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Brought up, and read the First time.
Mr. Cousins : I beg to move, That the clause be read a Second time.
I shall have regard to the Government's intentions as set out during the last debate. They have made it clear that auditor liability will be debated again in a future companies Bill, which is why it was unnecessary to press new clause 10 to a Division. I shall also have regard to the fact that, according to the Government, we shall have an opportunity to revisit all these matters in the fairly near future.
Nevertheless, new clause 9 draws attention to two issues that the Bill does not cover, but which I hope will be dealt with in some form in any new Bill that comes before us next year. I shall deal as rapidly as I can with those issues, the first of which is the importance of rotating auditors. The current position is that the auditing and accountancy world has accepted the need to rotate audit partners, but not the case for rotating audit firms. That contrasts with the provisions applying to our colleagues in local government, in respect of whom the Audit Commission has insisted on a review of audit relationships every five years and required a test of the continuity of the audit service provided by an audit firm. That service must include the ability to report irregularities, and to report independently and clearly on the effectiveness of the organisation involved. Of course, that provision is not framed in quite the same way as a requirement to rotate audit firms, but it perhaps provides the Government with some guidance on how they should address such issues. It would be wholly wrong for the Audit Commission to impose on local government and other public bodies requirements that were not to be imposed on public companies in general.
It is also true that the rotation of auditors is an issue that constitutes unfinished business so far as the famous Sarbanes-Oxley legislation is concerned. The United States Congress did not resolve that issue clearly through its discussions, but that is no reason for this House to avoid addressing it. There is a need for a clearly independent relationship between auditors and those whom they audit. It is difficult to see how that can be achieved where there is a long continuity of relationship between audit firms and those whom they audit. Such a relationship clearly leads to collusion and connection, and to established practices that might not be in the interest of a fully independent audit.
The current practice of changes in audit partnersitself achieved as a result of much campaigning and debate in the 1980shas not led to robust audits. There
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is no example of an incoming audit partner produced by rotation having blown the whistle on the conduct of a previous audit partner. Of course, audit partners change anywaysome retire and others leave the firm in questionbut even in those contexts, there are no examples of partners commenting unfavourably on the work of other partners.
A further concern, about non-audit services, is addressed in new clause 9. In a recent case involving the Royal Automobile Club, the outgoing firm of auditors suggested that the incoming auditors, PricewaterhouseCoopers, had undercut it by 50 per cent. in order to secure the audit. It claimed that that demonstrated a determined approach to price audit work on a predatory basis, so as to secure an appointment that might enable PWC to introduce higher priced consultancy services to the RAC in due course. Yet that seems not to have produced any corresponding robustness in the first year of the PricewaterhouseCoopers audit.
There is considerable evidence that big investment management organisations would prefer a system involving the rotation of audit firms. The pension fund company Hermes has called publicly for such rotation and, in a survey published in February 2002, a majority of finance directors expressed the belief that companies should be compelled to rotate auditors every few years. The issue is very much on the agenda and the risk of collusion certainly informs the debate on corporate governance.
New clause 9 also deals with the separation of audit services from non-audit services. It is a fact that almost three quarters of accountancy firms' income derives from selling non-audit services to their audit clients. That creates the danger that audits might be used as loss-leaders to secure non-auditing work, with big firms sometimes undercutting mid-market ones in precisely the way that I described in respect of the RAC case. It is clearly essential that auditors be completely independent of the company in question and that they have no material interest in the judgments that they make concerning the financial statements that they audit. By selling non-auditing services, auditors acquire a material interest in protecting and defending aspects of those financial statements. Their position is no different from that of an employee and the potential for conflicts of interest is clear.
According to a poll carried out on behalf of the accountancy regulators, nearly 83 per cent. of company executives said that a desire to gain more non-audit work impairs auditor independence. Nearly two thirds of auditors themselves agreed with that point of view, and more than half the auditors surveyed also agreed that the remuneration of audit partners is affected by their ability to generate non-auditing services within the same company. Such a connection between the audit function and non-audit services in respect of the same source has been a factor in a number of well-known company failures. Recent examples include Enron and Parmalat, and there are a whole host of examples from the more distant past. Enron's auditors, Arthur Andersen, also supplied quite expensive non-audit services to that company. Its financial rewards were directly connected to those sales, and the same incentives and possible collusive relationships are also a factor in the UK audit market.
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Similarly, the Department of Trade and Industry's inspector's report on Maxwell called for major reforms of auditor independence. That has been reflected over the years in a whole host of DTI inspectors' conclusions. In 1979a year that many of us in this Chamber will remember for other reasonsone such report reached the following succinct conclusion: "In our view, the principle of the auditor first compiling and reporting upon a profit forecast is not considered to be good practice, for it may impair their ability to view the forecast objectively and must endanger the degree of independence essential to this work."
Finally, I should tell the House, that whether it likes it or not, this issue will come before us in some form. Under the Sarbanes-Oxley Act 2002the recent legislative result of the Enron affairthe provision of nine kinds of non-audit services from a company's own auditors is now banned. Congress did not accept the idea of a disconnection between audit and non-audit services, but it did set out nine things that would be banned from being provided by an audit firm to the firm that it audits.
It is instructive to list those nine aspects. The first is bookkeeping services relating to the accounting records. Then we have the design and implementation of financial information systems; evaluation services or expressions of the opinions of fairness; actuarial services; the ability to outsource internal audit functions to the same firm that was supplying the external audit; non-audit services such as management functions or human resources advice; any activities as a broker or dealer or investment adviser; legal services or other expert services unrelated to the audit; and any other service that the accounting board set up under the legislation would later determine by its own regulations to be impermissible. That is a fairly comprehensive range of services that audit firms are banned from providing to the companies that they audit.
The issue will not go away because many British-registered companies will have those rules applied to them if they list in the US. It is very much a live issue. I would like to know how the Government intend to respond to the issue now. The House will have to consider the matter again and it should certainly form part of our debates on the new companies Bill that the Minister outlined in the previous debate.
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