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29 Jan 2003 : Column 886—continued

Ms Hewitt: I am grateful to the hon. Gentleman for his broad support and welcome for the statement and the proposals. He began by setting out the principles. As I said, there cannot be complete protection against determined wrongdoers. The best defence against wrongdoing is the integrity and incorruptibility of the individuals concerned. That is why we want to strengthen not only professional standards but oversight, monitoring and enforcement of them. The reforms must be designed, and have been designed, to strengthen the competitiveness of our companies. At the outset of the work and report, Derek Higgs said that the reforms are about promoting the greater success of our companies, not least by strengthening the confidence of the people who invest in them. We believe in self-regulation where possible, legislation where necessary. That is what we have practised, and I think that the balance in the package is right.

Let me stress and develop what the hon. Gentleman said about the need to avoid one size fits all. Derek Higgs clearly acknowledges that. Perhaps I can clarify matters by confirming that the Higgs proposals apply to listed companies, pension funds and major charities. They do not apply to alternative investment market listed companies. However, he recognises, as we do, that the circumstances of companies, especially smaller companies, that fall within the scope of the combined code will be different. It is important for the FRC to reflect that in the wording of the revised code and it explains why we rely on comply or explain. There will be circumstances in which it is not sensible or appropriate for a company, especially a smaller firm, to meet every Higgs recommendation or combined code standard. They will be able to explain that to their shareholders. That is the great merit of comply or explain.

The hon. Gentleman asked about the implementation of Sir Robert Smith's recommendations, in particular the role of the FSA. The suggestion is that the FSA will extend its proactive enforcement role by conducting a risk assessment to guide the work of the financial reporting panel. Instead of the FRC simply waiting for problems to be drawn to its attention or worries to be raised, the FSA, having conducted a risk assessment, will draw the panel's attention to those audits on which it thinks the panel should focus.

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Let me elaborate on the implications of toughening standards for the purchase and delivery of non-audit services. Sir Robert Smith's recommendations involve stronger policy and standard setting by the audit committees of the companies that purchase the services. Each committee will have to review that and set out company policy on it. On the other side of the fence, where the audit companies themselves are concerned, I am asking the Financial Reporting Council to consider the recommendations by my colleagues in the combined group who have suggested much tighter controls on what audit firms can sell. For instance, a prohibition on the supply of internal audit services by the external auditor might involve checking on management controls. Similarly, a ban on the provision of non-audit services might create a mutuality of financial interest and perverse incentives to distort either the audit or the non-audit services, or both.

The hon. Gentleman asked how all the different groups fit together. I draw his attention to the helpful diagram in the DTI review. By bringing the Accountancy Foundation and the FRC together, we are creating a single unified regulator under which will sit the Auditing Practices Board with its enhanced role, the investigation and discipline board with its strengthened powers, and the professional oversight board, which will include the audit inspection unit. That is a much simpler and more rational system than we have had until now, and because it all fits within the FRC, I think that the hon. Gentleman will find the complementarity of roles that we both want. Finally, he urged on me speedy implementation of the recommendations—that is precisely what we are now doing.

Mr. Martin O'Neill (Ochil): I welcome the Secretary of State's timely statement. She has avoided, as she said, the excesses of Sarbanes-Oxley, but at the same time she has been able to ensure a proportionate response to the drop in confidence in accounting services and the way in which businesses are run. Intriguingly, however, she missed one point that has been a matter of discussion in recent weeks—trying to avoid the practice of giving golden handshakes to failed executives. The issue provokes great bitterness and discontent, and I know that it will be a subject of a private Member's Bill later this week. However, I feel that my right hon. Friend missed the opportunity to address the issue, and wonder whether she could tell us why.

Ms Hewitt: I am grateful to my hon. Friend for his welcome for this package and for giving me the opportunity to comment on an issue about which, as I have said before, I feel extremely strongly. I have often said that big pay-offs for large corporate failures are unacceptable, which is why last year I introduced new company regulations requiring an annual shareholder vote on the directors' remuneration report for quoted companies. Company owners should, above all, take the matter into their own hands and sort it out. Of course, I am aware of the private Member's Bill proposed by the hon. Member for Tunbridge Wells (Mr. Norman), whose aims I entirely support. We have had an opportunity to discuss his Bill, and I told him that I share the concerns, of investors in particular, about the

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way in which it would work in practice. We are assessing the impact of the changes that we have already made to company law, and I intend to consult on whether further changes are needed to deal with rewards for failure.

