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Mr. David Drew (Stroud) (Lab/Co-op): If my right hon. Friend does not mind my saying so, something is missing from the Bill, as the administration process needs to be made more transparent. Accountants and auditors play a specialist role in running companies in difficulties, but the lack of transparency means that the companies, their workers and pensioners are completely in the hands of the administrators. Would my right hon. Friend care to look at this matter to see if we can open up that secret garden, as insolvency practitioners can do enormous damage to our country—let alone individual companies?
Jacqui Smith: My hon. Friend is right that that is not within the remit of the Bill, but I, like him, have dealt with constituency cases that demonstrated that we need to shed light on the process for the sake of people's jobs. I cannot undertake to look at that matter in this Bill, but as is the case in a range of areas in corporate governance and financial reporting, we will ensure that the greatest amount of transparency and information are provided so that we can serve the best interests of businesses and the people who depend on them for their jobs and livelihood.
I was outlining the review process, which confirmed that the British system of company regulation was fundamentally sound. The priorities for change, however, were to build independence, transparency and high standards of corporate governance to keep Britain at the forefront of company regulation. Many of the recommended changes were aimed at companies and accountants and did not require legislation. Audit firms, for example, have agreed to rotate at regular intervals the lead and other audit partners working on a company's audit. Non-legislative changes, including the reform of the combined code I mentioned earlier, work with the targeted statutory provisions in this Bill to create a measured, well-considered and thorough response to the problems highlighted by Enron and WorldCom. The review ensured that there was wide consultation leading to much consensus, both on what should be done and how it should be done. In particular, there was much agreement that, wherever possible, transparency was preferable to inflexible rules.
Lynne Jones (Birmingham, Selly Oak) (Lab): The Bill merely proposes rotating the partners of an auditing company. Is my right hon. Friend satisfied that that is sufficient, as it is hardly likely that a partner who replaces his colleague as auditor will criticise him?
Jacqui Smith: We started from the belief that auditors are professionals who are committed to their responsibilities to company shareholders. My hon. Friend may be suggesting that an alternative is to make it a statutory or compulsory requirement to rotate the firm. No other European country has undertaken to do that.
The emphasis on good practice already adopted by the profession, such as rotating the audit partner, is likely to bring about improvements. My hon. Friend says that that is the only thing the Bill does, but that is
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not the case. We have taken non-legislative action, as well as legislative action in the Bill, to create a comprehensive range of improvements with respect to audit, in terms of the independence of the regulation of auditors, the recommendations that Sir Robert Smith made in his report, which are now enshrined in the combined code, and the rotation of audit partners, as I outlined. All those together help to build the improvements in the quality of audit which—I agree with my hon. Friend—we want to see.
Bob Spink : With all due respect to the right hon. Lady, I hardly see how she can pass the Bill off as providing a comprehensive range of solutions to the problems in company law. The Bill simply tinkers at the edges. It would be far better to tackle the wholesale reform of company law, rather than introducing piecemeal solutions such as the Bill.
Jacqui Smith: The hon. Gentleman accuses me of doing something that I do not think I did. I did not say that the Bill was a wholesale reform of company law. I said that, together with the non-legislative measures taken following the reviews that the Government carried out, it brought about a comprehensive change in the system of audit regulation and independence. That is what the Bill focuses on, particularly the role of auditors. It is right that we did that in response to the concerns raised internationally and certainly in the House after the Enron and WorldCom scandals. As I suggested, there is a fundamental need to ensure that we have faith in our financial reporting and our corporate governance. Of course it is important that we also take action more broadly on company law reform. That is why we instituted the company law review and why we will introduce more fundamental legislation as parliamentary time allows.
To build on what I was saying to my hon. Friend the Member for Birmingham, Selly Oak (Lynne Jones) about the scale of what is being changed with respect to audit, the Bill, in line with the principle of transparency, extends the requirements for disclosure of the non-audit services that a company buys from its auditors. It completes the review process by giving legal underpinning to many of the changes that have already taken place.
Lynne Jones: My right hon. Friend is correct—as she would be, being the Minister in charge of the Bill—that there are many measures in the Bill, but are not most of them very weak? Again she mentions non-audit activities. The United States legislation passed in response to the Enron scandal, the Sarbanes-Oxley Act 2002, prohibits certain non-audit functions or requires the rest of them to be authorised by the audit committee. Why are our provisions so much weaker than those in the US?
Jacqui Smith:
Given the experience of the US and the fact that the Enron and WorldCom scandals happened there, it can hardly be argued that the basis of our regulatory system is much weaker than theirs. It is true that the changes made in the Sarbanes-Oxley legislation with respect to non-audit services took a different route
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from ours. That Act lists a range of non-audit services which it would be illegal for the auditor to provide. Interestingly enough, the list is not as wide-ranging as some believe—it does not include tax advice, for example. That is not forbidden in the Sarbanes-Oxley legislation. We took a different approach, in line with our principles-based approach to company legislation, so that, for example, under the new ethical standards drafted by the Auditing Practices Board and currently out for consultation, it would not be appropriate in this country to provide alongside audit many of the non-audit services that are contained in the Sarbanes-Oxley Act. Alongside that, we have clarified the detail that companies must provide to their shareholders on types of non-audit services and money spent on non-audit services.
Mr. Austin Mitchell (Great Grimsby) (Lab): Will the Minister give way?
Jacqui Smith: I shall give way in a moment.
We can take one of two approaches to audit regulation. We can take a rules-based, legislative approach, which was adopted in the United States, or we can build on the principle-based approach that we already have in the UK. My hon. Friends push for more legislation, but I ask them to consider which of those approaches has been most successful up to this point.
