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1.30 pm

Justine Greening: People who are prosecuted are not always found guilty and the provision may well lead to spurious cases that put reputations on the line. The judgment as to whether the auditor’s judgment about whether he or she knew that a risk was unreasonable will be made by the courts, rather than by the auditor as at present. Can Ministers name one case that they believe should have been brought to court, but which was not because this offence did not exist? We would all be interested to hear which cases they feel have not been dealt with as a result of not having this law in place. I did not receive an answer to that question on Second Reading or in Committee. Perhaps I will finally get an answer today. The danger is that very few—if any—prosecutions will be brought. At the breakfast briefing last week, the Minister for Industry and the Regions seemed at pains to stress that the offence would be rarely used, and yet the ramifications for business and the audit profession could be broad.

Mr. Austin Mitchell: The hon. Lady asked for an example. I wonder whether the Department of Trade and Industry report on the performance of Coopers and Lybrand as auditors in the Maxwell case might provide her with a convincing one. The evidence cited was that the senior partner at Coopers and Lybrand summed up the strategy when he told his audit staff:

Robert Maxwell—

Was he therefore recklessly conceding to the wishes of Maxwell?

Justine Greening: The hon. Gentleman raises another potential problem with the clause as it is drafted, to which I will come later. Frankly, I do not think that it is for Members to interpret what that Coopers and Lybrand partner was saying. One of the amendments that the hon. Gentleman has tabled would mean that audit companies could only carry out the audit, and not provide any other form of service. Clearly, audit companies provide a whole host of services to their clients, ranging from due diligence to tax and IT. Who knows what the Coopers and Lybrand partner was talking about?

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Margaret Hodge: The hon. Lady has referred twice to remarks that I made at a breakfast meeting at which she and I were both present. I just want to put the record straight in the House. I said that, of the 700,000 or so audits that take place a year, most are carried out scrupulously by auditors, with diligence and honesty. However, that does not mean that we do not need an offence to assure ourselves that all audits are carried out scrupulously, diligently and honestly. Most people do not commit murder, but that does not mean that we do not have an offence on the statute book to prosecute people who do so. Her argument is spurious.

Justine Greening: I would counter that the Minister’s argument is far more spurious than mine. The offence of murder does not change everybody else’s behaviour towards one another, but the proposed auditor offence will change the behaviour —[ Laughter. ] Hon. Members are laughing, as if knowing that there is an offence of murder is what stops law-abiding people from killing one another. I fail to see how that furthers the Minister’s argument in relation to the auditor offence. I am sure that she will try to come on to that. [ Interruption. ] The Minister is saying that it is a poor argument. I presume that she is talking about her own comments.

My final point about how the offence will affect the audit process is that audits will be more costly. Audit work will need to be broader to prove that all anomalies discovered—not just potential anomalies—have been followed up. Everything will get followed up. Those costs will almost certainly be passed on to companies—large, medium and small—placing additional unnecessary costs on them. I have a large number of small and medium-sized companies in my constituency and I know that they will not welcome the prospect of increased audit costs, which might put some of them at risk of going out of business.

In the other place, Baroness Noakes, who has a vast amount of experience in this area, said of the Bill:

She goes on to say, of auditors:

We ignore the views of people such as Baroness Noakes at our own risk. I agree with her comments. Is that really what we want to achieve—an across-the-board raising of audit costs and risk-averse auditing for an offence that may capture only one or two, or perhaps several, rogue auditors?

Vera Baird: I have great respect for Baroness Noakes, but after she made those comments we explored in greater depth the extent of criminality, as the hon. Member for Cambridge (David Howarth) has made clear. It appears that I satisfied the hon. Lady’s colleagues, as none of them is here to support her today. She should look at what Baroness Noakes said in the context of the issue having been more fully explored by us in Committee. I doubt that Baroness Noakes would say what she said then if she had heard our argument in Committee.

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Justine Greening: I have, of course, spoken with Baroness Noakes and she is pretty comfortable with her initial comments. The Minister did take some time to run through the Government’s rationale for this offence, stating that, in her opinion,

But even having said that, when I asked about the issue of auditors occasionally making mistakes—given that they are human—and following up anomalies, she said:

—the auditor—

Surely that is the heart of the problem. That is why audit costs will rise if this offence is passed today. The Minister said so in Committee. Will she agree to assess the impact of this aspect of the Bill once we are, perhaps, two years into its operation, and will she agree to revisit the offence if it proves to lead to unnecessary and disproportionate rises in audits costs for businesses?

Moreover, to return to the intervention that was made by the hon. Member for Great Grimsby (Mr. Mitchell), given that audits are carried out by teams of people, ranging from the audit junior to the assistant manager, the manager, the director, and the partner, in practice it could prove difficult to establish which team member committed the offence. I presume that we could have a situation in which several auditors on a team would be prosecuted simultaneously because it was not clear where exactly in the team the “knowingly and recklessly” behaviour associated with the offence took place. In Committee, I expressed my doubts and said that that might be a fatal flaw. Before that is brushed off by the Minister, I refer again to the corporate manslaughter legislation, which had a fatal flaw and ultimately proved entirely ineffective in the courts because of that flaw, to the extent that the House—I think today—has had to set up another Committee to look at a fresh version of that legislation. Perhaps the Minister can comment on how she expects that it would be assessed which audit team member should be prosecuted. Does she expect that multiple prosecutions of team members might arise?

