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Lord Clinton-Davis: My Lords, the Labour Government in particular caused a number of reports to be made on the aberrant activities of companies and, in that regard, every report had a recommendation.
Does the noble Lord totally ignore that? Is that something which counts for nothing?
Lord Griffiths of Fforestfach: My Lords, I am not suggesting that such a report is not valuable. What I am suggesting is that we already have, as has been said by the noble Lord, Lord Hodgson, an enormous amount of regulation with which companies have to comply. Before we increase regulation as a result of Enron, we would do ourselves well to ask what benefits we can realistically expect from such regulation. That is the simple point that I was making.
The other point I make is in relation to what was said, initially by the noble Lord, Lord Brennan, and then by the noble Lord, Lord Haskel; namely, that we live in a society which is entirely driven by greed and that, as a result, the concept of shareholder value is not a good one. From my perspective of sitting on company boards, shareholder value is necessary as an objective simply in order to survive. When a country the size of China is entering the WTO and exporting their products here, shareholder value is necessary. If we do not pay attention to shareholder value, we will not be in business tomorrow.
In order to achieve that shareholder value, one has to do much more than simply go after profit. Profit is the result of producing a service or a product which people want. It is that which is the value.
I turn to the subject of accountancy and also non-executive directors. In relation to accountancy, many have mentioned possible reforms of the auditing process in order to make it more effective. Mention has also been made of re-tendering of audit work; audit firms not doing consulting; companies not hiring finance staff who were formerly employed by their audit company; non-executive directors appointing auditors, and so on. However, a number of speakers have said, "Let's go easy in this respect".
I believe that Enron has created a crisis of great proportion. In such a crisis, we need very simple rules. The last thing we want is a lot of complexity. If we want to restore public confidence, first—this is where I would be in favour of increased regulation—we must have simple rules stating: that every board must have a beauty contest every so many years in order to look at its audit work; and that an audit company cannot undertake consulting for that company. If you start trying to trim, it seems to me that you cannot restore public confidence.
Secondly, when it comes to financial reporting, transparency in terms of the numbers is absolutely critical. I am no accountant, but, although they may be legal, certain current practices also seem to me to be misleading. Let us take, for example, the question of off-balance sheet liabilities. This is really a call to the accounting profession. I believe myself to be reasonably intelligent, but I find the footnotes to some accounts totally impenetrable. In my view, the annual accounts of a company should be providing not just the professional investor but also the average investor with sufficient information to make an informed decision. Financial reporting has a long way to go in that respect.
A few years ago, Warren Buffett said that three questions should be asked by an audit committee of its auditor. First, if the auditors had prepared the accounts, would they basically be different from the way that the company prepared them? Secondly, if the auditors were an investor, would the information provided have been sufficient to make an informed judgment about that company? Thirdly, if the auditor were the CEO, would the internal audit system of the company, as suggested by the noble Lord, Lord Barnett, be something that was up to scratch? There is a further problem for the audit profession; namely, where do you find good auditors? If it is more attractive to be proactive running companies, or to operate in other areas—investment banking, and so on—there is a real problem about getting high quality people who can examine others, such as the directors of a company like Enron.
Finally, although there is little time in which to say anything, I should like to make one comment. We have seen many reforms of corporate governance in this country. It seems to me that we could have more of those reforms. The Government could play more of a
role in the process and we could limit the role of non-executive directors, but the values of non-executive directors lie at the heart of the issue. You need a CEO and a chairman who have integrity; management that has integrity; and, indeed, a board that has integrity. You cannot regulate in that respect, but you can try to create an ethos within the business community that those are the shared values that apply. If we go down that route, I believe that that will prove to be the way to inspire public confidence.4.53 p.m.
Lord Newby: My Lords, like other noble Lords, I congratulate the noble Lord, Lord Brennan, on introducing this extremely timely debate. In speaking this afternoon, I declare an interest as chairman of a company that seeks to advise other companies about how they should exercise their corporate social responsibility.
The noble Lord, Lord Brennan, talked about the basic human emotion of greed, which drove many of the people at Enron, and in many of the other companies to which he referred, to disaster. I should like to add two other basic human emotions; namely, ambition and pride, which, when mixed with greed, produce a particularly heavy cocktail at the heart of running a big company.
I should like to begin by discussing the role of the accountancy profession. This role is especially important because it is central to the management of all businesses. The effect of Enron has been to undermine confidence in the profession not only in the United States but more generally. Certainly, with allegations of the shredding of documents in the United Kingdom, the industry in this country cannot afford to be complacent; nor will the fact that accountants in this country have to form an overall judgment about the state of a company, rather than simply following set rules, be completely reassuring to many investors.
