnover of this company, "Why are you there?". And he said, "We are there because our clients are there, and our clients need our services; where we're delivering what they need, we have to be here to do it." And I think that is probably entirely relevant to PricewaterhouseCoopers' position in some of these developing countries.

Ann Clwyd

  639. But then you are saying that, on occasions, you have to turn a blind eye; you may say it is in the best interests of the country, you may say it is in the best interests of your clients, you may say you want to change the climate?
  (Mr Helsby) I do not think I was saying that.

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