Select Committee on Treasury Minutes of Evidence

Examination of Witness (Questions 260-279)



Mr Plaskitt

  260. In your speech you ended up by saying that all the failures you talked about, management, corporate governance, audit failures, were all made possible by inadequate regulation and accounting rules.
  (Lord Sharman) Yes.

  261. Should we feel confident about the extent of regulation here in the UK? I am beginning to form a picture of an accountancy business which is on the whole writing its own rules, doing its own investigating and funding its own regulator.
  (Lord Sharman) You can take some comfort from a fairly considerable amount of progress which has been made since the problems we had in this country following the scandals of the 1980s and early 1990s. There is further to go. I certainly subscribe to the notion that the major accounting firms should not fund their own regulator. It seems to me that regulation must not only be independent, it must be seen to be independent. For that reason, I am quite strongly in favour of independent funding of that body. There is always the lingering suspicion that "He who pays the piper calls the tune". On the issues affecting regulation, the Foundation, which has not been in existence for that long, is headed in the right direction, but there are clearly some more things which need to happen, things like how much transparency there is over quality processes in the accounting firms is an important issue.


  262. It would appear that some of the activities of the hedge funds may have exacerbated the demise of Enron. You mentioned hedge funds in your speech. You said that ". . . as much as 30 per cent of the daily turnover of the LSE may be due to hedge funds". Does this mean that a corresponding risk to financial stability also exists in the United Kingdom and, if so, what can be done about it and by whom?
  (Lord Sharman) The situation in Enron was quite special in that the hedge fund activity, which I understand was quite massively shorting the stock, that is selling it in the hope that it is going to drop and then buying it back more cheaply, triggered the collapse of the financing arrangements. I do not want to get into a lecture about financing arrangements because they were very complex, but the key element in Enron was that if the share price fell below a certain level then the debt got called and that is what happened. I think that you would expect, when a company has problems and hedge funds decide to take positions in it, that is what they are there for. I do not think the risk is as great in this country but I am not an expert in that field.

  263. On the issue of corporate governance, a lot has been made of how to give company boards more spine. You addressed that in your speech. You suggest that work still needs to be done to establish a practical limit on the numbers of non-executive appointments. Is this susceptible to a simple limitation? How do you allow within such a limit for variations in the level of work required?
  (Lord Sharman) I do not think it is susceptible to an absolute limit of four or three or two or five or something like that. The role and responsibility of non-executives actually vary within a company. For example, if you are chairing an audit committee and things develop along the lines which I expect them to in audit committees, then the chairman of the audit committee is going to have quite a lot more to do. I do think we need to look at the time commitment and the time constraint by company. It ought to be a situation which at least is negotiated between the non-executive and his board as to how much else he will do.

  264. Say some individual had 15 or 20 non-executive directorships, what would your view on that be?
  (Lord Sharman) My view is that if you had 15 or 20 non-executive directorships of listed companies you would be a miracle worker.

  265. Would you still be a miracle worker with eight or ten?
  (Lord Sharman) It depends on the size. You are getting near it.

Dr Palmer

  266. How would you like to see the role and responsibilities of non-executive directors develop? It seems to me that it is a remarkably ill-defined job which in many cases basically comes down to years of fairly inactive contribution followed by moments of panic.
  (Lord Sharman) A number of things need to be done. First and foremost, we need to look at what constitutes independence. It is talked about a lot in the context of non-executive directors. We need to look at that because the important thing is independence of management and independence of the company in the sense of the management process. The definition of the role and responsibility is an important issue. So far as I am aware basically our law provides that the responsibilities of directors, be they executives or non-executives, are not different. If you sit as a member of a board you are collectively responsible and individually responsible as a member of that board. It does not matter whether you are the chief executive or a non-executive, you share the same responsibility. I would hope the joint inquiry of the Treasury and the DTI will come with something on that definition of role and responsibility. Whether or not, in the fullness of time, there needs to be a distinction in law, is something which needs to be debated. As regards the other areas, there is a woeful lack of internal and external training of quality available for people who want to become directors and it is not unreasonable to expect non-executive directors to have what we call in many professions continuing professional education. You should keep up to date and there should be a means of demonstrating that you are keeping up to date.