Post-Enron, things simply cannot continue as before. I share the view of the industry that a knee-jerk response that simply accepted all the possible areas of reform would be inappropriate. But during the course of this afternoon's debate we have heard a number of suggestions that should now be seriously considered. Let us start with the role of the auditor. A number of suggestions have been made in terms of a rotation of auditors. I would not wish to go as far as to have a formal shift or change in the audit company on a regular basis; indeed, where that has been tried in Brazil and Italy, it has not worked. However, there is an argument for having a more frequent rotation of audit staff.
I certainly agree with those speakers who made the point that the practice of former audit partners joining companies that they previously audited—and doing so within a short period of their working in the audit company—either as members of the board or in an advisory capacity, must stop. There is a question over how long a moratorium might be; for example, should it be a year or two years? In my view, it should be at
least two years and there may be an argument for a longer period. Clearly there is an issue about the extent to which non-audit work should be undertaken by auditors. However, I agree here with my noble friend Lord Sharman. It is very difficult to prescribe in the area. It is necessary for the audit committee to keep a very close watch on the process, rather than setting very precise limits. I also agree with my noble friend's suggestion that government should take over the funding of the Accountancy Foundation.We also had a long discussion on the role of non-executives. Like other noble Lords, I welcome the setting up of the Hewitt review. The suggestion of my noble friend Lord Clement-Jones of a two-tier board for large companies needs to be considered. That is one dramatic way of being able to shift current practice. However, even with that structure in place, it would be very difficult for those on the supervisory board, unless they are very assiduous, always to get underneath exactly what the executive board is doing. I certainly agree with the suggestion that there should be a limitation on the number of cross-directorships that arise, and on the number of non-executive directorships that any individual should hold.
Enron has demonstrated the need for many such changes. It also demonstrated the fact that complicated, sophisticated companies look to areas of weakness in order to undertake areas of corporate practice that they could not manage at home. The partnerships in Enron that caused many of the problems were undertaken offshore because those concerned could not have got away with those activities in the United States. Therefore, the whole question of extending best practice in terms of accountancy, tax rules and international standards to countries that do not currently adopt such standards should remain high on the agenda of this Government, and on that of international bodies.
Although today's debate has naturally concentrated on the accountancy profession post-Enron, I hope that the House will forgive me if I refer briefly to another area where public confidence in business is currently taking a battering. I refer to the split capital investment trust sector. This sector has grown over the past decade and a half—from nothing to a series of over 120 funds with assets of over £13 billion. However, in recent weeks a dozen splits announced that they were in default of their banking covenants. It is estimated that between 20 and 40 other funds are at risk, with possible assets between them ranging from £4 billion to £5 billion.
The sector has been characterised by a high degree of cross-holdings between one firm and another, creating a pyramid of values that was bound to collapse given a significant market downturn. That downturn has now occurred, leading to a systemic collapse of at least part of the sector. Those who are losing out are not only institutional investors, but tens of thousands of small investors who invested in splits believing them to be low-risk vehicles for long-term savings. They did so in part because the funds were
marketed as low risk and recommended by their managers as a means for saving for school fees or retirement, for example.I hope that your Lordships will forgive me for quoting from a letter that I received yesterday from a couple who invested their life savings in a split trust that has now defaulted. They write:
- "Our investment was made in the knowledge that there was a risk of a fall in capital commensurate with such a higher than market dividend, but the thought of a total loss was never thought of, and our perusal of the literature received from the management Co. never suggested such a possibility".
A number of serious allegations have been made against the sector that need a quick and authoritative answer. First, did the pervasive extent of cross-holdings amount to collusion and a reckless disregard for investors' funds? Secondly, were directors in breach of their Companies Act duties to act in the interests of shareholders by putting their own interest first as recipients of extremely high bonuses based on fees earned by their companies? Thirdly, how extensive was the mis-selling of splits to small investors, some of whom have now lost their entire investment? Fourthly, is there a case for compensation for those investors? Finally, will the splits now waive all their fees while the crisis is sorted out?
The Financial Services Authority is currently undertaking an investigation into the management of split level trusts. Given that they are publicly listed companies quoted on the Stock Exchange, with boards of directors at least nominally independent of the fund managers, there is a major question about the responsibility of the Department of Trade and Industry. I should be most grateful if the Minister would say whether the DTI intends to launch its own investigation or to leave the whole issue to the FSA.
