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Lord Brennan: My Lords, before the noble Lord sits down I shall use his last minute. I should be grateful if
he could answer a simple question: what is the total size of the funds in the financial system against which £720 million has been spent to regulate it?
Lord Hodgson of Astley Abbotts: My Lords, it is minuscule. It is impossible to measure. Probably one-tenth of 1 per cent, depending of course on how one measures it and what one is including; for example, whether one is including foreign exchange transactions. It is hard to get the whole sum. It is an infinitesimal sum, but it is still a large sum.
4.8 p.m.
Viscount Bledisloe: My Lords, I, too, thank the noble Lord, Lord Brennan, for initiating the debate. I speak in the debate because as a barrister I have been involved in a number of cases dealing with corporate collapses and with the attribution of responsibility. In particular, I have detailed knowledge of the Barings bank disaster, to which the noble Lord, Lord Hodgson, has just referred.
I agree almost entirely with the noble Lord's diagnosis of what went wrong at Barings. However, I must correct him on one point. It was the bondholders who suffered a grave loss and not the charity shareholders. I do not think that they can be dismissed as people who ought to have known when taking the risk.
The debate has been somewhat dominated by the Enron affair. So far we know little about the matter. However, it must be regarded as a somewhat unusual case. I think that the noble Lord, Lord Sharman, would agree that there are not many cases where auditors are found shredding documents. We must not extrapolate from Enron to the generality of business.
I have three particular points. First, we should not assume that whenever a company goes bust someone must be legally and morally at fault. As the noble Lord, Lord Haskel, said, it is in the nature of business that some enterprises will fail and that investment involves some degree of risk. Unfortunately, we in this country are now rapidly acquiring a culture of blame that says that because something undesirable has happened, someone must be held liable. That culture and concept is fundamentally misconceived and profoundly damaging. But that perhaps is a wider topic for another day.
My second point relates to the position of what are normally called non-executive directors. It may well be that "independent" is a better term, but there is a real distinction between those who are just directors and those who are also the leading managers of the company and involved in day-to-day management.
In many of the collapses, and certainly in the Barings case, the action or inaction of non-executive directors is wholly irrelevant. Barings was the result of failures of management. If management had applied to its business a reasonable understanding and an ordinary appreciation of risk and return, there would not have been that collapse. But there was nothing in
the Barings case which a board of independent directors, or indeed an audit committee, should have seen or done.Of course, it is desirable to have good non-executive directors or good independent directors, who have real independence, have an inquiring mind and an understanding of the business. But there is and must be a clear limit as to the extent of their role. Nothing in life can be successfully run by a committee on a day-to-day basis, whether it is a ship of the Royal Navy, an Arctic exploration or a commercial enterprise. If management is subjected to constant supervision and interference by non-executives, or if the auditors are second guessed by an audit committee, not only will enterprises of great pith and moment be sicklied o'er by the pale cloud of debate, but also responsibility will be diffused. Everyone will comfort himself by the fact that others are thinking about it whereas what is needed is a clear allocation of managerial responsibility so that someone knows that the buck stops with him and that it is his job to know whether the facts and figures of his department make commercial sense.
Thirdly, I refer to regulation. There may be, of course, some instances where a specific regulation would prevent a particular abuse, although as the noble Lord, Lord Sharman, said, one must remember that the ingenious and improper mind will rapidly find a way of avoiding or evading almost any regulation. However, on a much more general point, we must resist the siren call which says, "Something went wrong. We must make rules that ensure that it never happens again". "It must never happen again" is a sound but hopeless cry. One hears it after every rail disaster. Noble Lords stand at the Dispatch Box and say, "We must ensure that it never happens again", but we know as sure as eggs is eggs that it will because one cannot have rapidly moving vehicles, aeroplanes or trains without them occasionally crashing. One cannot have successful entrepreneurial businesses without occasionally a rogue or a fool making them go wrong. To go round saying that it must never happen again is to kid oneself and the public.
There are two great dangers in regulation and particularly in over-regulation. First, those involved in complying with the regulations spend their time ensuring that they have complied with the rules, filling in forms to ensure that the ratios tally with the requirements in the regulations. What they ought to be doing is looking at the fundamentals of the business and considering whether the reports and figures are consistent with the basic principles of commerce. Barings would never have happened if the fools on that board had ever said to themselves, "There is no such thing as a high rate of profit with no risk". Regulations will not teach them that simple lesson.
