Companies (Audit, Investigations and Community Enterprise Bill [Lords]

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Mr. Mitchell: I am mortified by the Minister's description of my amendments, but has she not in her last few sentences put her finger on precisely the point? The provision is a burden on business; it is a cost for business to bear, and the issue is whether that is proportionate to the risk. That is why—in amendment No. 7, for example—I have sought substantially to narrow the number of companies. As a result, larger companies, whose importance is greater than the individual company, would be caught in the net, while smaller companies, where the risk to the broader sector is much less, would be excluded. Her proposal is undoubtedly a burden on business; the issue between us is whether it is justified.

Jacqui Smith: The issue is certainly whether the proposal is justified, but it is also whether there will be additional monitoring, over and above that which exists. Auditors are subject to direct monitoring by their supervisory body, but those arrangements will be largely replaced, and major audits will be monitored by means of the independent arrangements put in place in the Bill. The important point is that although the activity will be similar, it will be carried out independently of the supervisory body. That will introduce an important element of independence to the system, and the new monitoring arrangements will provide a more focused and challenging regime for auditors.

The recognised supervisory bodies are already required by statute to have effective monitoring arrangements. Clauses 1 and 2 change who is required to carry out certain monitoring functions, specifying an independent body instead of the supervisory bodies. As those bodies are already required to have adequate monitoring arrangements, the provisions should not, in practice, impose significant additional burdens on them or on businesses—the audit firms, not the companies that were audited in the first place.

The new audit inspection unit of the FRC, which will carry out the monitoring function, has been working closely with the recognised supervisory bodies to ensure that the new independent monitoring arrangements and the bodies' own monitoring arrangements operate seamlessly. Where an audit firm is subject to monitoring by a supervisory body and the AIU, we envisage those organisations working together, making joint visits to minimise the regulatory burdens on the firm.

The AIU has already commenced work at the major firms of auditors and is working closely with the supervisory bodies' monitoring units. So, not only is the Bill replacing something that currently happens by means of new, independent arrangements, but work is already in hand to ensure that that is carried out

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effectively and in a way that minimises the risk of burdens being imposed.

In speaking to amendments Nos. 4, 5 and 6, the hon. Member for Sutton Coldfield outlined his concerns about the definition of the term ''major audit''. We do not want to define the term more closely in legislation, not least because it is hard to predict which companies might be economically significant in the future, as new technologies and business practices change the business and investment environment. We have therefore categorised major audits as audits of listed companies or those of

    ''any other company in whose financial condition there is a major public interest.''

Public interest cases are defined as

    ''matters which raise . . . important issues affecting the public interest.''

In both examples, it will be for the person responsible for making decisions on recognition to determine where it is acceptable for the line to fall. At present, that person is the Secretary of State, but subject to Parliament agreeing to other clauses in the Bill, we intend to delegate the function to the Professional Oversight Board for Accountancy, a new subsidiary board of the FRC, of which the AIU is a sub-committee.

Mr. Mitchell: I think I heard the Minister say that it is important to draw the net as widely as she has not least because a different type of company from the one that she or I might expect to be involved today could need to fall within the net. I agree with her. Can I therefore take it that she will accept the amendment, which would change the definition to ''qualifying companies'' and enable her, in her capacity as a DTI Minister, to determine which companies qualify?

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Jacqui Smith: We have made it clear that the determination of which companies within the general definition should be subject to the monitoring will, following other measures in the Bill, be the responsibility of the Professional Oversight Board for Accountancy. Clearly it will be important that people know what those decisions are, but that is not an argument for the amendment, which, on the whole, seeks to narrow the ability to react flexibly to the audits that are most likely to need independent monitoring.

Mr. Michael Moore (Tweeddale, Ettrick and Lauderdale) (LD): I am not clear that the Minister has quite made her case. Will she give us some examples of which recent cases might have been referred. She said earlier that new technology companies might appear and grow to become major public interests, but those would be caught by the definition proposed by the hon. Member for Sutton Coldfield of a company that we would expect to see in the FTSE 350 index. I am listening carefully to the Minister, but I am still struggling to understand what the major public interest definition will be. Surely we should try to make the process more transparent, but the proposals appear to give the responsibility for the definition to a small group that, by its nature, will not share it with the rest of us.