Mr. Jim Cousins (Newcastle upon Tyne, Central) (Lab) rose—
Mr. Deputy Speaker (Sir Alan Haselhurst): Order. It would help if the right hon. Lady gave an indication.
Mr. Cousins: The Minister knows that the Sarbanes-Oxley Act does not contain a system of exemptions for British companies that are registered and quoted in the United States, so the provision about the separation of audit and non-audit services will be imported into the British system by that route. Has she closed her mind to a statutory provision on the separation of audit and non-audit services, because possible conflicts lie ahead if she has?
Jacqui Smith:
We have not closed our minds to anything, which helps us to improve confidence in both financial reporting and the quality of audit. My hon. Friend is right that the Sarbanes-Oxley Act has implications for the operation of UK companies, and it has potential implications for UK audit companies operating in the US. Nevertheless, that does not mean that the US and the UK must take the same approach to delivering the same objective. As I suggested earlier, evidence suggests that our approach has successfully achieved the objectives of effective auditing and confidence in financial reporting. Confidence in the quality of auditing depends on high standards for the training and supervision of auditors, high standards of practice and ethics and an independent system for investigating and disciplining auditors who fall short of those standards.
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A clear recommendation from the reviews was that the regulatory regime for the accountancy and audit profession could be simplified, improved and made more visibly independent by combining the bodies under the Accountancy Foundation with those under the Financial Reporting Council. That has created a single, independent group of organisations responsible for the recognition and supervision of the professional accounting and audit bodies, the preparation of accounting and auditing standards and for ensuring that major companies' accounts comply with the law and accounting standards.
That reorganisation has already taken place with the profession's full involvement and the Government's full support. The Bill makes the necessary amendments to legislation to support those organisational changes and bolster the independence of those arrangements. In particular, it requires that ethical standards, quality control and disciplinary action for audits of public interest companies be independent of the professional bodies themselves.
The Bill also contains measures to help auditors do their jobs properly and effectively. It extends the range of people from whom auditors are entitled to obtain information and, in effect, requires directors to state that they have not withheld relevant information from auditors. We redrafted that provision in response to concerns expressed while the Bill was in another place, and it now sends a clear and useful signal to directors and auditors, while avoiding placing an unreasonable duty on, for example, non-executive directors.
In addition, the Bill contains important clauses aimed at strengthening compliance with the law and standards on accounts, which, again, largely involves implementing recommendations from the post-Enron reviews. The Bill strengthens the body responsible for compliance—in practice, the financial reporting review panel, which is part of the Financial Reporting Council group. It will, for example, enable the Inland Revenue to pass to the panel information to help it in its function of securing compliance with accounting requirements. The panel will also be able to require information to assist it in its inquiries, and its scope will be extended to cover interim as well as annual reports.
Of course, the vast majority of British companies conduct their business honestly and produce accurate financial reports. They will seldom, if ever, be subject to enforcement action by bodies such as the financial reporting review panel or the DTI's companies investigation branch. However, a very small minority of companies do seek to abuse the system and we need to take firm and effective action against them. Their misdeeds can harm not only their own customers, suppliers, employees, creditors and investors, but confidence in companies generally. That is why the Bill contains some amendments to the powers of company inspectors and investigators.
In a typical year, the companies investigation branch receives more than 5,000 complaints about companies. All are examined to see whether they merit formal investigation. Some are passed to other bodies, such as trading standards authorities, the Financial Services Authority or the police. Each year, the DTI itself investigates some 350 companies out of the total of 1.8 million. Where an investigation reveals significant wrongdoing, further action can be taken. In 2002–03,
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following DTI investigations, 80 companies were wound up by the courts, 17 directors were disqualified, and seven individuals were convicted of offences. Moreover, my right hon. Friend the Secretary of State can disclose the otherwise confidential information resulting from investigations to a regulatory or professional body, such as the FSA, the financial reporting review panel or the Accountancy Investigation and Discipline Board, so that it may take action where appropriate.
The amendments in the Bill to increase investigators' powers—for example, to enter and remain on premises and require documents and information, including from third parties—are modest and remain subject to safeguards to protect human rights, legal privilege and banking confidentiality. But they are necessary to prevent a very small number of people from exploiting limitations in the existing law so as to frustrate investigations. That small minority gives companies a bad name. Indeed, victims are often other companies, as well as other organisations and individuals. These changes are therefore necessary and urgent, and it is right to include them in part 1, which is about maintaining and improving standards of financial reporting and preventing abuse.
I turn to the subject of director and auditor liability, on which the Government published a consultative document in December last year. That was in response to calls from some quarters to change the law dating from the 1920s that prohibits companies from agreeing to limit the liability of their directors or auditors. We received more than 120 responses to the consultation, from a wide cross-section of British business. The Government are grateful to all those who took the time and trouble to respond to the consultation. My right hon. Friend the Secretary of State set out our response in a written statement this morning. I do not intend to repeat that statement, but it explains that we propose to table amendments in Committee to tackle concerns that good candidates for directorships are being increasingly deterred by the risk of lengthy and expensive legal proceedings. I shall ensure that hon. Members on both sides of the House receive those amendments as soon as possible.
The statement also explains why the Government do not propose to introduce a cap on auditor liability. However, we remain committed to improving the operation of the audit market. We will continue to consider any proposals, including the possibility of limiting liability on a proportionate basis by contract, which can be demonstrated significantly to enhance competition and to improve quality in the audit market. We urge auditors, business and investors to work together to examine whether proposals for a system of proportionate liability via contract are practical and desirable.
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