Examination of Witnesses (Questions 240-256)|
TUESDAY 25 JUNE 2002
240. My point is, would we not be coming at
it from the other side, not your side, that you would be presenting
to the global business community very, very tough and strict rules
of audit and accounting, big hurdles to cross; is there not a
risk that they would say, "Right, we won't base ourselves
in the United Kingdom, we'll get out"?
(Mr Simms) Can I make just a couple of comments on
that. Just going back to some fundamentals about how markets operate,
one of the things which classically underpins market failure is
a lack of information; what we are talking about doing is making
more information available. What we would hope is that, with these
better reporting requirements, you would have more trust in the
market-place, you would have less volatility and less instability.
And, just in case it sounds like it is coming from way out of
left field, as a proposal, we dug around and discovered that,
in the 1920s, the Chairman of General Electric, Owen Young, was
pushing the idea of stakeholder boards, as a fundamentally different
model for corporate governance. These are ideas that perhaps do
the rounds, depending upon the levels of instability; and I do
believe that instability, market instability, is a major issue
at the moment.
Chairman: We mentioned Company Law Review,
so maybe Jim Cousins could go into that one.
241. In a sense, you have already covered this
ground, but just to reiterate it, your view of the proposal in
the Company Law Review for an Operating and Financial Review that
looks forward is that it will not prove adequate; and it will
be helpful if you just set out the reasons why you do not think
it will be adequate?
(Ms Doane) Right now, the OFR, in its proposed format,
recommends that directors consider reporting on social and environmental
issues, not on financial issues, where it is deemed to be relevant
to a company's operations, I believe "material" is the
legalistic term there. Why does that fail; well, it is up to directors'
judgement. We already know now that companies fail to report and
consider these issues, and they do not necessarily perceive them
as being relevant till it is too late. If we go back several years,
you can look at Shell as being one example. We only have less
than a third of the FTSE 350 reporting on the social and environmental
impact, only 16 of the 79 companies that are actually issuing
reports put any relevant, measurable, social indicators whatsoever,
in spite of the fact that there is a very full set of guidelines,
the Global Reporting Initiative, out there. The OFR will not make
things any different; companies do not want to put their head
above the parapet, if there is no need to, because it is a risk
to the company, it is a risk to shareholders, it is a risk to
society, and it may reduce their share price. So, the OFR, if
it is not deemed to be relevant, and it leaves it up to directors'
judgements, there are no considerations on wider stakeholder issues,
it is up to directors.
242. Now one of the ways this issue is tackled
in the United States is through listing requirements on the New
York Stock Exchange, the 20F statement, which is, in effect, an
Operating and Financial Review. Because the responsibility for
listing now lies with the Financial Services Authority, have you
approached the Financial Services Authority to see what work they
are doing on listing requirements, because, if listing requirements
covering the ground you want to cover were imposed, that would
completely bypass the need for parliamentary legislation?
(Ms Doane) I have to say, one of the concerns we have
is, and I face this every day, trying to muddle my way through
these things, there is a great deal of confusion, these things
are embedded in company law, they are in the OFR, and the OFR
should be covering that, but yet, if you are saying we should
look at the FSA and their rules, these should be compatible, what
is in company law should be absolutely compatible with what is
in listing rules. The problem with looking solely at listing rules
is, you are dealing only with London-based companies; we are looking
at extraterritorial issues as well, in respect of company law.
(Mr Simms) Maybe, just as a brief post-script to the
previous question, as well, going back to first principles, what
are the values that we hold good for the operation of good markets,
and increasingly we hear, coming from the G7, from Gordon Brown
and his equivalents, in the G7, that the fundamentals are about
accountability and transparency and these are essential to stable
market-places, and yet we still have the situation where Britain
gets brought to book for having the highest number of its multinationals
not living up to the OECD guidelines on bribery and corruption.
So we feel there is kind of an awful long way to go.
243. The emphasis of today's conversation has
been on accountancy, but before you get to the accountancy the
directors of different companies have their own responsibilities,
and they take the primary responsibility for some of the things
that have gone wrong. We have had, in this country, several different
looks at corporate governance, Cadbury, Hampel, Greenbury; how
do you see some of these problems being corrected by changes in
(Ms Doane) I am not sure I quite follow the question.
244. The issues we are addressing are that companies
have gone wrong, they have misstated their financial position,
and that has not necessarily been discovered by auditors; but
the initial target ought to be the directors. How can these circumstances
be avoided by changes in corporate governance?
(Ms Doane) By widening out accountability, by adding
extra levers of control through stakeholders, I think it would
place a great deal of potential impetus on change and transparency.
