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Mr. Mark Hoban (Fareham) (Con):
I rise with some trepidation because I am probably the only person in the Chamber who has worked for one of the big four firms
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that the hon. Member for Great Grimsby (Mr. Mitchell) called into disrepute. I am a non-practising chartered accountant, and I want to focus my speech on auditors' liability.
The Minister was right to stand firm against the siren voices of her colleagues, especially the hon. Member for Great Grimsby, who called for more detailed regulations and rules on aspects of audit firms' operations, because a rules-driven approach has been shown not to work in certain jurisdictions. The principles that underlie UK accounting standards, rather than the rules-driven approach that underpinned US practice, explain why we have managed to avoid the great corporate collapses experienced in the States over recent years. It is important to stand behind the principle-driven approach on regulation and accounting.
Having said that, it is a great shame that the Bill has not been used to limit auditors' liability by setting up rules for proportionate liability or capping the liabilities faced by audit firms—different approaches to tackling liability that, I suspect, would have different consequences for the market for audit services. It is especially disappointing that this morning's written ministerial statement used the cover of the Office of Fair Trading report as a reason not to proceed with limiting liability through the Bill. The report has come in for a fair bit of criticism from not only the accountancy profession but independent commentators, due to its relative merits, the time scale in which it was completed and its lack of a thorough investigation of the market. I hope that the Government will support and encourage the consultation process to which the Minister referred in her speech and the Secretary of State referred in the written statement so that the issue will not continue to fester for years to come.
Limitation of liability is a problem for auditors for two reasons. First, the legal position is that an auditor held responsible with other parties for the loss suffered by a company, no matter how minimal its role in that loss, is liable as a consequence of joint and several liability to pick up the whole loss. People often sue audit firms because they believe that they have deep pockets. The hon. Member for Great Grimsby highlighted the fact that insolvency practitioners pursue firms of auditors to recover losses suffered by creditors and shareholders. It is right and proper for them to do so, as they have a duty to maximise the amounts that they secure for creditors. Sometimes, however, auditors are seen as an easy target, compared with directors, who may not have the resources of accountancy firms.
Secondly, limitation of liability is a pressing issue because of the financial risk to which my hon. Friend the Member for Sutton Coldfield (Mr. Mitchell) referred. Large firms of auditors may be unable to secure sufficient insurance cover for the financial risks that they face as a consequence of claims. If cover is not in place firms are exposed to the danger of a catastrophic loss, leading to the collapse of the business. That also acts as a barrier to other audit firms that may wish to enter the market for large audit clients—a point to which I shall return. As well lacking access to insurance cover an audit firm, by virtue of being a people business and a partnership, may lack ready access to capital. A big four
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firm may have a £1 billion turnover in fees, but its net assets are a quarter of that sum. A successful claim against such a company could lead to its collapse.
We need to think carefully about the consequences of not implementing limitation of liability. Audit firms will continue to tighten their client acceptance and retention procedures, which determine whether or not they take on or retain a client. When I worked for an audit firm, there was a distinct tightening of risk management. Audit firms are focusing much more on risk in a range of different areas, especially client acceptance and retention. In recent years, their procedures for doing so have become more rigorous, and as the risks faced by auditors increase as a result of the growing size and complexity of their client companies, they will adopt an even more rigorous approach to client acceptance. Auditors will look more carefully at high-risk factors and companies, and decide whether or not they want to be exposed to the risk that such companies bring. They may start to show the independence that the hon. Member for Great Grimsby wanted them to show by turning such clients away. That process could start if limitation of liability is not implemented.
Mr. Austin Mitchell: Does the hon. Gentleman think that that careful scrutiny of clients is more common than the widespread practice of low-balling—putting in a low bid to get the audit contract? We have heard several examples of things that firms have done to get their foot in the door and get the contract, so that they can sell other services. However, they have to reduce the quality of the audit, perhaps by using unsupervised and untrained staff, and cut corners so that the audit meets the cost given in their bid.
Mr. Hoban: The hon. Gentleman's intervention demonstrates the weakness of his case, as he tends to overstate the extent of low-balling and collusion. In her written statement today, the Secretary of State referred to the reputation of audit firms, which they know they risk if they produce poor quality audits. The value that they place on their reputation stops them cutting corners and risking the quality of their audit work. In overstating his case, the hon. Gentleman does himself an injustice, as earlier he made a powerful argument about problems that need to be tackled.
