Memorandum submitted by Mr Duncan Alexander
I understand that in light of the Enron collapse your Committee is now examining the arrangements for the financial regulation of public limited companies in the UK and specifically the links between UK accounting firms and their clients.
I use as my initial examples the current Enron scandal and the Sound Diffusion plc saga here in the UK starting in the late 1980's. My perspective comes from being a working investor creating and running small businesses and being a passive investor by investing in publicly quoted companies around the world. My company and I were among the 11,000 public shareholders caught in the Sound Diffusion plc collapse. I have made contributions to the DTI Company Law Review. The Auditing Practices Board on Aggressive Earnings Management and the Sandler Review Team on medium and long term retail savings.
In summary, I believe investors require their company auditors to be impartial and independent. The danger is that the Big 5 accountancy firms may have turned a profession into a business. It is now clear that our current control structures are unable to deliver the independence, integrity and the public interest factors their clients require. I believe that over the last decade there has been an unhealthy alliance of company management, auditors and over-ambitious politicians which has damaged the effective functioning of owners control over their businesses. We must now rectify this matter by:
1. Reversing the House of Lords Caparo ruling
2. Reinstate independence and integrity to auditing through a new Companies Act
3. Ban the audit and non-audit mix
4. Establish a firm link between investors and their company by having an owners audit committee.
First of all, you need to establish what role a UK public shareholder should have. Is a member of a company merely the owner of a tradable lottery ticket or a member of a participating democracy? Lottery tickets believers should now jump to the last paragraph of this letter. Others, then need to decide their need for balanced and verified information. I believe shareholders thought that this was the purpose of them voting to appoint auditors and requiring them to report back to them. We now know from the William Powers Jr report to the Enron Boardextract enclosedhow secret off-balance sheet partnerships were hidden from the owners. Once these "Special Purpose Entities" were disclosed, the firm was forced into bankruptcy. In the Sound Diffusion plc saga, I asked the auditor before the last AGM the depreciation basis on which the televisions were leased to customers. I was told that this was commercially sensitive information but I should not worry because Paul Rutteman from Ernst & Young was a world authority on leasing contracts. This was my first hint that the auditors were actively colluding with management in the production of the figures to the owners. The DTI report later disclosed a £6.4 million error in Sound Diffusions TV leasing contracts.
This leads me to believe that there must be a split between audit and non-audit work. You must not have auditors auditing their own firms work. It would be useful to have the companies audit committee dominated by owners who had say two per cent of their own personal assets invested in the company and who had a fiduciary responsibility to other public shareholders.
One of the other corporate governance problems seen in both Enron and Sound Diffusion plc is how you tackle over focused and over ambitious individuals who corrupt a companies control systems and bring ruin to the owners and other stakeholders. It might be useful for the Treasury Committee to commission psychological research into cognitive dissonance and denial, and how these problems should be addressed.
Overall, history may record that the 1990 Caparo judgement robbed individual investors of the right to rely on the financial information they required to control their companies. Then there emerged a mechanistic style of management which combined with accounting and political interests which may have then created the first world-wide financial bubble. I would suggest that the solution is to return control back to shareholders, provide clearly defined rules for the business game and deliver a cost effective regulatory and legal systemjust a small task for your committee members to tackle?!
13 February 2002