Let me give you one example, that I was speaking to some people
at a conference in Oxford last weekend, and when they said, "How
would you actually implement stakeholder accountability, it's
unwieldy, it's ridiculous, we can't have that, we have to keep
things narrowly with directors?" Let us look at an environmental
example. Company X is polluting in the river, it does consult
with their stakeholders closely, the provincial boundaries, or
the regulation is national; what good does it do, what happens
to company Y, who is beyond the boundaries of where they are accountable
to, is having to pay for the effects of the clean-up, in effect,
so that their factory can operate. As soon as you widen accountability
to stakeholders, regulation happens at a civil level, that company
raises the issue to company X and they in turn deal with the issue,
or the barrier. What that does is it makes the problem more open
245. If I might interrupt, I do not think you
are really addressing the question I am raising. I am raising
the question of the company, a board, or a company, structured
presently with executive and non-executive directors, with various
precepts as to what the directors' responsibilities are; how can
that arrangement, if it can, be reorganised to ensure that we
do not get the Enrons, we do not get the Equitables, we do not
get people who are, deceptively, presenting false accounts of
the company's behaviour?
(Ms Doane) And what I am saying is that you need a
board structure that is not just executives and non-executives
getting information from inside the company, that you need a wider
board structure, that has stakeholder representation first, and
you need them to get information from outside the company and
ensure that that is fed into the system; it cannot only come from
246. Why cannot it come from within; directors
read newspapers and they are members of society too?
(Ms Doane) The impacts of companies and what is happening
outside of companies, but, at the moment, they are only concerned
with the financial impact; if that is their only concern, that
will be a myopic view and where you end up at the end of the day,
if you do not take into these wider considerations information.
There is also, if you look at the case of employees who are getting,
they are all part of the system, they are getting share options,
it is in their interests to make sure the financial bottom line
wins at the end of the day. You have to have people who do not
have a financial stake in the company.
(Mr Simms) We are basically arguing that the whole
governance structure should be opened up, to resemble not a shareholder
arrangement but a stakeholder arrangement; so that, as Deborah
says, everyone from the local community, where a particular firm
might be based, through to its staff, everybody who is directly
or significantly indirectly impacted by the business should begin
to have a stake in the decisions that are made.
247. Can I suggest that it is not easy to define
such stakeholders, is it?
(Mr Simms) It is not, and it will be different, depending
upon which sector, which kind of company you are looking at. What
we can say is that we have outlined some proposals about how such
stakeholder boards would work, and we can certainly send that
through to the Committee for consideration.
248. Can I move on from there, because another
central element of the criticism of the Big Five is that they
are providing audit services with other services, and they are
cross-subsidising the two. Do you support a complete prohibition
on auditors doing other work for companies?
(Mr Simms) I have to say that we came to the conclusion
that a basic measure that was necessary, which I do not think
we are alone in thinking, this, is that there should be a complete
separation between the function of auditing and the provision
of other services. We have looked at some of the academic surveys
that have questioned people in the profession; we think, even
within the profession, there is an awareness that there are compromises,
there are conflicts of interest, which automatically emerge as
soon as the value of the ancillary services you are providing
gets close to or overtakes, as they have, the value of your basic
249. Have you looked at the possible impact
on the cost of accounting services of doing that?
(Mr Simms) We do not have sufficiently sophisticated
economic models to be able to guess what the outcome of that would
be, no; so we cannot answer that now, no.
250. Could it not mean also that you would have
some very narrow auditors who have no experience outside their
(Mr Simms) One of the problems that we do have at
the moment, in terms of the proposals that we are making, is from
where would you draw your new generation auditors who are going
to be aware of and sensitive to other issues, such as social and
environmental issues. And one of the criticisms that we do have,
even though this is obviously not a mandatory requirement and
not part of the formal audit, is that, as the more progressive
companies have started to report voluntarily on their social and
environmental performance, they are going to auditors who basically
lack the skill set to be able to provide intelligent and detailed
reports of that nature. Some of the early attempts by the Big
Five, as they have moved into that market, have been embarrassingly
poor in quality, and we mention a couple of those in the report.
So it is certainly the case that we believe, as public expectations
of corporate performance change, and as these conflicts of interest
continue, that there will need to be a new generation of auditor,
significantly more independent than the ones that exist at the
moment, significantly more sensitive to a wider range of concerns
than just the bottom line.
251. In your paper, at one point, and you have
referred to it again this morning, you do refer to this issue
of intangibles; and this is a point that I put to the representatives
of the institutes when they were in front of the Committee, and
they did not demur from a ballpark figure of 70 per cent of the
value of British listed companies being represented by intangibles.
