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Mr. Greg Knight: Will my hon. Friend clarify a matter that may indicate whether the hon. Member for Newcastle upon Tyne, Central (Mr. Cousins) made a valid point in his intervention? If my hon. Friend is arguing that we should accept new clause 1 and the associated new clauses, that is a perfectly legitimate point to make, but if he is urging us to accept new clause 1 and is saying that its operation should be retrospective, the hon. Gentleman's point might have some merit.
Mr. Mitchell: I reassure my right hon. Friend that I am certainly not suggesting that new clause 1 should apply retrospectively. I am trying to propose a range of different opportunities to resolve the problem. New clause 1 contains the solution that the Government will eventually reach—it is certainly my preferred solution—but it is not the only way to resolve the problem, as I shall attempt to persuade the House.
Permitting auditors to limit their liability by reference to proportionality does not remove financial risks from audit firms. Furthermore, proportionate liability does not guarantee the survival of an audit firm. In an extreme case, the loss caused by a firm's negligence could be greater than its financial resources. However, such liability would reduce significantly the likelihood of a catastrophic corporate failure bankrupting an audit firm, while making it far more attractive for some of the mid-tier firms to compete more vigorously to audit companies in the FTSE 350, and perhaps later, in the FTSE 100. For all those reasons, new clause 1, which would permit auditors to limit their liability by reference to proportionality, has a great deal to commend it, and I hope that the Government will at least accept the principle today if not the new clause.
I offer new clause 2 as an alternative approach. Although the Secretary of State for Trade and Industry has ruled out the introduction of a cap, she had concluded in favour of doing so until she learned of the Chancellor's strong opposition. The OFT confirms in its report, to which I referred a moment ago, that a cap set appropriately would not be anti-competitive, so clearly, any cap would have to be set by the Secretary of State or by someone else with delegated authority, such as the Financial Reporting Council. That would be necessary to ensure that the cap was set appropriately.
New clause 2 proposes to set the limit at twenty times the UK audit fees. I am not wedded to a multiple of twenty. Some have argued that it is too high and others have suggested that it is too low, but it represents an appropriate level, high enough to provide proper redress when something goes wrong and low enough to reduce significantly the possibility of a large claim bankrupting the auditors. There are not many providers of services and goods in the UK that face a penalty of twenty times.
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Sometimes, a single failure at a certain moment gives rise to the audit failure. More often, however, the problem has arisen over several months or occasionally years, and it is necessary for that purpose to regard the failure as what the insurance industry calls a single event. In other words, if the auditors fail to detect a fraud that begins in one accounting period and it is detected in a later period, the auditor's liability would be limited to twenty times the average fees paid to it in those years. That is an important principle if we are to avoid double counting, and it forms the substance of new clause 2.
New clause 3 is similar to new clause 2, except that a single monetary sum—£75 million—would be imposed on all companies. PricewaterhouseCoopers suggested that sum in its response to the Government's consultative document. I am persuaded by its logic that £75 million is not an unreasonable figure. In its submission to the Department, it says:
"For all but the very largest companies, losses arising from an auditor's negligence are very unlikely to exceed this amount, so such claims would effectively not be capped. For the very largest companies, which give rise to risks of loss greater than £75 million, it is appropriate that they should carry the excess risk themselves. We further believe that a statutory cap at this level will improve the likelihood of mid-tier firms taking on larger audit engagements, thereby increasing choice in the marketplace."
The Government have made it clear that they expect any form of limitation of auditors' liability to be such that it promotes competition. I can certainly understand that a cap of more than £75 million would be so far in excess of the ability of mid-tier firms to meet an award of damages against them that it would do nothing to encourage them to compete for larger audits. Indeed, even for the big four, a settlement of damages much above that figure could be met only by the firm mortgaging its future, with the inevitable consequence that the firm would become unattractive to possible new partners and, indeed, many of its existing partners. Inevitably, therefore, in the long term, such a settlement would lead to terminal decline. Such a firm's ability to invest in new technology and in the development of the people whom it was able to retain would be severely damaged. That would not be in the interests of either competition or preserving high-quality audits, which are dependent on the involvement of high-quality people as audit partners and audit managers.
New clause 4 is both the simplest and most deregulatory measure in the group. It would permit a company to enter into any contract to limit liability with its auditors provided that shareholders approved such a contract in a general meeting. The requirement for any contract to limit auditors' liability to be approved by shareholders in such a meeting would address the abuse that gave rise to the provision in the Companies Act 1929 that I cited at the start of my speech, which eventually became section 310 of the Companies Act 1985. The measure was required because of directors and auditors who conspired to enter into cosy contracts to limit their liability that became known to shareholders only after a loss had been suffered and an action had been launched against the directors or auditors. No doubt some would argue that the 1929 Act would have been better if it had simply required such contracts to be approved by shareholders. In any event, 75 years later, in a radically different and more litigious
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and transparent age, we can ensure that any contract would be effective only if it were visible to, and approved by, shareholders.
Mr. Fallon: Before my hon. Friend moves on from new clause 4, does he accept that there could be an alternative danger? A big four auditor could put huge pressure on a company by saying that it would withdraw its services unless the company approved such a contract in a general meeting.
Mr. Mitchell: My hon. Friend might be on to a good point, but once a new system were set up—albeit not necessarily that outlined in new clause 4—the risk of such an event would be less than he suggests.
New clauses 5, 6 and 7 effectively mirror new clauses 1, 2 and 3. However, they would impose a limitation by statute, whereas new clauses 1, 2 and 3 are permissive and would allow companies to limit auditors' liability by contract if shareholders so wished. New clause 8 combines the benefits of proportionality with those of a cap. It would provide for a belt-and-braces approach that would combine the equity of proportionality with the safety net of a cap to guard against a catastrophic claim.
We have tabled the eight new clauses to help the Government. Conservative Members have no vanity of authorship, so we are happy to be corrected by the many skilled officials and draftsmen who serve the Minister.
Several events have taken place since Committee. It was said in Committee that the Government would amend section 310 of the 1985 Act to permit auditors to limit their liability by contract with reference to proportionality if it were made clear that the audit profession, the business community and investor organisations supported it, and that such an amendment would enhance competition in the audit market and improve the quality of auditing. I understand that all those conditions have been satisfied—I shall deal with each in turn—yet the Government have failed to table an amendment to address the matter.
The Institute of Chartered Accountants in England and Wales, which represents the auditors of almost every listed company in the United Kingdom, supports proportionality by contract and has said that the big four and mid-tier audit firms, which are the actual auditors of the listed companies, support such reform. Other accounting bodies, especially the Institute of Chartered Accountants of Scotland, also support the reform. It is thus clear beyond doubt that the Government's first requirement that the audit profession supports the reform has been met. The CBI, which represents larger quoted companies, and the Quoted Companies Alliance, which represents smaller quoted companies, support the concept of auditors being permitted to limit their liability by reference to proportionality.
Mr. Greg Knight:
Would there not be a further benefit if liability could be limited by entering into free contractual negotiations because there would be no need to alter the law on negligence, which is a tort?
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