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29 Jan 2003 : Column 881—continued

Auditing and Accounting

12.32 pm

The Secretary of State for Trade and Industry (Ms Patricia Hewitt): With permission, Mr. Deputy Speaker, I should like to make a statement about the report of the co-ordinating group on audit and accounting issues and the report of the review of the regulatory regime of the accountancy profession, which my right hon. Friend the Chancellor and I are publishing today. Copies of both reports have been placed in the Library.

Last year, the collapse of Enron, WorldCom and Andersen's in the United States appalled investors all over the world. Millions of people saw their savings and pensions collapse. As I told the House last year:

So there was no need for the UK to rush into a Hewitt-Brown version of the Sarbanes-Oxley Bill: but, equally, it would have been folly to sit back and say "It couldn't happen here".

Structures, standards and regulations can never be a complete defence against individuals determined to do wrong, nor can they wholly protect us against a culture of corporate greed and loose ethics, but we owe it to savers, investors and employees, as well as to all the honest business people whose reputations have been tarnished by those scandals, to ensure that our defences are as robust as they sensibly can be.

The reforms that I am announcing today, along with those proposed last week by Derek Higgs and Sir Robert Smith, will raise standards of corporate governance. I emphasise that these reforms, in essence, cover only listed companies. They will strengthen our accountancy and audit professions and provide for a more effective system of regulating the professions. Together, they make up a complete package of reforms that are comprehensive and mutually reinforcing.

First, I shall deal with boardrooms. Following Derek Higgs's proposals, the combined code on corporate governance will be strengthened to provide: that at least half the board, as well as the chairman, should be independent, as should all members of the audit and remuneration committees and a majority of the nomination committee; that the definition of an independent director should be strengthened and clarified; that the separation of the roles of chairman and chief executive should be reinforced; and that new descriptions should be given of the respective roles of the board, the chairman and non-executives.

Mr. Higgs's report showed a startling picture of the way in which top-level appointments are handled, with more than half of directors being appointed through personal contacts and friendships. I welcome his proposals to promote meritocracy through an open, fair and rigorous appointments process. As part of the follow-up to the report, a group led by Professor Laura Tyson of the London Business School will examine ways of bringing candidates, including women, from the non-commercial sector to greater prominence. It will report to me in May.

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In revising the combined code, the Financial Reporting Council will implement the recommendations of Sir Robert Smith's group that the audit committee should: consist entirely of independent members, with at least one having relevant financial experience; monitor the auditor's performance, especially on independence and objectivity; and develop and implement policy on the purchase of non-audit services from the auditor, with reference to tough new ethical guidance. Following well-established practice, listed companies will be required either to comply with the provisions or to explain to their shareholders why they are not doing so.

The second aspect of our reforms concerns tougher measures to underpin auditor independence. Following the recommendations of the co-ordinating group, I can announce, in addition to an enhanced role for audit committees and a tightening of the provision of non-audit services by auditors: that the professional bodies have already changed their regulations so that the lead audit partner has to be rotated within five years; that partners and senior employees of audit firms will not be able to take up employment with a company they audit within two years of leaving their audit firm; and that most of the UK's large audit firms have already agreed to publish an annual report, to provide management and financial information; and, in particular, to reveal levels of dependency on single clients, including how the firm handles conflicts of interest and interdependence issues. We think that that will work on a voluntary basis. If not, we will make such disclosures a condition of auditing listed companies.

I am also calling for the standards and ethical guidance for auditors on the provision of non-audit services to be toughened even further.

We will also strengthen the enforcement of accounting standards. At the moment, the financial reporting review panel steps in only if particular concerns are raised with it. However, the co-ordinating group recommends, and we agree, that enforcement of those standards must be proactive. From now on, the Financial Services Authority will help the financial reporting review panel on enforcement—especially by identifying the high-risk cases that most merit investigation. The FSA and the panel will need to agree as soon as possible a memorandum of understanding to clarify their precise roles and responsibilities.

