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Mr. Greg Knight: The debate has been interesting. I congratulate my hon. Friend the Member for Sutton Coldfield (Mr. Mitchell) on having done his homework. I trust that the Minister has done her homework too, although Conservative Members fear that it has been retained on the desk of the Chancellor of the Exchequer. The hon. Member for Newcastle upon Tyne, Central (Mr. Cousins) also made an interesting and thoughtful speech. If the Minister has other things to do this afternoon, she could rise to the Dispatch Box and indicate that she is minded in principle to accept one of the new clauses tabled my hon. Friend the Member for Sutton Coldfield, and we could all get away earlier.

It is odd that the DTI conducted a consultation on auditors' liability. The consultation commenced in December 2003 and specifically covered that issue. Responses were requested by 12 March this year, so the closure date has long since passed. One would expect the Minister to have assessed the value of that consultation and to have reached a policy decision. I do not like piecemeal legislation or a piecemeal approach to problems, which is the approach taken in the Bill.

A full overhaul of company law is required and provisions such as the new clauses tabled by my hon. Friend the Member for Sutton Coldfield should be encompassed in wider company law legislation. I am
 
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therefore disappointed that the Government are seeking to proceed in one area, while we await whatever proposals they may have to change company law in the future.

My hon. Friend the Member for Sevenoaks (Mr. Fallon) said that he was attracted to new clause 1, which I, too, find the most attractive of those tabled by my hon. Friend the Member for Sutton Coldfield. However, I do not share his concern about new clause 4, which could have the opposite effect to that which he suggests; that is, it could lead to mid-market firms entering the marketplace, thereby weakening the cartel that was mentioned by the hon. Member for Newcastle upon Tyne, Central. New clause 4 is not as bad as my hon. Friend suggests, because it seeks to allow free contractual relations to take place. The benefit of proceeding in that way is that the law on negligence does not need to be reviewed because free contracting parties are allowed to build into their agreements a scope on the limit of liability.

2 pm

The hon. Member for Newcastle upon Tyne, Central spoke eloquently to his new clause 10. Looking at its precise wording, I see nothing that is incompatible with new clause 1; indeed, it could be a supplement to the provisions of new clauses 1 or 4. There is no conflict between taking a twin-track approach in allowing free contractual relations and imposing the duty, as would new clause 10, that before any exemption or contractual limitation is agreed, the shareholders and employees must have a statement. That would be a belt and braces approach. In supporting new clause 1, I am also somewhat attracted to new clause 10, which is in no way incompatible with the argument advanced by my hon. Friend the Member for Sutton Coldfield.

Mr. Cousins: I am grateful to the right hon. Gentleman for his kind remarks. Does he also accept that recognising a duty of care would be a significant change to the legal framework in which the big four accountancy firms operate?

Mr. Knight: I am attracted to a duty of care provided that it is circumscribed and well defined so as to avoid court actions of the sort that take place all too often in the United States.

I hope that the Minister will be prepared to respond positively to the constructive suggestions that have been made, particularly by my hon. Friend the Member for Sutton Coldfield, and that she will tell us what action the Government intend to take.

The Minister for Industry and the Regions (Jacqui Smith): In response to the opening remarks of the right hon. Member for East Yorkshire (Mr. Knight), I can think of nothing more rewarding or enjoyable to do this afternoon than to take part in the Report and Third Reading debates on this Bill. Having said that, I do not intend massively to extend the proceedings, because, as the hon. Member for Sutton Coldfield (Mr. Mitchell) said, we had a relatively short but good-natured and well-informed Committee stage in which we dealt with many important issues. That followed considerable scrutiny, and changes that the Government were willing to make, in the House of Lords.
 
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With these new clauses, we return to the aspect of the Bill—auditor liability— that has given rise to the most significant debates, not least because the eight new clauses that the hon. Member for Sutton Coldfield has tabled for consideration today are those that we also debated at some length in Committee.