  267. This is all very reminiscent of pension fund trustees and school governors and other people who have lots of responsibility but you do not really have the time to do the job properly. What positive benefit is there in having non-executive directors which outweighs these drawbacks? Do we actually want them at all?
  (Lord Sharman) If you look at Enron and you look at WorldCom and you look at the others, in all of the cases you get very powerful executives at the centre of a business. I cannot see any other system, other than a system of corporate governance, which involves people who are not executives. Be it a two-tiered board, which is what you see in continental Europe in many places, be it a unitary board with non-executives here, I cannot think of another system which can get people close enough to exercise control.

  268. How do you think the role of audit committees might be enhanced?
  (Lord Sharman) In three ways. First, the audit committee should assume responsibility for the appointment of auditors, that is to say, it should be an audit committee activity, recommending to the board. In many cases when auditors are appointed, there is usually a heavy involvement of the finance group in deciding who to recommend to the board. I think that should be exclusively the remit of an audit committee. They should become much more responsible for managing the relationship with the auditors, that is to say that the key interface between the corporation and the auditor should be the audit committee, which in my book is composed entirely of non-executive members. Finally, they should establish a series of processes which ensure that their auditors remain independent. They should report against all of those things in the annual report, saying here is a report. We have a great report of the remuneration committee but the audit committee does not say anything about what it has done and those things would help enhance the audit committees.

Mr Fallon

  269. I was struck in your speech where you said that you were disappointed that other major firms did not follow the example of KPMG and Ernst & Young in publishing financial statements about themselves as auditing firms. You say, ". . . the affairs of some of these firms are remarkably opaque". Which ones are those?
  (Lord Sharman) The other firms are the other big firms, that would be PriceWaterhouseCoopers, Deloitte & Touche and Andersen.

  270. What are they hiding?
  (Lord Sharman) I do not know.

  271. Was the decision by KPMG to publish a financial statement in part related to its structure which limited partners' liability?
  (Lord Sharman) Yes, it happened at the time at which we decided to incorporate the audit practice. It was related to that but at the time we had the option just to publish the financial statements of the audit practice and we decided to go much further.

  272. You would now like to see all the audit firms publish full financial statements and audited to the same standards of public companies that they audit.
  (Lord Sharman) Yes, I would.

  273. Why do you think they are not?
  (Lord Sharman) Why do I think they are not publishing them or not auditing?

  274. Not publishing.
  (Lord Sharman) I do not know. I only know that I believe that when you have a crisis of confidence, which is what you have in a profession, one of the ways in which you can overcome that is to be more transparent about what you are, what you do and what you make out of it.

  275. Are you now talking about PriceWaterhouseCoopers?
  (Lord Sharman) I am talking about PriceWaterhouseCoopers, Deloitte & Touche and Andersen.

  Mr Fallon: All three of them.

Mr Cousins

  276. Do you think the Government struck a very soft deal when they agreed to limited liability for accountancy partnerships?
  (Lord Sharman) I do not believe it was that soft. Having been one who campaigned for the introduction of limited liability partnerships, I believed that it was necessary at the time, I believed that most, if not all of the major accounting firms are heading in that direction, which will mean they have to publish financial statements. I believe also that transparency in that regard needs to go further than just financial statements. I do not think it was a soft deal.

  277. My question was not really about the advantages or disadvantages of limited liability but whether the Government could have struck a stronger deal when it provided the legislation allowing for limited liability for accountancy?
  (Lord Sharman) You asked me whether I thought they had. I think they could have done obviously. One of the things which was an option, and I cannot speak for those who put forward the legislation, was that there should have been something in return. You could have had stronger regulation and that was certainly being negotiated at the time. You might well have asked for more transparency than just financial transparency, which is all that is required within that Act. You might have asked for transparency over the quality control processes and things like that.

  278. Governments now are big customers of the Big Four accountancy firms. Do you think there can be collusive relationships between Government and the Big Four just as there can be collusive relationships between big companies and the Big Four?
  (Lord Sharman) The obvious answer to that is that there can be collusive relationships between any two parties if they decide to become collusive. It is not just accounting firms and governments. Any two people can agree to collude if that is what they want to do.

  279. What could you suggest to prevent the risk of collusive relationships between Government and the Big Four firms?
  (Lord Sharman) Openness and transparency is the way you do it. You have to disclose everything. In my judgement if everything is in the public domain it makes it that much more difficult to collude.

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