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Mr. Fallon: The House can well understand the background against which the hon. Gentleman introduced the new clause. As he said, there have been too many financial and accounting scandals, not just in the United States, but in the UK. That is why many of our international companies, as well as American companies, now face having to implement Sarbanes-Oxley. When we consider Cousins-Jones against Sarbanes-Oxley, I fear that Cousins-Jones—the new clause before us—is equally vulnerable to some of the difficulties of implementation. I would like to take issue with some of drafting of the new clause.
First, the proposed new subsection 27A pejoratively lumps together tax-avoidance schemes with consultancy and advisory services. The hon. Gentleman might have strengthened his case if he had not linked them so ostentatiously.
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Secondly, as the hon. Gentleman told us, Sarbanes-Oxley makes a clear distinction between the different types of advisory service, which is an important point. It is too easy to say that there is "audit" on the one hand and "non-audit" on the other. It is possible for an auditor to identify some important tax advice that is needed in a company. There is no one more natural than the auditors themselves to carry forward that tax or other accounting advice that is needed. That is why it is interesting that tax advice is not on the list that the hon. Gentleman read out. With great respect to the hon. Gentleman, who has followed this subject for a very long time, it is too easy to brand in a single sentence consultancy and advisory services and tax-avoidance schemes. There are many non-audit services that may be directly linked to audit and many others that may not.
With respect to proposed new subsection 27B, the hon. Gentleman's example from local government was not a valid one. As he recognised, the test in local government is a continuity test. What new subsection 27B proposes is an absolute bar. Auditors would not be allowed to carry on after the five years, even if they met some of the criteria laid down under the local government test. That is why I am not attracted to that proposal.
Let me clarify what the important issues are. Where there is an imbalance between the audit fee and the remuneration for non-audit services, there should be some recognition of the fact and perhaps some test of proportionality. Clearly, if predatory pricing is taking place or an audit firm is simply offering an incredibly cheap audit in the full knowledge that there will be a whole package of non-audit work that it will then secure, that amounts to a real issue. The hon. Gentleman may recall that I raised that matter with the Financial Services Authority, which was itself engaging in the practice of paying its own auditor three times as much for its non-audit work as it was for the audit. The issue is real but, with great respect, it needs to be tackled in a slightly more sophisticated way.
Sir Robert Smith (West Aberdeenshire and Kincardine) (LD): Will the hon. Gentleman expand on the point about balance? Does he mean balance in respect of the volume of work or the value for money of that work as between the audit and the non-audit function?
Mr. Fallon: I was thinking neither of the volume of the work nor of the value for money, but of the fee that would be available to a particular firm. Predatory pricing takes place in any business or industry and I would like to see some safeguard so that audits cannot be bought on the cheap and new audit firms cannot buy their way in with the knowledge that a great volume of non-audit work would immediately fall to them. It is an issue that we need to reflect on and tackle, but it is not properly covered by the new clause.
The independence of partners is also an issue. We have already discussed the practice of ensuring that partners are fully independent not just from one audit to the next when they take over the audit from another partner, but within an audit firm as between partners
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responsible for audit work and those responsible for non-audit work. It may well be that more could be done to ensure that those Chinese walls remain impenetrable.
Finally, will the hon. Gentleman reflect again on what never seems to be considered when proposals such as this come up—the whole issue of costs? There is a related issue because, if all firms have to rotate their audit every five years, that could well reinforce the cartel rather than opening it up, with firms being passed round between the big four on an automatic rotating cycle. That is one issue, but there is also the issue of cost. It may be that a firm is perfectly happy with the auditors that it has, and simply has to go through the whole process of tendering the audit out, with all the extra cost that that entails, simply to meet some box-ticking requirement.
Cost is an issue, not so much for the big firms that have big auditors, but for the others. The new clause refers to "a large company", but I am not sure whether that is a Companies Act 1989 definition or refers to the FTSE 100 or 300 companies or to all public limited companies. In any case, there is clearly a cost to such requirements and we need to be more careful to establish what exactly it is before going down the route of automatic rotation. For all those reasons, I have some doubts about the new clause.
Mr. Andrew Mitchell: I pay tribute to the hon. Member for Newcastle upon Tyne, Central (Mr. Cousins) for tabling this interesting new clause, but I fear that I cannot be much kinder about it than my hon. Friend the Member for Sevenoaks (Mr. Fallon).