I am grateful to my hon. Friend the Member for Newcastle upon Tyne, Central (Mr. Cousins) for tabling his new clause, which enables us to widen the debate.

It is worthwhile returning to first principles. There is widespread agreement that audit plays a crucial role in our market and in ensuring trust and confidence in our businesses. It is therefore important, as the hon. Member for Hexham (Mr. Atkinson) observed, that all those who need and want to access high-quality audit services are able to do so. We need to maintain a complete market in which the principles of competition ensure that completeness and help to drive quality through the system. In addition, we need to maintain, and preferably to improve, the quality of the audit process and of the information that is available to those who need it.

Those are the criteria by which we should judge any reforms that we make, and I shall use them to judge the eight different dishes that the hon. Member for Sutton Coldfield has served up to us.

I shall start with new clause 4 because it is the most straightforward. It would remove auditors from section 310 of the Companies Act 1985 and allow them to negotiate limited liability with their clients, free of statutory constraints and subject only to shareholder agreement to any proposed limitation of liability. The Government consultation considered a similar option and found that just over half of respondents were opposed to the proposal, partly for reasons that hon. Members rehearsed today.

Under that system, the market would set the level of any limit. That was a key fear of some of the respondents to the consultation. One major company commented:

"if the cap is left to individual negotiation, lack of competition would probably mean that the audit profession will push liability caps down over time".

Other respondents were concerned about the client's ability to negotiate an appropriate limit. There was concern that companies could find themselves in a weak bargaining position, particularly in situations where only a very few firms are capable of conducting the audit or where there have been past issues arising out of the audit. It is obviously important that the Government take note of those concerns and of the fact that more than half the respondents did not see this option as the way forward.

Furthermore—I hope that this is music to the ears of my hon. Friend the Member for Newcastle upon Tyne, Central, although I cannot promise to provide that all afternoon—we are conscious that the current rules were introduced in the late 1920s in the light of difficulties whereby directors and auditors had, in effect, colluded to the detriment of shareholders. We certainly do not want to see the return of those scandals.

New Clauses 2 and 6 would restrict, or permit restriction of, any liability to a figure of 20 times the audit fee, or—when the auditor has committed the same act of default in two or more consecutive audits—the average of the audit fee paid by the company in those
 
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periods. An upper ceiling set as a multiple of the audit fee has the merit of making the limit proportionate to the audit fee. However, it does not in any way reflect the loss caused to the company. To that extent, it is an entirely arbitrary figure in relation to any actual loss, and it will have arbitrary results.

At one extreme—where there are very high audit fees, for example—that approach could result in liability at levels that auditors suggest they cannot afford, thereby not solving the problem that hon. Members set out in the first place. At the other extreme, where there are low audit fees, it could mean investors being compensated for only a small proportion of the loss that they suffered through the auditor's negligence.

That dichotomy and problem cannot simply be addressed by changing the multiple from, for example, 20 to 10 or 20 to 40, because what improves the position at one end of the scale makes it worse at the other. That is a fundamental problem with the idea of a cap that reflects a multiple of the audit fee. It is of further concern that any limit that is based on a multiple of the audit fee would create a potential incentive for auditors to keep the fee as low as possible. At first sight, that might appear to be a good thing, but it is not in shareholders' interests for auditors to take short cuts. Indeed, under the regime set out in the new clauses, they have a positive interest in paying a high fee so that they can claim more back if things go wrong. It is therefore ironic that the new clauses could create a position whereby, because of the potential for claiming back in the case of a problem, the purchaser wishes to pay more than the supplier wants to charge.

The Government have considered the options in new clauses 2 and 6 carefully and concluded, again with the majority of the respondents to the consultation, that they are wrong in principle and in operation.