Secondly, the existence and the role of regulators creates a dangerous and false feeling of security. Time and again the managers in the Barings case have said, "Oh, we know that Singapore, and in particular the financial markets in Singapore, have very strict regulation by very strong regulators. Those regulators are happy and therefore we know that there could not
be anything seriously wrong". Thus insidiously, regulation diffuses and dilutes responsibility from management where the buck should be and should stop.In all these debates we must never forget the fundamental principle that a good business depends on proper control by a sound and sensible management, which understands the essential rules of sound commerce and applies them to its particular enterprise with a proper understanding of its risk. Pace the noble Lord, Lord Sharman, no rules or regulations can make the incompetent or dishonest into beings who are competent and honest.
I do not have time to deal with audits, but I venture to suggest to the noble Lord, Lord Brennan, that it is certainly not true that auditors never detect frauds and irregularities. When they detect them they are put right and one does not see that. It may be that when they are detected before they have got too far they cease to happen. The cases which emerge where auditors have not seen something are the rarity and not the regularity. The problem that auditors have when things go wrong is not that the audit rules are wrong, but that the relatively junior people who are, for reasons of cost, inevitably doing the donkey work, just fail to read the message which is inherent in the fact, perhaps because they have not the experience or the time within the cost to do so.
4.17 p.m.
Lord Clinton-Davis: My Lords, the whole House will be tremendously indebted to my noble friend for initiating this important debate. We have heard from the world of business, of accountancy, of the clergy even, and from bankers and barristers, and I am the first solicitor to open my mouth. I believe that there will be another soon.
It is very important that the questions posed by the noble Lord, Lord Brennan, govern our attention this afternoon. Of course, we have been blighted by the Enron scandal. It is important that that should occupy our thoughts. But it is not the only issue, as the noble Lord and others have pointed out, that should be important to us. For example, the issue of auditor independence has been cited, and that is very important. The Law Society has given its full attention to the issue and it has also addressed the European Commission Competition Directorate. As a result of those activities the big eight were reduced to the big five as regards the world of accountancy.
It was considered at that time that conflicts of interest could arise, which could have deleterious effects on the issue of competition. Who is to say that the Law Society was wrong then? Is this not still a highly germane issue in the light of the Enron affair?
Solicitors, in particular, have to be conscious of the requirement for independence just as much as auditors do, but independence is viewed in different ways. It is vital that auditors should be able to provide objectivity in viewing the financial position of a client and, for that reason alone, the auditor should not enjoy—or be
seen to be enjoying—a fiduciary duty to the client. As I understand it, this is not always the case in the United States.A solicitor, on the other hand, has a very different relationship with a client, and I speak here of solicitors who have served on audit committees. Confidentiality to the client is a prime necessity. In other words, the auditor should never get into bed with the company, but the situation may be totally different for the solicitor, although I must stress that adherence to the law remains essential from his or her point of view.
The Enron affair has established a strong case for ensuring that auditors comply fully with a much stricter regulatory regime. They should play no part in misleading shareholders, nor, in my view, should they impair their independence by offering consultancy services that could have that effect.
The problem of consumers being vulnerable to unqualified advisers and fraudulent management companies is vitally important, and the Law Society is not alone in this regard. The National Association of Citizens Advice Bureaux has reported an increased number of inquiries from people who have simply failed to understand the terms of the agreements that they have signed with management companies dealing with accident claims. The Blackwell Committee and the Leggatt report have also covered vital matters.
What is especially wrong with accident claim companies is the way in which many of them go about their business. No one has referred to this tonight. For such organisations, the lay client is a burdensome necessity. They are often extremely aggressive, and frequently persuade the client to settle the case on terms that are distinctly disadvantageous to the client. That they do this is, in my submission, entirely beyond doubt.
I turn to the question of tribunals. Unqualified advisers frequently provide inadequate advice and representation in these circumstances, and the client is often persuaded to settle on terms that could, frankly, be considerably improved. I hope that the Government will soon confront these, and other, issues, which are central to the way in which tribunals on personal injury cases are dealt with.