Dr. Vincent Cable (Twickenham): May I, too, welcome the Minister's courtesy in giving us early sight of the statement? Like the Conservative spokesman, I agree that its contents are both good and controversial. It is a welcome follow-up to the Higgs report, requiring accounting companies to produce proper accounts, which they often have not done in the past, and the tidying-up of regulation.

Is that enough? There has been a crisis in capitalism and there is a fundamental lack of trust in corporate behaviour, particularly in independent audits. It is striking that on the three big issues that the Government had to confront—audit rotation, competition policy and conflicts of interests—they have not taken the robust action that one might have expected. I shall pose a series of specific questions. First, on corporate governance and Higgs, I welcome the fact that the Government are now taking the initiative to break up the magic circle and break the incestuous links between non-executive directors. As there will be a demand under the reforms for more non-executive directors, what action will be taken to ensure that the existing community does not take on excessive numbers, which is already happening? Why have the Government not responded to advice to set limits on the number of non-executive directorships and chairmanships?

Secondly, on rotation, if it is indeed impractical to rotate audit companies, do the Government not accept that there are great dangers from close personal relationships developing between individuals in audit companies and the companies that they are auditing? Why are the Government not taking steps to encourage or demand that, for example, all audit partners—all signing partners, not just the lead partners—are rotated and that all members of audit teams are rotated, to ensure that those incestuous links are broken?

Thirdly, on conflicts of interest, surely the Government accept that it is inherently unsatisfactory for an audit company simultaneously to carry out an audit role and seek to carry out or carry out big IT consultancy contracts for the same company? The issue is subtle and complex, but surely there should be action beyond the Government's guidance to ensure that the most obvious conflicts of interest are simply stopped? On competition policy, do the Government accept that having four groups auditing the accounts of the top 500 companies is inherently unsatisfactory? The problem is difficult because those companies are global, but do the Government have any plans to pursue with the European or American authorities a combined approach to competition policy to try to break up the groups or introduce more competition in the market?

Finally, why was there no reference whatever in today's statement to the Comptroller and Auditor General and the National Audit Office, as both the private sector and the NAO have suggested that there is a major role for the NAO in auditing private accounts,

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possibly nominating auditors? That would be an excellent way in which the public and private sectors could collaborate, so why is there no reference to it?

Ms Hewitt: I see that the Liberal party is swinging to the left today.

The hon. Gentleman talked about widening the magic circle of directorships. I entirely agree. As I said both in my statement and when we announced the appointment of Derek Higgs to conduct the review, it is not satisfactory, however good the individuals, to have a limited number of people on the boards of our major companies. The hon. Gentleman asked whether there should be a statutory or regulatory limit on the number of directorships. I draw his attention to Derek Higgs's clear recommendation that a full-time executive director should not take on more than one non-executive directorship and that no individual should chair the board of more than one major company.

However, as I told the Conservative spokesman, one size fits all is not appropriate. To try to set a single figure as a ceiling for the number of directorships and non-executive directorships that one individual may hold would not take account of the fact that some directorships may be in much smaller companies and so on. Some non-executive directors, particularly chairs of audit committees, have a much larger company burden than other independent non-executive directors. So I believe that we have got the balance right.

The hon. Gentleman raised the issue of whether the entire audit team, as well as the lead audit partner, should be rotated. Various review teams have looked at that matter carefully, because it was raised as an obvious solution to the problem. As with the issue about rotation of audit firms, the problem is about getting the right balance, ensuring that cosy incestuous relationships do not develop—that was part of the problem at Enron—while not destroying the expertise built by an audit team in relation to its client firm. There is evidence that some of the worst problems arise in an audit firm's first year, when the team, by definition, is completely new. Again, there is a balance to be struck, and we have approached it sensibly.

The hon. Gentleman wanted me to say more about non-audit services, including IT services. I draw his attention to the recommendation in the co-ordinating group report that the new regulator should further restrict the circumstances in which auditors supply internal audit services, and ensure that there is a strong presumption against supplying any internal audit services other than in exceptional circumstances. The report suggests that the regulator should review the circumstances in which it is permissible to provide valuation services, actuarial services, litigation support services, taxation services, and services involved in the design and supply of IT and financial information technology systems. A strong case is made for much stronger standards being set for audit firms. They will complement the strengthened provisions in the combined code that result from Sir Robert Smith's recommendations.

The hon. Gentleman also asked about competition in the supply of auditing and accountancy services. Of course that is a matter for concern, although the Office of Fair Trading has looked at it already, at our request,

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and has agreed to keep it under review. The market for such services is increasingly European and, indeed, global. At a regional level, where smaller companies are concerned, the competition for supply is rather greater.

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