Let us consider new clauses 3 and 7, which, in some ways, are even more arbitrary in their effects. Under the proposals, the auditor's liability could or would be limited to £75 million. We have serious concerns that the approach would be anti-competitive. Some alternative arguments have been put today, but a major difference already exists between the big four audit firms and the next group, the so-called tier A firms, on the proposal. The Government have been told that a simple limit, which is fixed at a figure such as £75 million, would benefit the biggest firms but do little or nothing for some of the smaller and medium-sized firms, which risk being wiped out by such a sum. That approach could therefore entrench the current position and do nothing to aid our objective of enhancing competition in the audit market.The option clearly does not have the unanimous support of auditors, let alone investors. It is seriously flawed and the Government cannot accept it.

Let us consider new clauses 1 and 5, which, as hon. Members have said, are based on proportionality. New clause 8 mixes that idea with the sort of numerical cap against which I have just argued. New clauses 1, 5 and 8 raise more questions than they answer in running together contract and tort, and contribution between two or more liable people and that between company and auditor. However, despite the comments of the hon. Member for Sutton Coldfield on the disadvantages of the system of joint and several liability, I welcome his apparent agreement that any solution such as a proposal
 
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to limit liability proportionately by contract should be placed in the context of the current law on joint and several liability.

One of the attractions of a proposal to limit liability proportionately by contract is that it would not involve some of the much wider implications and unintended consequences of a full-scale reform of the law on joint and several liability but could enable the introduction of elements of proportionality.

The response to the proposals, especially in new clause 1, is that there may be scope in the system of joint and several liability for the auditors to limit their liability in some way to an amount that, in lay terms, is proportionate to their responsibility. That idea emerged in the course of our consultation. The Government did not present such a proposal for consultation but, as happens in good consultations, it emerged during the process and has rightly received serious consideration. It has come to be known as proportionate liability by contract.

2.15 pm

It is relatively easy to understand how a system of proportionate liability by contract could work between professional advisers, albeit with shareholders or the liquidator bearing the risk that one or more of those who had been negligent are unable to pay their share of the sum involved. As I have made clear, the Government certainly does not rule out that approach. However, it raises many questions that we need to work through with companies, auditors and investors before reaching a conclusion and a way forward.

For example, what should happen when directors have been dishonest, the auditors have been negligent in not detecting the dishonesty, and the company has suffered further loss? It is possible to argue that the company would not have suffered such losses if the auditors had done their job. According to that logic, auditors should be responsible for all the loss that their negligence caused the company. However, that would not do much to reduce auditor liability.

Alternatively, one could argue that the shareholders were responsible for choosing the directors and ensuring the maintenance of proper systems of corporate governance and hence should bear the risk of the possible dishonesty of the people whom they choose for the job. Accordingly, the auditors should not be held responsible for any loss. I hasten to add that that is not an argument that the auditors wish to advance; it would deprive the audit of purpose. However, I hope that it demonstrates some of the difficulties.

There are key questions, such as: should auditor's liability vary according to how much money a negligent or fraudulent director can pay back, assuming that he can be found and has assets? How different is that from the current position? Should the auditor's maximum liability vary in some way according to the negligence of the conduct of the audit? Some recent cases show that simple slips can play a key part in leading to huge losses. Do the simple slips matter, or should we ask the courts to consider the whole question of how the audit was planned and conducted? What guidance can we give
 
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them to distinguish between an audit that was 10 per cent. flawed and one that was 5 per cent. flawed? Is it possible to have degrees of audit failure?

Those are not easy questions but that does not mean that they have no answers. However, new clauses 1, 5 and 8 propose no answers. The Government have therefore concluded that there are too many unanswered questions currently to ask hon. Members to approve any reform. Moreover, stakeholders have stressed that it is important that changes to the liability regime take place only as part of a package of reform in which both the audit's quality and competition in the audit market are enhanced. Indeed, there is no reason why work to improve further the quality of the audit should not proceed immediately, in parallel with consideration of the rules of liability. I am pleased about the proposals from the Institute of Chartered Accountants in England and Wales to which the hon. Member for Sutton Coldfield referred. That is a good sign of action to deal with quality of audit.

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