Those measures will be underpinned by the third element of our reforms—more effective regulation of the professions. The Financial Reporting Council will assume the functions of the Accountancy Foundation. That will create a unified, independent UK regulator with three clear roles: setting accounting and audit standards; proactively enforcing and monitoring them; and overseeing the self-regulatory professional bodies. The Financial Reporting Council has, under the chairmanship of Sir Bryan Nicholson, developed an excellent reputation. The Accountancy Foundation, led by Lord Borrie, has also done valuable work. I thank them for that.The new combined body will build on both their achievements.

After wide consultation, the DTI's review team made three recommendations, with which I agree. First, the Auditing Practices Board should take over from the professional bodies the responsibility for setting standards for independence, objectivity and integrity.

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Oversight of other ethical standards will become the responsibility of a new professional oversight board. The Ethics Standards Board will be wound up in due course. I greatly appreciate the work that its chairman, Christopher Jonas, and his colleagues have done to take forward the ethical agenda and to provide the basis for the new board's work.

Secondly, a new independent inspection unit, located within the FRC, should take over from the professional bodies responsibility for monitoring audits of listed companies, major charities and pension funds.

Thirdly, the long-delayed investigation and discipline board should come into operation quickly to provide a truly independent forum for hearing significant public interest disciplinary cases.

It is vital for the new structure to have clarity of accountability and responsibility together with the appropriate powers to operate effectively in the public interest. There is a strong case for statutory underpinning to make the new body work. We will consider that further and report our conclusions to the House.

The proposals that I have outlined are substantial and mean significant changes to the way in which companies and auditors carry out their work. The package should be implemented as quickly as possible. Changes to the regulatory structure will be made immediately. The Department will lead an implementation steering group, on which Sir Bryan Nicholson, Lord Borrie and Peter Wyman, president of the Institute of Chartered Accountants in England and Wales, have kindly agreed to serve.

An FRC with enhanced responsibilities will need more investment. The Government will pay their share of core running costs, but I also expect companies and the profession to contribute. It is in all our interests to make the changes work and it is fair that we all pay for the improvements.

The changes to the combined code that arise from the Higgs and Smith reports will be made in the early summer once the FRC has consulted on the precise wording. All those measures will be taken forward alongside our long-standing programme of company law reform following last year's White Paper.

The proposals are not a response to short-term market movements. They are about strengthening the foundations of our capital markets for the long term. I want to thank Derek Higgs and Sir Robert and his group for their excellent reports as well as all those who participated in the co-ordinating group under the joint chairmanship of the Under-Secretary of State for Trade and Industry, my hon. Friend the Member for Welwyn Hatfield (Miss Johnson), who is responsible for competition and consumer affairs, and the Financial Secretary. I pay tribute to the officials who so swiftly took forward the review of the regulatory regime.

The overall package is tough when that is needed but measured and proportionate. It will ensure that our corporate governance structures remain among the best in the world for the benefit of millions of pensioners, savers and businesses that depend on them.

Mr. Tim Yeo (South Suffolk): I am grateful to the Secretary of State for making a copy of her statement available to me this morning.

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I broadly welcome the Government's approach. As I said last July, when the interim report was published, there are significant differences between our approach in Britain and that in the United States. Our principles-based approach is right and should continue to be championed.

I hope that the Secretary of State will agree with me on four broad principles. First, no regulatory system, however stringent, can provide total protection against the consequences of human greed, folly or corruption. In auditing and accountancy, as in all matters of corporate governance, the best safeguard against fraud, abuse and incompetence is the integrity and conscientiousness of the men and women in positions of responsibility.

Secondly, any change to existing practice must be scrutinised for its effect on Britain's competitive position and whether it makes wealth creation easier or harder. The purpose of regulation of auditors and accountants, the role of non-executive directors and so on is to provide some protection for lenders, investors, employees and customers. However, it cannot replace the duty of all those people to carry out their checks and responsibilities. Care must be taken not to increase business costs unnecessarily.

Thirdly, self-regulation should always be the preferred option for professions such as accountancy. The statutory route should be taken only when it is clear beyond doubt that self-regulation is inadequate.

Fourthly, even when we rely on self-regulation, any codes of practice or guidance systems must acknowledge the need for flexibility and understand that requirements that may apply to companies of a specific size or type are wrong for many other businesses. A one-size-fits-all approach is damaging.