David Howarth: Before the hon. Lady finishes, I invite her to explore the meaning of “dishonestly or fraudulently” in her amendment. Does she mean by dishonest or fraudulent what fraud means in the Fraud Bill, which is that there has to be an intention to cause a gain or a loss—a gain, for example, for the defendant or a loss to the victim?

Justine Greening: The hon. Gentleman brings me neatly on to what I was about to say. Amendments Nos. 439 and 440 would substitute the words “knowingly or recklessly” with “dishonestly or fraudulently”. They would thus prevent the litigation risk from being excessively increased for auditors, in line with his comments about alignment with our understanding of the concept of fraud in current law.

Although our amendments would leave an auditor offence in place, they would take away the negative by-products to which the clause as drafted will lead,
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such as companies having to put up with auditors over-auditing under the new law compared with what they would have otherwise done under the current law in order to be comfortable with declaring accounts to be true and fair.

Let me turn briefly to the other amendments that hon. Members have tabled. Amendment No. 684 would be unworkable. As I have said, audit companies provide a whole host of services for their clients, such as tax advice, IT systems consultancy, internal audit, due diligence work and regulatory filing work. The restriction suggested under amendment No. 684 would harm not only the businesses that clearly value the additional services that they engage audit companies to provide, but audit businesses themselves.

Amendment No. 686 proposes to limit auditors to serving a maximum of five years. Again, I would be concerned that the amendment would lead to added costs for companies and auditors because they would spend too much time on costly tender processes. New auditors have to take time to get to know client operations and doing that regularly would perpetually add unnecessary costs, prevent auditors from carrying out efficient audits on behalf of their clients and, dare I say, lead to the risk that auditors would be less able to spot that one anomaly that represented a major problem because they had not been involved with the company for as long as they ordinarily would have been. For small, medium-sized and large companies alike, that would add not only cost, but risk.

Amendment No. 759 would be unworkable and unfair. It would devalue the accounts of companies not involved in any dispute unnecessarily. It would also have an impact on large accounting firms with offices throughout the world. The corporate structure of such a body might be that a large accounting firm in Europe was merged with another firm in Asia. In such circumstances, it might well be impossible to say whether a regulatory action taken in one continent should be included in the report for an office not merged in the other continent. It would be difficult to make the amendment stick.

We are broadly happy with the Government amendments. Although we have already heard several interventions, I look forward to hearing hon. Members’ contributions to the debate and, of course, the Minister’s response to the issues that I have raised.

David Howarth: The problem that we face is due simply to a slip that a Minister in the House of Lords made when attempting to be helpful by describing the meaning of “recklessly”. That Minister was not a lawyer and his words caused the auditing and legal professions some anxiety about the Government’s intention in their use of the word. Whatever the Minister meant to say, the entire problem was cleared up in Committee by the Under-Secretary of State for Constitutional Affairs, the hon. and learned Member for Redcar (Vera Baird), when she said—as she repeated today—that “recklessly” was used for a thoroughly subjective offence because a risk taken must be unreasonable in the mind of the person taking it. If so, I do not think that the bad consequences identified by the hon. Member for Putney (Justine Greening) will follow.

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If we are to understand the situation as it now stands, we must go back to the legal context of actions against auditors. There are two liability pressures on auditors in civil law: the auditor’s contract with the company; and the threat of a negligence action by other possible victims. An important aspect of the introduction of the new crime with which we are faced is that the Bill will reduce the contractual pressure that might be put on auditors. The Bill will, for the first time, allow auditors to contract to limit their liability to the company itself. Indeed, we will later debate amendments that challenge that very possibility.

1.45 pm

Justine Greening: The Bill will not allow auditors to limit their liability unreasonably.

David Howarth: That is correct, but the fact that it will allow auditors to limit their liability at all is a new departure. There will thus be a reduction in the contractual pressure on auditors.

Justine Greening: Is the hon. Gentleman saying that he thinks that it is a good idea that auditors should be exposed to unreasonable liability?

David Howarth: I think that the hon. Lady is confusing the liability rule and the test in the Bill—they are quite different.

It is crucial to bear it in mind that the circumstances under which auditors can be sued in tort by third-party victims of negligent auditing are extraordinarily limited. The fundamental problem is the form of loss. Pure economic loss, as it is known in law, can be sued for only when the auditor has assumed responsibility to the victim of the particular negligent act. That usually means that no liability is found because the court thinks that the primary responsibility of the auditor is to the company, not to any third-party victims. The number of cases in which auditors have been found liable of negligence to third parties is very small. There will be little pressure—or less than there is now—on auditors from civil liabilities across tort and contract after the Bill has been passed. That is the context of the introduction of the new crime to try to rebalance the situation.