I shall conclude by asking my right honourable friend what I hope are some relevant questions. Will the Government take steps to ensure that qualified lawyers can carry out advice work in contemplation of proceedings before courts or tribunals? As an alternative to that, will the Government require claims management companies and unqualified advisers to stick to a code which would stop sharp practice? I hope that the Government will do their best to ensure that the customer should approve only those who adhere to such basic standards.
The elements of a standards code might well include: a cooling-off period; some indemnity insurance; suitable consumer redress when appropriate; transparency about what the consumer has to pay; a ban on doorstepping potential clients; and a ban on paying claims management staff only on a commission basis. I hope that these questions have been relevant to
the debate. I regret that no one seems to have tackled these important issues. This debate is not only about auditors, or about the Enron affair. It is about a wide variety of matters that are equally important.4.26 p.m.
Lord Clement-Jones: My Lords, I would like to declare an interest as a solicitor, and also as the former company secretary of a major FTSE 100 company. I congratulate the noble Lord, Lord Brennan on instituting a timely debate, and on a thoughtful, if rather bleak, speech.
I am tempted, unusually, into this area because I believe that, following the events of this year, we have reached a watershed in corporate governance. We have had crises of confidence in corporate governance in the past—I remember particularly well the Robert Maxwell case. I am sure that the Mirror pension scheme is engraved on the hearts not only of many professionals but of many of those affected by the case. There have been attempts to deal with corporate governance in a voluntary way. Many of your Lordships have talked about Cadbury, Greenbury, Hampel, Turnbull—the mantra goes on—and the combined code. There has been a succession of governance and risk management tools to give investors assurance about the governance and risk management of their companies.
Those attempts were worthy, and it is only with some reluctance that I have concluded that the current role of the non-executive director is no longer viable for major PLCs. In the past, we have relied on the non-executive director—sometimes a retired professional or executive, often a busy current full-time executive—to fulfil the role of watchdog on behalf of the shareholders. In reality, however, despite attempts to boost their role through the various codes, that is a quite impossible task, except, perhaps, after a crisis has happened. We have audit committees and remuneration committees, the membership of which is often entirely made up of non-executives, yet abuses have occurred. In fact, it is noticeable how newsworthy it is when a remuneration committee really works and takes a robust line on remuneration, as it has in the Vodafone case, with Penny Hughes in charge of the remuneration committee.
The other frequently cited role of non-executive directors is that of their relationship to shareholders and investors. Chief executives, however, regard that as a major part of their role, as the share price is key to the perception of a company, to the measurement of performance and, indeed, to the chief executive's bonus. Non-executives can and do have a major impact on the social responsibility aspects of a company. But the question that needs to be asked is whether that is more than skin deep.
The fact is, as the noble Lord, Lord Haskel, pointed out, that executive directors are far better informed than non-executives will ever be. It is no longer tenable that non-executives should have the same legal duties as executive directors. I agreed with a great deal of
what the noble Lord, Lord Freeman, had to say, but on that aspect I part company with him. Someone being paid to do, say, one day a month for a major company is hardly in a position to argue with the full-time executives of that major company. Often they are appointed precisely because they will not do so. However, companies get the professional advisers that they deserve.Though I am happy to discuss future governance of the accounting profession, I do not believe that that is at the root of this problem. Unless the governance of a company is strong, the professional advisers will inevitably see their main route to retaining influence as serving the interests of the executive management team of the company. That is professional and human nature.
How many auditors will actually spill any beans at all to the non-executive audit committee when the executive directors are asked to leave the boardroom, or express doubts about any aspect of the company's financial controls? Therefore I welcome in particular the Secretary of State's announcement on reviewing the role of the non-executive director. I am pleased also that the Secretary of State wants to see more active institutional shareholders following the Myners review.
We already have two types of director who should have different legal duties. We should rapidly move towards a fully effective two-tier board system for our major companies. A supervisory board should be charged with the duty of ethical and financial quality control and governance. That board should be accountable to shareholders for that aspect of the company. The members of the board should be properly remunerated; they should be serviced by staff; and they should be fully supported by legal and financial expertise. There is a good case to have the internal audit function reporting to that supervisory board.
On the other hand, the management board should be responsible for commercial strategy, trading and financial performance. In the words of Patience Wheatcroft, the City editor of The Times, who conducted an effective, sceptical campaign about the role of non-executive directors, the executive directors should walk the plank if they do not perform.