Turning from that specific area back to the main issue, several noble Lords have discussed the need for the development of a more ethical corporate culture and practice, in which some of the practices undertaken by Enron and its accountants would simply never have been contemplated by the board or executives. I strongly agree, but I fear that to rely solely on the good nature of senior executives in every case to see off the triple vices of greed, ambition and pride is to wish for the moon.
Our current regulatory framework, complex and expensive though it may often appear, is necessary to keep those three vices at bay. It must be kept under constant review. To take the point made by the noble Viscount, Lord Bledisloe, it may not be possible to stop every financial or other man-made disaster happening, but it is surely only sensible to try.
5.3 p.m.
Baroness Noakes: My Lords, perhaps I may first declare some interests. I am a chartered accountant and a member of the council of the Institute of Chartered Accountants in England and Wales—indeed, I am a former president of the institute. I was a partner of KPMG until 2000 but have no on-going interest to declare in that regard. However, I should say that I have a number of friends who are currently
partners in KPMG or other members of the "fat four". I am also what I am learning to call an independent director of a number of companies and in that capacity am a member or chairman of audit committees.Like other noble Lords, I thank the noble Lord, Lord Brennan, for introducing this important debate. Noble Lords who have spoken today have contributed much wisdom and practical experience and we have had an excellent debate. In particular, I welcomed hearing the right reverend Prelate the Bishop of Oxford contributing to a debate on business affairs, and I agree with him about the importance of the issue of values. I sincerely hope that they can exist within a framework of shareholder value.
The issue of Enron has clearly been the driver for this debate—it was the largest corporate failure in the history of the United States. We may never know the truth behind what led to the Enron collapse. Some strands, including inadequate accounting rules and action or inaction by auditors, are identifiable, but it seems certain that behind those failures were directors determined to flout the rules for their own purposes.
Indeed, if we consider major corporate failures the world over, directors must be first in the firing line. The most notorious cases in this country in recent years, such as Maxwell and Polly Peck, involved one or more directors—executive directors, management—set on breaking the rules. Those directors have often been dominant personalities whose apparent commercial success made it more difficult to challenge them.
But not all corporate failures are linked to fraud in the boardroom. If I think back to my first year of accounting training, the biggest corporate failure, which shocked the business community in 1971 was that of Rolls-Royce. That did not involve overbearing or fraudulent directors but directors making a major commercial misjudgement.
I mention that not to diminish the importance of the collapse of Enron but to remind your Lordships—as have other noble Lords—that corporate failure is a natural consequence of the capitalist system on which our economy is based. Capitalism has fuelled our economic growth and that of other Western economies. Global economic prosperity rests on it. But capitalism involves risk taking. Capital markets, shareholders and management all accept that risks sometimes turn out badly. Some business enterprises will fail. Last year alone, there were more than 30,000 liquidations and bankruptcies in this country. Business failure is an unfortunate fact of business life.
One reason that our economy has been successful has been its relatively light regulatory burdens. Of course, our business community always complains about the level of regulatory burdens—and rightly so. Especially since 1977, regulatory burdens have been rising—the British Chambers of Commerce estimates their total cost at £15 billion. But our economy is still relatively flexible, which has meant that we have a greater ability to withstand global slowdown.
It is important to remember the underlying virtue of the flexibility of our economy when we consider what responses are needed to corporate failure. It may be
tempting to think of ratcheting up regulatory systems as a response to Enron, but I sound a note of caution. Increasing regulatory burdens could drive business out of this country or prevent inward investment from coming here. As my noble friend Lord Hodgson pointed out, regulation carries costs for business.We know that other regulatory burdens on business in this country are coming. There is the so-called enterprise Bill, which will increase regulatory burdens, and at some point during the life of this Parliament, the company law review will increase the regulatory framework for companies.
Today is not the time to debate the substance of those issues, but it is time to debate how we approach the regulation of business. We must be careful that we do not simply respond to corporate failure by massively increasing the rules and regulations surrounding business. We must ensure that the benefits of any additional regulation outweigh the costs. We must ensure that we do not strangle the spirit of entrepreneurship, which is important to our economic success.
We should also remember that major corporate failures can result as much from government action as from the actions of directors or auditors. The most shocking corporate failure in this country in recent months was the assassination of Railtrack by Mr Stephen Byers, who is, remarkably, still Secretary of State for Transport, Local Government and the Regions. When the Government address the issue of corporate failure, they should consider carefully whether they come to the task with clean hands.
