Select Committee on Treasury Sixth Report



  1. We believe that this evidence would repay careful analysis and assessment in the context of the Government's response to the events of Enron. We therefore commend it to the relevant bodies (paragraph 3).
  2. Although we recognise that we have rather different arrangements from the United States for the oversight of the accounting profession and for financial regulation, we believe that it would be dangerously complacent to assume this. What has happened in the United States has shaken confidence worldwide in matters such as the independence of auditors from company management. We agree with the Government that it is important to restore this confidence (paragraph 5).
  3. As our evidence demonstrates, a lot of work by Government, regulatory bodies, professional bodies and others, is currently in progress. This report therefore necessarily has something of an interim character to it. We shall continue to keep developments under review and will return to this matter in due course (paragraph 7).
  4. We note the array of arguments against auditor rotation. There would undoubtedly be additional costs and some potential risks. Nevertheless, the absence of any kind of rotation requirement leaves a perception - and almost certainly the reality - of an undesirable cosiness between some firms and their auditors. This poses even greater risks. We accept the need for auditor or audit firm rotation in principle, and we want the Government to produce proposals to implement it (paragraph 11).
  5. We note that re-tendering is a regular feature of many public sector appointments, and we have received no evidence that this operates to the detriment of the quality of work carried out. We consider that there is a good case for requiring audit committees to look explicitly at rotation of audit firms every five years. We believe that the audit committee should be obliged to make a statement to shareholders on those occasions when they decide to retain the existing auditor after conducting such a five yearly review.
  6. We recommend that the Ethics Standards Board considers urgently, in the light of the evidence we have received, whether the existing provisions are adequate. We believe that there is a good case for requiring rotation of the audit partner/manager on an audit every five years, rather than the present seven years. We also believe that there should be a time limit preventing auditors from being employed by a firm which they have audited. This should be at least one year (paragraph 13).
  7. Confidence in the independence of the auditor is central to the integrity of the audit. Independence is clearly open to question when auditors also perform a significant consultancy role - especially when the audit contract may have served as a loss-leader to acquire this more lucrative business. We therefore believe that there is a strong case for disclosure in relation to non-audit work. We believe that the Audit Committee should be required to assess the extent of non-audit work and should be required to notify shareholders of any potential conflicts of auditor interest. We recommend that the audit committees of listed companies be required to publish details of audit and non-audit contracts, giving a detailed justification of the arrangements to shareholders (paragraph 17).
  8. We believe that, as a general principle, auditors should not be permitted to audit work done by themselves. We recommend that certain non-audit-related services should not be provided by a company's auditors and we want the Government to produce proposals to enforce this, including a strict definition of such services (paragraph 19).
  9. We believe that an Accounting Standard on revenue recognition and to control aggressive earnings management should be introduced, on a national or an international basis, at an early date (paragraph 22).
  10. We were disappointed at the leisurely approach of the Accounting Standards Board. We believe that there are issues for the Board that require action before 2005 (paragraph 27).
  11. Sir David expressed concern that the current method of funding of the IASB could lead to indirect pressure, through withdrawal of funding. He cited an example of a threatened withdrawal of cash when American industrialists expressed disagreements with IASB thinking on accounting for share options and other areas where there are, or were likely to be, differences of view between the Board and American interests. He considered that "ideally the best way of funding us...would be to put a levy on registrations around the world". We strongly support Sir David Tweedie's robust stance in resisting such pressures (paragraph 28).
  12. We are generally opposed to the use of share options as a significant source of remuneration in public companies. We shall wish to take evidence on this later. We agree with Sir David Tweedie that an International Accounting Standard that properly reflects the value of such options should be agreed. We believe that share options used for executive and other remuneration and payment should be prudently accounted for as future negative net income on a company's profit and loss account
  13.  (paragraph 31).