I welcome much of Derek Higgs's report. The Secretary of State referred to listed companies. Does she include alternative investment market listed companies, off-exchange market companies and foreign companies that have a listing in London in that category? There are wide variations in the size and nature of the businesses even among the fully listed companies. The Higgs recommendations do not entirely acknowledge those differences.

I am worried that, for example, the recommendation to require a senior, non-executive director to develop an independent relationship with shareholders, separate from that of the chairman, chief executive and other executive directors, may be a recipe for division and conflict. That will not improve standards of corporate governance.

I am also concerned about the requirement for some smaller listed companies that half the board, or, if the chairman is included, a majority of the board, shall be independent. I am concerned that that recommendation is onerous, expensive and unnecessary. Further consideration should be given to both those recommendations before they are incorporated in the combined code.

Since institutional investors already have the power to address many of the concerns that Higgs has focused on, does the Secretary of State have any practical suggestions about how those institutions can be encouraged to take a more active role beyond the lip service that is so frequently paid to that need?

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I welcome the recommendations of Sir Robert Smith, and particularly the involvement of an entirely independent audit committee in scrutinising the purchase of non-audit services from an audit firm. That, coupled with a little more transparency, should remove the need for greater restrictions on the freedom of clients to employ their auditors for non-audit work—a freedom that I believe is often in the best interests of shareholders, as when, for example, a client wishes an auditor to help with due diligence work on a proposed acquisition. The Secretary of State says that she would like guidance relating to non-audit services to be toughened still further. Will she explain exactly what she has in mind in that respect?

Looking at the issue of auditor independence, I warmly welcome the steps that the profession has taken on a voluntary basis to meet public concern and maintain confidence.

On the issue of standards, can the Secretary of State clarify exactly what role she expects the Financial Services Authority will play? She says that she is asking the FSA to agree a memorandum of understanding with the financial reporting panel. Will she clarify what issues she thinks that memorandum should cover?

Turning to the regulation of the professions, I welcome the extensive consultation that has taken place and pay tribute to the institute and to its president, Peter Wyman, for his role, and also to the work of the Financial Reporting Council.

Although the Secretary of State referred to a unified, independent regulator with clear roles, it would be helpful if she could explain how she thinks the distinct roles of five different groups will be defined and how their work will interact. I refer to, first, the FRC itself; secondly, the independent inspection unit to be located within the FRC; thirdly, the Auditing Practices Board; fourthly, the professional oversight board; and, fifthly, the investigation and discipline board. Is there any risk of duplication? Will their responsibilities really be clear to outsiders? Is there a danger that what starts to look like a proliferation of bodies may obscure accountability?

There is also the crucial question of cost. At a time when company profits are under pressure, not least because of the extra burden of tax and regulation imposed on them by the Government, there will be concern that audit fees and other charges may rise significantly because of these proposals. What does the Secretary of State expect the effect on profits to be? What will be the Government's contribution to the budget of the FRC?

In addition, when will the Secretary of State be able to say whether legislation is needed to implement the proposals? What timetable is envisaged for their implementation? Does she agree that after a period of consultation there is every advantage in quickly resolving the uncertainty that has inevitably existed in recent months?

Britain has a real chance to lead in the setting of standards for audit and accountancy. We must continue to champion our principles-based approach and the success of much of the self-regulation that has prevailed here. Both the nature of new legislation in the United States and the confusion over key appointments to

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regulatory bodies there are a warning of what may go wrong when a hasty reaction to a corporate scandal occurs.

I hope that the areas of remaining uncertainty in the Secretary of State's statement will soon be addressed. In the long term, the interests of shareholders and management should be aligned. Since every member of a pension fund and every holder of a life insurance policy has an interest, both in the standards of corporate governance and in the profitability of businesses, today's proposals affect almost every man, woman and child in the country.

In the six months since the issues were last discussed in the House, share prices have fallen and uncertainty in financial markets has increased. It is all the more important, therefore, that moves to rebuild confidence do not add excessively to the burden of cost and regulation. Our response to the problems must continue to be proportionate to the dangers involved. The essence of what is needed is not necessarily more regulation, but better regulation.

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