The Government have announced several actions in specific response to the Enron case. First, there is the review of non-executive directors announced by the Secretary of State for Trade and Industry, which has been welcomed by many noble Lords. On these Benches, we welcome such a review in principle. Although the announcement of the review made it sound as if some action was involved, there is still, I understand, no chairman or person to take forward the review. The person whose name was mooted in the newspapers, Sir Peter Davis, appears not to have wanted to take up the challenge. Perhaps, that is not surprising, given the succession of reviews—Cadbury, Hampel, Greenbury and the like—that have already covered the area. What is the status of the review of non-executive directors? Who will lead it? What are the terms of reference? When will it report back?
The second review announced by the Secretary of State for Trade and Industry was a review of audit and accounting issues. It is to be taken forward with the various regulators in the field. What are the terms of reference for that review? When will it report? I would also like the Minister to say whether the proceedings of both reviews will be open to the public. Will they take evidence in public? Will they cast far and wide for contributions? Will the reviews be open and transparent?
The reviews will touch on issues that are central to business life and the existence of a successful business community in this country. Their recommendations
could have far-reaching implications for business. It must be made clear that a broad spectrum of business interests can contribute to it fully and openly.The accountancy firm at the heart of the Enron scandal, Andersen, has close links with the Government. It worked closely with the Labour Party before the 1997 election and was rewarded with the rapid settlement of long-running litigation undertaken by the previous Government against it over the quality of its work on De Lorean, another corporate failure, albeit less spectacular than Enron. The Secretary of State was director of research for what was then Andersen's consulting arm.
What are the Government doing about Andersen's Enron role in the UK? I am aware that the majority of the issues relate to the US offices of Enron and Andersen, but Andersen's UK office was singled out for special mention by the US authorities when the US firm was recently charged with criminal acts relating to the destruction of evidence. What is the Government's current approach to work done by Andersen? Are there any contracts in progress or any contracts for work for which Andersen are bidding? What do the Government intend to do if there are any such contracts?
Many issues are raised by the Enron failure. I hope that the Government will be prepared to face all those issues, even those close to home. I hope also that the Government will not fall into the trap of creating more regulatory burdens on business—that includes auditors—without being sure that those burdens are outweighed by the benefits to our economy.
5.14 p.m.
Lord McIntosh of Haringey: My Lords, my noble friend Lord Brennan is to be congratulated on the timeliness and importance of the Motion and on having attracted such a range of expert contributions. As has been suggested by several speakers, that has happened because, although Enron is not mentioned in the Motion, attention has been wonderfully concentrated by the largest, most serious corporate failure in the history of capitalism. Perhaps it is going a little too far to call it that; but certainly several speakers have questioned things that should have been questioned before but may not have been.
We start in the knowledge that company failures, as has been said, are a normal part of business life. They can result from misjudgments in corporate strategy, from an inability to adapt to changing market conditions, or from simple bad luck. They can also result from weak systems of control within companies, from failure to apply those controls rigorously, from human weakness—greed, ambition and pride—and, in a significant number of cases, from dishonesty and fraud on the part of the employees and managers of a company.
As has been made clear by the Enron case, they can arise also from failures in accountancy, Whether they are failings in external or internal audit, all those things can and do happen. I doubt whether the noble
Lord, Lord Brennan, was right to say that no company was ever saved by its auditors. I suspect that the companies that are saved by their auditors do not come to public notice, and the fraud does not bring the company down. The poet said:
- "Treason doth never prosper, what's the reason?
- For if it prosper, none dare call it treason".
We must accept that no amount of regulation by Government could prevent all failures occurring. On that, if on little else, I agree with the noble Baroness, Lady Noakes. Certainly, we could not expect to provide benefits to consumers or the economy by propping up failing companies. As has been said, taking risks, with all the rewards that it brings, is at the heart of the free market. However, we take seriously the failures that raise issues relating to regulation or public confidence, and I shall set out some of the things that have been done in the past 10 years or so and some of the things that are being done now and will be done in the future.
We must get the balance right between regulation and encouraging enterprise. We must make the United Kingdom an attractive place in which to do business, and we must consider the issue in the wider sense. The noble Lord, Lord Hodgson of Astley Abbotts, gave some importance to the cost to business of regulation, although even he admitted, under questioning, that the cost was infinitesimal in the context of the turnover of the financial services business.
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