  14. We support the concept of international standards, a view apparently shared by a large majority of institutional investors worldwide. We believe that Sir David Tweedie's evidence indicates that there may be real difficulties in securing their acceptance in some major areas, although we are heartened by Sir David's view that all the core international standards should be in place by 2005. Pressures to agree a comprehensive range of Standards by 2005 must not dilute standards applicable in the United Kingdom, particularly in relation to a 'true and fair' view (paragraph 32).
  15.  The regulatory structure of the accountancy profession raises questions about rigour and independence. These arise as a result of the regulatory process being funded by the industry itself, and, in particular, in the way these funds are collected. We welcome the efforts being made by the Accountancy Foundation to improve the industry's regulatory regime. We recommend that the Government give this issue urgent examination, and that it considers the introduction of industry funding arrangements similar to those which operate in the case of the Financial Services Authority (paragraph 36).
  16. We believe, though, that the existing regulatory framework of the accountancy profession is cumbersome and excessively complicated. We consider that there is a strong case for a single, independent, regulator, which is not only independent but seen to be independent (paragraph 37).
  17. In the context of our current inquiry, a number of witnesses have proposed a much more proactive role for the non-executive directors in relation to the auditing function. Sir John Bourn suggested that non-executive directors should report on a range of matters relating to the audit. He added "the external auditors should know that this discussion with the non-executive directors is an important part of his work, and that his ability to satisfy the non-executive directors is crucial in the determination of whether he stays the external auditor." We support this idea. We also agree with Lord Sharman that the role and responsibilities of non-executive directors might benefit from clarification (paragraph 39).
  18. We believe that there is a good case for an audit committee composed of non-executive directors, rather than the board as a whole, to be responsible, in the case of quoted companies, for selecting the firm of auditors to be put to the shareholders for appointment, and for fixing the auditors' remuneration (paragraph 40).
  19. We expect the Higgs Review to produce proposals which cover these important matters. We recognise that there have been serious abuses of the practice of non-executive directors undertaking paid work with the same company. We expect the Higgs Review to address this issue positively (paragraph 41).
  20. We welcome the fact that the Government has now responded to the Company Law Review, but remain concerned that there is no definite Parliamentary timetable for its implementation. If it becomes clear that action is needed in the light of Enron affair, we would not be happy for this to be delayed until comprehensive legislation can be introduced. We consider that the Government should give higher priority to this matter, not least because of the threat identified by the Chairman of the FSA and arising from the current proposals for the EU Prospectus Directive, to the use of the Listing Particulars as a means of imposing new requirements on listed companies. We recommend that, as a minimum, the Government gives a commitment to publish draft legislation in full in the course of the next Session of Parliament (paragraph 44).
  21. It is clear that the EU expects to be a serious player in the ongoing debate about the role and regulation of auditors, and the development of corporate governance standards within the EU. We urge the Government to ensure that United Kingdom interests, and regulatory standards, are fully protected in developing common European approaches. In this context, we were concerned by Sir Howard Davies' comments that the proposed Prospectus Directive could undermine the present role played by the Listing Rules in enforcing corporate governance requirements on listed companies. Other groups have also expressed concern. We recommend that the Treasury seek to ensure that the United Kingdom's standards of financial disclosure and corporate governance are fully safeguarded during negotiations on the Directive (paragraph 53).
  22. We intend to follow the progress of the proposals in the United States for a Public Company Accounting Oversight Board and to consider whether a similar body would be appropriate in the United Kingdom, possibly with reciprocal powers (paragraph 55).
  23. The Enron and Worldcom collapses have shaken confidence in company accounts, and consequently in the professionals responsible for running companies and for financial reporting. Although these cases have, for the most part, arisen in America, the crisis of confidence has spread far further (paragraph 56).
  24. We acknowledge that the regulatory environment in the United Kingdom is very different from that of the United States. We also recognise that a large amount of work has already been done in the United Kingdom to improve accounting, auditing and corporate governance. But there can be no room for complacency. There are still features of the accountancy regime which appear to us to be insufficiently robust. We are not convinced that the accountancy bodies appreciate the scale of the problem. These risks must be minimised in the interest of confidence. The oversight system must be made more effective (paragraph 57).

  26. The business of accountants is almost wholly based on confidence. The rapid demise of Arthur Andersen in the light of the Enron scandal is eloquent testimony to this point, as was the decline of Spicer and Pegler. We accept the argument of the professional bodies that the potentially catastrophic consequences for its firm and their employees of poor quality work act as very powerful disciplines on partners, and that the public perception of what auditors can be expected to achieve may be unrealistic. Nonetheless, we believe that public expectations demand a greater degree of accountability from the accountancy profession (paragraph 58).
  27. We agree with the Government that a principles-based approach is preferable to a rules-based approach. Although the, sometimes difficult, judgements that must be made in a principles-based approach lack the apparent certainty of a rules-based approach, we take the view that the events of Enron demonstrate the hazards of the latter, legalistic, approach. We have seen no evidence that the lawyer-dominated approach favoured by the US offers advantages over the professional judgement approach favoured here (paragraph 59).
  28. We also think that there are public expectations of a greater degree of activity from the Government. Very shortly, it will publish the interim report of the CGAA. We shall be looking for clear evidence that issues we have identified in this report are being addressed with urgency and firmness of purpose. We expect to look further into this matter when we have had a chance to study this report (paragraph 60).
  29. We share concerns about the problems of 'revolving doors', whereby personnel involved in public sector contracts move from the public sector to the profession, and vice versa. We recommend a cooling-off period between employment in accountancy or consulting firms or contracts with the Government (paragraph 61).
  30. Although, perhaps inevitably, this report has concentrated on the role of accountants and of company management, the responsibility for ensuring that companies are well run and providing proper reliable information rests on all the stakeholders, including the shareholders. We believe that considerable improvements in the governance of companies can be brought about by greater shareholder interest in its affairs. We urge all shareholders, and institutional shareholders in particular, to face up to their important responsibilities in this respect (paragraph 62).


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