I am a reluctant convert to that structure for a company. I believe that currently non-executives can play a valuable strategic advisory role to boards. But that is as far as it goes. I do not believe that the appointment even of a designated senior non-executive director will do the trick in governance terms.
In summary, I do not believe that we can carry on tinkering about with a bit more corporate governance here and a bit more corporate governance there. If we are genuine about ensuring proper governance, protecting shareholders' interests, managing risks and so on, we need to think more radically. A two- tier governance system deriving inspiration from continental models, but being far more proactive and with responsibilities far more carefully defined, is the best way forward.
4.33 p.m.
Lord Barnett: My Lords, I begin by declaring an interest as an accountant and, some time ago, being the chairman of a moderately sized accountancy body of the kind that was eaten for breakfast, or morning tea, by KPMG. I admit willingly that I have never shredded a single paper. I should also declare an interest in that I am a non-executive chairman of two companies and have been a non-executive chairman and director of others in the past.
I thank my noble friend Lord Brennan for introducing this important debate at this time. We all know that the Enron affair damaged both company boards and the accountancy profession rather more than many of the other failures and serious problems did in the past, for reasons of which we are all aware.
Many major investigations have already taken place by the DTI and the US Congress, and Paul Volcker was brought in by Andersens a bit late to look at what could be done for them. I noted what my noble friend Lord Brennan called "profit mania". I am not too sure about that. Greed certainly could have been one of the causes of the Enron disaster—money is often the root of all evil and that was certainly a problem in which the directors and indeed the auditors seemed to be involved.
That said, it would be nice if, as the right reverend Prelate the Bishop of Oxford said, we could have a moral value on the boards of companies. However, the code of most of the companies with which I have been involved has been to increase their profits. I do not apologise for that; I understand that that is one of their major functions. I would love it if we could all have moral values, not only boards of companies, but we do not.
I hope, as a member of a company board, that boards take proper account of what is legally sensible and right and what is good corporate governance. But I do not know enough yet about the causes of the Enron affair to be able to advocate more regulation of a statutory kind. It is far too early to say and we should not rush into that kind of legislation. And I do not necessarily go along with the noble Viscount, Lord Bledisloe, that regulation is positively damaging to corporate bodies. Some action will be needed, not necessarily with statutory regulation, but such action could be taken now before we need to take legal action.
It should be recognised, and I hope it is, that directors of most companies—certainly the ones of which I am aware—and most accountants are perfectly honourable men and women who should not be condemned along with what happened to Enron or Andersens. I am sure that all the accountants in Andersens, other than those directly involved in the issue, are perfectly decent, honourable people. So we have to be careful about who we find guilty in these affairs. We must not allow the Enron affair to besmirch the whole of the accounting profession. Many companies I know would not be happy to have the name of Andersens as their auditors—they may like KPMG, but I shall come to that.
Clearly, changes are needed. Some FTSE 100 companies and even more, have already appointed internal audit bodies. Those bodies need to be truly independent of the board and the auditors of the company. That is crucial. Otherwise neither the directors nor non-executive directors would know, as somebody said, how to deal with the problems that arise. It may not stop all the fraud and corruption that takes place, but I like to think that it would go a long way towards dealing with some of it. If there is, as there seems to have been in the Enron affair, collusion between a chief executive and the auditors, enormous problems could be created even for a properly appointed internal audit committee.
Much has been said in this debate about non-executive directors. Somebody even referred to them as "so-called" non-executive directors. I can say that a non-executive director is someone who is not an executive. That certainly applied in my case and applies in most. But much attention has been focused on them. The very first question a non-executive director should ask on being appointed is: "Do we have a properly appointed independent internal audit system?". That is crucial because they cannot do the job if they do not have such a body.
After asking that question—and asking if there is proper insurance for directors, of course—we need to know how non-executives are appointed. The noble Lord, Lord Freeman—I have a lot of regard for him—said that he did not believe that they were now appointed in the way that they were in the past. Again I declare an interest; most of my appointments as non-executive director arose from contacts and connections I had, some no doubt because I was a Peer of the realm and a former Cabinet Minister. It could be that I was appointed on every occasion precisely because I am such a wholly competent person. I would like to think so, but I doubt if that was the reason—at the start anyway. Later, that may have been found to be so. There is no doubt that Peers and former Cabinet Ministers are appointed because of their connections and are not always the most competent of people.