As we have heard, problems can be caused by audits that go wrong—the Enron and Maxwell cases have been raised. We must thus ask what form the new crime should take. The choice is between a knowing and reckless crime, and a dishonest and fraudulent crime. The difference between the two is not that which the hon. Lady described, because she fundamentally misunderstands the notion of recklessness. In one crime, the most important thing is the consequences for other people and the defendant’s state of knowledge about those consequences, while causing gain or loss is crucial for the other crime.

Given the circumstances in which problems arise in audit cases, it is not especially relevant to worry about whether auditors are dishonest in the sense of wanting to gain for themselves from a situation. The important point is the consequences for other people and whether an auditor unreasonably—subjectively unreasonably—
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took an unreasonable risk. Given the balance of the measures in the Bill and the fact that pressure on auditors is being reduced in some respects—the civil liability pressure on them is quite low anyway—the form of the crime that has been chosen is acceptable, especially given what the Minister has said on many occasions about the Government’s view of the meaning of the word “recklessly”. I will resist the Conservative amendments.

Mr. Austin Mitchell: It is interesting to get a clear-cut opinion from the hon. Member for Cambridge (David Howarth), who is leading for the Liberal Democrats, at least on this issue, and an opinion in favour of the Government. I welcome that.

I was amazed at the case advanced by the official Opposition for their amendment. My view is that this part of the Bill is far too sympathetic to auditors, particularly the big four. I intended to call it “The prevention of cruelty to the big four and other endangered species”, until I saw the provision, which puts teeth into the Bill and which I warmly welcome.

The hon. Member for Putney (Justine Greening) presented a picture of the big four as paragons of virtue, always doing proper, efficient and effective audits—creatures without sin. In fact, they are powerful multinationals and they have a responsibility to review their operations and, where possible, to restrain them. They are not in danger of extinction. The Government have given them special protections in the Bill, including the effective capping of liability. They are huge multinationals rolling in money. Their combined global income is $70 billion a year. They audit 99 per cent. of the FTSE 100 companies—

Justine Greening: I note that the hon. Gentleman’s comments relate to large audit firms. Does he have a view on how the Bill will affect small audit firms, which may have to pass on higher costs to small businesses?

Mr. Mitchell: It is certainly true that the main problems are caused by the big four. Their failures and their practices act as a slur on the entire accountancy profession and audit. However, the Government’s aim, and ours, is to achieve proper, effective audit. Audit is valuable, important and required by law, and it might require some increase in the costs of audit to make it as effective as it should be. That is a price that we should be prepared to pay for good audits, but my worry is that the big four do not provide a good audit because they are involved in a collusive relationship with companies. They are selling services to them and using audit as a foot in the door for the sale of other services. That is the import of our amendments Nos. 684, 686 and 759, to which I shall speak briefly.

The sale of other services creates a collusive arrangement. The audit firms derive 75 per cent. of their profits from the sale of other services. I cite the case of the RAC audits. PriceWaterhouseCoopers undercut the incumbent auditor, Stoy Hayward, by 50 per cent. to get the RAC audit. Stoy Hayward’s senior partner accused PriceWaterhouseCoopers of undercutting it to secure an appointment that might enable it to introduce higher price consultancy services to the RAC. That is exactly what happens.

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Such firms cut the price of audit, which means cutting its effectiveness and must mean increased pressure on the auditors, in order to get their foot in the door and use that as a market stall from which to sell other services. That brings them into a collusive relationship with the managing director, chief executive and senior figures in the company, because they are more lenient about the audit, about possible failures and about arrangements made in the audit that may raise eyebrows and be slightly dodgy, in order to maintain the good relationship and sell other services.

Following the failure of the Versailles Group in 2004, Nunn Hayward was fined for failures as auditors. It was making too much money from the sale of other services and the group was too important a client to be as stringent on the audit as it should have been. The big audit houses are prepared to restrict themselves in the sale of other services when they sell audit to local authorities. They agreed not to sell other consultancy services to get that market. If they can do it in the public sector market, why can they not do it in the private sector market? It will eventually bring down the price of other services because firms will get auditors bidding to provide other services, rather than entering into a collusive relationship with one auditor, which is a serious danger.

The US Government have been active in restricting the practice. The Sarbanes-Oxley Act placed restrictions on the sale of other services, which I am grateful to see we have followed in this country. Other restrictions are on their way and we should follow them as well. A collusive relationship is dangerous to the effectiveness, independence and accuracy of the audit. If the price of the audit is cut, that must cause pressure. The firm must be using untrained staff, cutting corners and not reporting things that should be reported, just to get the audit through at a certain price. We should ban the practice of selling other services.

Amendment No. 686 provides for rotation—a maximum of five years’ tenure as an auditor. The Government and the audit profession say that partners are already rotated, but that is not good enough. We must provide for auditors to be changed. It is necessary for a new pair of eyes to look at the arrangement, scan the papers of the previous auditor and take a view. Longevity of auditors means collusion. Longevity of auditors means a comfy relationship and the kind of situation that developed in the Maxwell pensions case.

I quote from the Department of Trade and Industry report on Coopers and Lybrand’s performance. The DTI report stated that the auditing firm

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