Early on in his remarks, the hon. Gentleman referred to Sarbanes-Oxley, which I fear he was praying in aid. He will be aware that the US decided against the mandatory rotation of audit firms and against a prohibition on auditors providing advisory and other non-audit services. Sarbanes-Oxley was largely about the US catching up with the UK. Where Sarbanes-Oxley leapfrogged the UK, the Government's consultative group on accounting and auditing recommendations brought the UK up to the level of the US. Indeed, there is some argument that this Bill completes that process.
It is clear that, taken together, the proposals in new clause 9—and new clause 10 in the previous group—would mean that the private sector would withdraw from auditing listed and public interest companies. Perhaps the hon. Gentleman believes that a state-owned auditor such as the National Audit Office should undertake the audit function. I do not, but I recognise that it would be the fastest way to persuade the Treasury that auditors should have limited liability, as under no circumstances would it wish to have to fund the NAO—or any other state auditor—on a joint and several liability basis when something went wrong, as it assuredly would.
The combination of mandatory audit firm rotation, together with a prohibition on the auditor selling non-audit services such as tax or consultancy advice to the company—both while it is that company's auditor and in the previous five years—would mean that the large firms of accountants will simply concentrate on everything that they do other than audit. Frankly, on any sensible commercial criteria, those large firms could hardly come to any other conclusion.
As I have said, the combination of the various proposals would certainly drive all private-sector audit firms out of the business of auditing. However, each
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measure on its own would be likely also to have that effect. Furthermore, each of the measures would have exactly the opposite effect from that which I assume is intended, in that the quality of audit would be reduced rather than enhanced. First and foremost, the quality of an audit depends on the quality of the people conducting it. Auditing is not simply a question of following a rulebook but of the exercise of judgment. It is about understanding a business and recognising where risk may lie. It is also about making sure that the audit is directed into the right areas and that the findings are understood, so that the right conclusions can be drawn from the audit.
I am advised that, almost without exception, the very high quality of people attracted into the accountancy profession say that they have chosen that qualification above other business qualifications because of the diversity of activity conducted by chartered accountants. It is essential, therefore, that we continue to permit auditors to conduct a wide range of activity, so that they can attract the very high-quality talent necessary for them to conduct high-quality audits.
Secondly, it is ludicrous to imagine a situation where an auditor could not offer any advice to a client. The auditor's knowledge of accounting, internal controls, corporate governance and many other related issues qualify him or her to give such advice. The auditor's deep—indeed, intimate—knowledge of a business that he will have gained from conducting an audit frequently makes him far and away the best person to give advice. The new clause would deny that source of advice to companies, thereby lowering the standards of financial reporting, internal controls and corporate governance in the UK, rather than improving them.
The Auditing Practices Board is independent of the accounting profession and is chaired by an eminent lawyer. It has just published new ethical standards for auditors. Broadly, they permit auditors to provide a wide range of services to their audit clients, subject to appropriate safeguards. That approach builds on earlier standards pioneered in the UK that since have been adopted around the world. The approach also makes sure that auditors have appropriate objectivity and independence and allows companies to take full advantage of the particular skills that the audit firm can bring to them. It would be insane to move away from that well-developed and much-copied system.
The second proposal is every bit as unwise as the first. If I understand it correctly, the intention is that a large company should be required to change its auditors every five years. I imagine that the hon. Gentleman is aware that such a system using a nine-year rotation period has operated in Italy for some years. I remind him that it was in Italy that the largest corporate scandal in Europe—to which he referred twice—took place. I do not know whether he has had a chance to look at the research conducted by Bocconi university in Milan, but it concluded that that system of audit firm rotation has reduced rather than improved the quality of auditing in Italy.
The fact that I can present that information shows that the Conservative party's research facilities have been working overtime. The hon. Gentleman must have been unaware of the Bocconi research, as he could not possibly have tabled this new clause if he had read it. I am sure that he is aware that the US General
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Accounting Office recently conducted a study into whether a system of mandatory audit firm rotation would improve audit quality. It concluded that the opposite would be the case.
Indeed, the concept of a system of mandatory audit firm rotation was considered here in the UK as recently as last year by the Government's consultative group on accounting and auditing issues, under the joint chairmanship of the then Financial Secretary to the Treasury and the DTI Minister then responsible for consumer affairs. The conclusion was that the risks associated with such a system more than outweighed any benefit. It found that the benefits could be achieved in other ways and, indeed, that they were being achieved as a result of measures introduced by the profession voluntarily and by the Auditing Practices Board.
I have some sympathy with the notion that auditors should make clear to shareholders the reasons for their resignation. However, that requirement is part of the law at present, and so that aspect of the new clause is not necessary.
3.15 pm
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