Another person often appointed is the senior auditor of a practice who retires, perhaps early, to take a non-executive directorship. That kind of conflict of interest is clearly serious and it needs to be examined very carefully. There has been talk of a one-year delay between retirement and appointment. Though many of them will do an excellent job, I am not sure about that; it needs to be looked at. We have to ask ourselves whether statutory regulation would help at present. I doubt it.
The other point that has been made throughout the debate, and elsewhere, is whether auditors should do non-audit work. The definition of consultancy is a somewhat difficult one. Much of it stems from the audit work done by a sensible partner who is doing a good job. Should due diligence on an acquisition be given out to someone else to do? There are all kinds of other areas, such as tax work and investment decisions, that are required by a partner and by the company. They will invariably arise in talking with the
partner: a perfectly decent, objective, serious partner. All of that could not be cut out, and we need to look very carefully at what is done in that direction.The problem of accountancy is the sheer size of it. They are now called the "fat four"—and I am not making any comment about the size of the noble Lord, Lord Sharman, but the "fat four" practices of which he is now, I understand, only a consultant. The problem has grown with the size of private companies, mergers, and so on.
It has happened and is happening in the accountancy profession. I checked with someone who was the senior partner of a modest-sized accountancy practice in the UK which merged with Andersen some years ago. They were a so-called alliance of separate partnerships. I asked him today what kind of a partnership it was, because it does vary. To my amazement, he said, "a federal partnership". We spoke about that at Question Time yesterday, and so I will not go into it again. I understand that Andersen itself is an alliance of small partnerships. We should not rush into statutory regulation before we know exactly where we are going and what has happened.
The Association of British Insurers represents, it is said, some 20 per cent of the stock market and so is not a small organisation. The investment fund managers, instead of writing letters to the Prime Minister and printing them in The Times, should think more carefully about what they are doing in their job as investment managers.
With that, I leave it, my Lords, as my time seems to be more than up.
4.43 p.m.
Lord Griffiths of Fforestfach: My Lords, I thank, as others have done, the noble Lord, Lord Brennan, for introducing this subject, which is very timely. I also declare my interests which are set out in the register. In particular, the membership of the boards of two companies in America, boards of which I have been a member for 10 years and both of which have been audited by Andersen over that period. I must say that the service we have had from them has been of the highest possible standard of integrity.
The subject of today's debate is of enormous importance to anyone who values the market economy. The collapse of Enron, as has been said, especially by the noble Lord, Lord Sharman, is different from the collapse of almost any other company that I can think of. Its failure on such a massive scale, with such repercussions, casts a cloud over all of us who have any association with business. It has undermined the credibility of the business world. The notion of one of the major five auditing firms in the world shredding documents when in difficulty is so appalling, and so impossible to justify on any ethical basis, that it calls integrity into question on a massive scale. Accountants, lawyers, independent directors, regulators—we all stand indicted because of that.
There are three questions that I find myself asking. First, the numbers which are being thrown up and which reflect the value of a company are being called
into question. Secondly, the validation of those numbers by an external firm is being called into question. Thirdly, the competence of independent directors is being called into question.I have no desire whatever to be complacent. I agree with what the noble Lord, Lord Barnett, has said about increased regulation. Perhaps I may say one or two things, however, before making some positive suggestions.
First, an economy which had no failures would, in my judgment, be an economy which was inefficient. It would not be an economy in which companies were taking risks and innovating. What seems to have happened at Enron is a disgrace. Nevertheless, when it started and for the first 10 or 12 years, it made tremendous innovations which have benefited consumers. Secondly, there is no regulatory system in the world which can ever outlaw fraud. If there was fraud in the Enron situation, it is something which, however much we try to change regulations, we shall never outlaw. Thirdly, Enron is not typical of corporations in either this country or in the United States. The remarkable thing is that it is such an exception. There are so many companies, as has been said by the noble Lord, Lord Barnett, in which the non-executive directors and the management are very decent, honourable people, who have very high ideals in business.
It has been said that we should think twice before embarking on regulation. Every extra piece of regulation that we impose on a company will involve a cost. The question we have to ask is: do the benefits justify the cost that we will be imposing?
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