Do you think that, with such a high percentage of the value of
British listed companies being focused on things which are inherently
very problematic to measure, we do have, in fact, the potential
for real crises of confidence in the returns of British companies?
(Ms Doane) What is interesting is, right after September
11, BA, one of the top performing companies in the UK, fell off
the FTSE 100, simply because of that sense of its intangible asset
base rather than its real asset base. One of the interesting things
we found was, when we looked into this issue, each accountancy
firm has their own way of measuring that intangible asset base,
it is not transparent and they will not share it with you and
they will not speak to each other. And one of the things we would
certainly like to see is, there is human capital, there is social
capital, there is a lot in that intangible asset base that we
need to draw out and we need to find relevant measures, but they
need to be transparent to the shareholder and to the wider public,
so that we can trust in what that measure really means, rather
than it simply being listed as one line on the balance-book, and
then seeing share prices of BA, and people's pensions, fall like
252. In your paper, on page 37, you have got
these various proposals that you make to tackle the problems in
the auditing sphere; and one of the proposals is that there should
be a cooling-off period that should apply when people are moving
from the auditing world into the companies that they audit. And
you suggested that it should be a minimum of three years, which
seems quite a long period of time; why so long, and would that
be consistent with human rights obligations, in respect of employment?
(Mr Simms) Technically, whether or not it would fit,
I would have to look into the human rights law to see where there
are any potential clashes on that, but we think it is a realistic
period of time. It is flexible how long people think it is now
respectable to stay in a particular company for a period of time,
but, in our experience, two to three years is a job cycle, and
that is why we went for that figure, we thought it was not too
long but not too short, and it was a reasonable cool-off period
for somebody not to be able to take employment on the promise
of having a particular set of contacts and insider knowledge that
could give them an inappropriate advantage in the work-place.
Two to three years is what we were thinking about; we put three
years, we think, actually, that is a realistic cool-off period.
253. Are there any precedents for having a period
of cooling-off that is that long?
(Mr Simms) That I do not know.
254. In one of your recommendations, you speak
about donations to political parties, and I am assuming you have
Enron in mind here. How widespread is the problem, and how much
do you think needs to be done about it?
(Mr Simms) One of the quotes that we have in the report
is from Senator John McCain, who pointed out that, where Enron
was concerned, they were all stained by the process, and I believe,
talking about the US situation here, but of the various committees
which feed into the regulatory process in the US, a good two-thirds
of its representatives had been touched either by political donations
by Andersen or Enron.
(Ms Doane) I do not know if Andrew has pointed this
out; we actually drafted the first draft of this report long before
the Enron scandal hit the press, so you could say that this is
quite widespread. In the UK, it is a very interesting scenario.
I do not know if you saw the FT, a number of weeks ago; it was
encouraged by PR firms for companies to engage in voluntary CSR
programmes, as a way of gaining political access. It is a different
type of lobbying that is going on here than is happening in the
UK, either than is happening in the US; so that is something that
is extremely widespread, certainly in the US, it is slightly below
the surface here, as far as I can see, from where I sit.
(Mr Simms) And just as a peculiar example of the bizarre
contradictions that can be thrown up, I would draw the Committee's
attention to the fact the Department for International Development
employed KPMG to look at the tax system in Belize, questioning
whether or not, if the Government was haemorrhaging resources
through having too lax a tax system, it should be either given
debt relief or receive aid. Now perhaps it was not pointed out
to the Secretary of State at the time that KPMG were also, simultaneously,
advertising their services through their Belize office for the
tax advantages of being established in Belize; so there are certainly
a number of problems.
255. So are you alleging an actual corruption,
or are you simply saying there is a perceived problem?
(Mr Simms) There is certainly a lot a collusion. I
would say that it is almost inevitable that corruption is taking
place, and I would pass on one comment, that was said in confidence
to me by a director of one of the Big Five accountancy firms,
when asked about the issue of bribery and corruption, and of a
number of issues that we raised with them this certainly was the
issue that they fear most, in terms of being exposed. The question
was asked in a fairly direct way about what happens in your associated
offices around the world, and the reply was that "It is just
a guess as to whether bribery, corruption and a range of illegal
practices are occurring in 30, 40 or 50 countries where we have
offices around the world." There is a major issue about the
consistency of standards throughout the families of the Big Five,
256. Can I thank you for your appearance this
morning, and also your publication, which will be very helpful
to us in formulating our report. Thank you very much.
(Mr Simms) Thank you for inviting us. We will send
on some of the supporting information that has come out of your
Chairman: Thank you.
7 Ev 125. Back