There is a risk that some clients will be turned away and will not find an auditor to audit their accounts. At the weekend, one newspaper referred to the prospect of companies in the financial services sector being unable to find an auditor, which would create a serious risk for capital markets and shareholders. Auditors must engage in a debate about the financial risks that they are prepared to accept when taking on clients and the extent of their financial exposure. Reluctance to limit auditors' liability could also restrict the work that they do. In the past few years, as I saw when I was in the profession, more and more information has been included in company accounts. In addition to financial data, there are reports on corporate governance, internal controls and, as was said earlier, operating financial reviews. Much of that information is non-financial and is not audited. Auditors are required only to give a true and fair opinion of financial statements, so a large part of the accounts that shareholders receive includes information that the auditor has not looked at. I looked at a copy of
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an audit report earlier today, and the auditors clearly differentiate between their work to test the accuracy and integrity of financial accounts and their work on non-financial data. They do not pass comment on the quality of a company's systems, on which the directors themselves report. They do not say whether those controls are adequate or inadequate—they simply say that a board has published a statement, and do not comment on the effectiveness of corporate governance or risk and control procedures.
I should have thought, however, that many investors would like the auditors to comment on those internal controls and corporate governance procedures. The risk to which audit firms would be exposed if they made such a report restricts to the minimum the scope of the comfort that they can give. If we want better-quality information to be given to shareholders, and if it is to be validated and verified by accountancy firms, we must look at their liability, and decide whether we want to restrict it to enable auditors to undertake more services of genuine value to investors and shareholders. The hon. Member for Weston-super-Mare (Brian Cotter) referred to the comments of the chief executive of the Institute of Chartered Accountants, Eric Anstee, who said:
"A fair liability regime encourages more transparent corporate reporting and enables auditors to exercise professional judgment on matters that go beyond the statutory audit requirements."
That is a valid point—if the Government want auditors to comment on the operating financial review and non-financial data and accounts, they must look at the liability faced by auditors in producing such work and consider whether they should restrict it to enable them to provide much greater assurances.
Another consequence of a failure to tackle limitation of liability in the Bill is a restriction of the number of firms willing or able to audit large companies. I became an accountant in the mid 1980s, when I joined a big eight firm. Those firms have now been reduced to the big four, which, as has been said, dominate the market for large audits, auditing every single FTSE 100 company and 97 per cent. of FTSE 250 companies. A catastrophic claim against one of the big four could restrict those firms to the big three. It could be argued that that creates an opportunity for someone to enter the market and pick up audit work, but under current conditions that is not possible, as Steve Edmonds of Grant Thornton pointed out:
"The OFT's report has not addressed the consequences of the marketplace if another Big Four firm were forced to seek protection from enormous professional indemnity claims. Were the Big Four reduced to a 'big three', it is highly unlikely that Grant Thornton or another mid-tier firm would seek to take the place of the former Big Four member in such a risk segment of the audit market."
Eric Anstee said of middle-tier firms:
"These firms wrote to the DTI at the time of the original consultation indicating they wished to audit larger public companies but were reluctant to do so either because they could not get insurance or because the potential exposure was too great."
There we have it. If we are looking to support the existing structure of the market or to support competition between audit firms, we need to reconsider the limitation of liability for audit firms. If we wish to move away from the big four and encourage middle-tier
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firms to audit larger clients, we need to limit liability for their sake, to reduce their exposure. Comments have already been made about the much greater dilution of power in some of the overseas markets where there is already limitation of liability. In Germany and Austria a larger number of companies are audited outside the big four because those smaller firms feel confident, given the existence of the cap on liability.
The principal argument against the limitation of liability is the concept of moral hazard—that if we start to restrict the liability of auditors, they will reduce the standard of their work and, in the words of the hon. Member for Great Grimsby, cut corners. I am not sure that that would happen. I have done work that was subject to unlimited and limited liability, and I do not believe that my standard of professionalism dropped between different types of assignment. One tackles all assignments with the same degree of care and the same sense of the importance of one's work for the firm's reputation.
The Government have made a mistake by trying to kick the issue of limiting auditors' liability into the long grass. By setting up an open-ended consultation process and by not tackling the issue in the Bill, they are creating the potential for a further concentration of the audit market down to the big three, and a situation where audit firms will turn away clients whom they consider to be too great a risk for them to bear. That will lead to a restriction in the type of work that audit firms will consider. I hope that the Government will take advantage of a short Committee stage to think again and take some positive action to tackle the issue of auditors' liability.
7.42 pm
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