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Jacqui Smith: I hope to talk later about the difficulties of limiting the definition to the FTSE 350, and also to address the hon. Gentleman's second point, about the transparency with which those decisions are made.

I shall explain how the monitoring would take place. Depending on the circumstances at the time, the monitoring unit could make different decisions about where the focus of monitoring should be. In its visits to the auditors the unit will be able to focus on certain audits on which there is a need to focus at any particular time. It is important that we maintain that flexibility, and the ability to focus on where there might be issues.

The hon. Member for Sutton Coldfield asked whether there would be a right of appeal against a decision that a company's audit was a major audit. The Bill does not impose a requirement that an audit be monitored where there is no such previous requirement. It is not as if there were a range of audits that were not previously monitored but now will be. Instead, clauses 1 and 2 provide that the monitoring of certain audits should be carried out by an independent body instead of by the supervisory body. We do not believe that that would impose additional burdens for the auditor, nor will there be additional burdens for the company, as the work of the auditor is being monitored. In those circumstances, it is not clear why there would be a desire for an appeal. Any disagreement between the supervisory body and those concerned with the independent monitoring arrangements about whether the arrangements would be applied in a particular case would be sorted out between the supervisory body and the arrangements.

Following on from that, we recognise that it is important that supervisory bodies know which company audits are to be monitored by the independent arrangements and which they will continue to monitor. The POBA will indicate which audits it will consider the independent monitoring arrangements ought to cover in order to comply with the minimum requirement. That takes up the question that the hon. Gentleman asked about how we will know where the monitoring will be. The POBA will promulgate that information to the supervisory bodies at the outset and whenever those requirements are changed thereafter.

Amendment No. 7, which would limit the automatic application of independent monitoring to the audit of FTSE top 350 listed companies, poses significant problems. It would not provide the necessary public reassurance that the audits of companies whose shares are publicly traded and which are subject to monitoring were clearly independent of the recognised supervisory bodies. That is the function of auditing.

As the hon. Member for Sutton Coldfield said, certain listed companies are relatively small. Nevertheless, I suggest that people will still depend on their financial reporting being sound and on the audit being appropriate. The quality of the audit is just as important to stakeholders in small companies as it would be for much larger companies. Limiting the

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provision to the FTSE top 350 would mean that the AIU might not be able to review the audit of a company whose share price performance took it rapidly downwards and out of the top 350. That might be precisely the type of company for which one would want to consider an audit.

We do not believe that the requirements for independent monitoring will impose the additional burdens on companies or the recognised supervisory bodies that the hon. Gentleman's amendments seem to suggest. It is not necessary or appropriate to limit the scope of the independent arrangements as proposed by the amendments. We should bear in mind the fundamental principle that we are maintaining the function of monitoring of major audits but ensuring their independence. That is important as it builds confidence in the quality of our audits and therefore in the quality of our corporate governance and financial reporting.

Mr. Moore: I shall be brief. I appreciate that the Minister has tried to explain clearly why the definition of the major public interest has to be as it is. I still retain reservations, however. Although it will improve transparency, accountability and oversight in the profession, the new structure will still leave us with a rather vague definition. I am not clear what external influences could rightly be exerted by the Secretary of State or Parliament.

I have two other quick thoughts. First, the notion is that because the audit firm, not the company, is being investigated, we should not place extra burdens on the company. That may be technically true, but the idea that no reference should be made back to the company at any stage during the process is wishful thinking. Secondly, the idea that a company whose audit became the subject of a major public interest review under the new structure would not be interested in why it should happen, or what it might do to its reputation and its share price, stretches the boundaries of credibility. An acknowledgement of that would be welcome. In the main, the developments are welcome, but I remain to be convinced that the definition is right.

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