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Baroness Thomas of Walliswood: My Lords, I am sure I am not the only person who is concerned about dysfunctional families. We know that such families are the single greatest predictor of offending behaviour. I myself have been involved, as a school governor, in ejecting from a school a child who, at five years old, was already totally unmanageable, even by experienced teachers. He came from such a family. What can we do at an earlier stage in the life of the family?

We know that such families can be cyclical. You cannot learn to be a good parent unless you yourself have been properly parented. "Respect" does not merely mean that of the child for the parent, but that of the parent for the child. We learn respect only by being respected. What can we do to intervene at an early stage and teach those who do not have the skills—who may even realise that—how to be good parents?

Lord Falconer of Thoroton: My Lords, that is an incredibly difficult but well-judged question. First, we must identify the children at risk. Secondly, we must make sure that the response to the child and the family is properly co-ordinated—not trying merely to deal with the problem as it develops at school but looking at whether the social services have a role. Thirdly, we must regard the problem as a family problem, not a childcentric problem. Parenting classes are often viewed with suspicion by families; but subsequent research indicates that parents say that they wish they

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had received that kind of help earlier. Fourthly, we must look at health problems. Fifthly, we must look at whether a family is involved in drug or alcohol abuse, which is frequently a predictor of trouble.

One could continue at length. The three critical factors are: early identification; a co-ordinated response; and someone having responsibility for ensuring that a co-ordinated response occurs. It is not a complete answer, but I suspect that there would never be a complete answer.

Lord Brooke of Sutton-Mandeville: My Lords, is the Minister aware that the first use of the word "civilisation" was by Mirabeau in 1757? It is therefore a youngish articulated concept. Does the Minister have views or suggestions on how individuals within the silent majority can make anti-social behaviour less likely?

Lord Falconer of Thoroton: My Lords, one of the things that happens when anti-social behaviour starts—for example, if a park or a street look increasingly untidy—is that the rest of the community begin to let their standards drop. So they begin to drop litter. If they step outside their front door and see a "tip" outside, that reduces the standard of their own conduct. How can society as a whole react? People can refuse to accept that kind of anti-social behaviour and ensure that what they see around them does not necessarily lead to a drop in their own standards.

Lord Bradshaw: My Lords, I declare an interest as vice-chairman of the Thames Valley Police Authority. Last Monday, I was at Slough magistrates' court. There were no probation officers—because there are no probation officers: there is no one to do the job. There is a grave shortage of court clerks and barristers—legal representatives are hired in by the Crown Prosecution Service on a jobbing basis. They are not professionals.

The police have put huge resources into Slough. The wall of the police station is covered with the names of people who have been arrested for street crime—which is what the Government want. But the courts system and the probation system are creaking at the seams. There are not enough officers. People cannot be found a place on a drug placement scheme because there are no places. The magistrates are told not to send people to prison because the prisons are bursting at the seams. The firm that collects people to take them to prison—Premier Prisons—does not do its job efficiently.

I am afraid that the anti-social behaviour order is a very good layer on the top, but I can assure the Minister that the foundations are awful. Is something being done to address these extremely serious problems?

Lord Falconer of Thoroton: My Lords, the spending round in 2000 increased resources to the criminal justice system. So, since SR 2000, the numbers of police and prosecutors have gone up. The picture that the noble Lord gives of the courts system is not borne

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out by the statistics, save in one respect, because they have been dealing for the past 10 years approximately with the same number of cases.

There is certainly a difficulty in relation to the Probation Service, but the spending on probation has risen by about 50 per cent since 1997 and in the past year by about £70 million. So the numbers have risen, but the demands being made on the Probation Service have increased, for all of the reasons that we have been discussing. The difficulty is not that people do not want to become probation officers. They have to be trained. There is not an endless supply.

It should be remembered that the number of prosecutors has risen; police numbers have risen; the courts are not dealing with any more cases; and we are asking the Probation Service to do more and more—and rightly. We must be patient while the stream of people with qualifications are trained to deal with this work.

So far as concerns prisons, there are about 72,000 people in prison. That is a large number. But the way in which the Prison Service has dealt with the problem over the past five years is very impressive.

We need to do lots to make the criminal justice system work better. I believe that we are going in the right direction. I believe that we are increasing the amount of resources. These problems cannot be dealt with overnight. One of the biggest issues is getting the trained manpower to deal with them. I was amazed by one remark made by the noble Lord, Lord Bradshaw. He said that there is a shortage of barristers. I have never heard that before.

Consolidated Fund (No. 2) Bill

Brought from the Commons endorsed with the certificate of the Speaker that the Bill is a Money Bill, and read a first time.

Corporate Governance

4.9 p.m.

Lord Brennan rose to call attention to the issues of corporate governance, following the recent reports on non-executive directors, auditing and accountancy; and to move for Papers.

The noble Lord said: My Lords, in a capitalist system there is an inevitable tension between two aspects of human behaviour. One is greed; the other is trust. It is by the resolution of this tension that we control greed, and yet recreate trust where it needs to be recreated. That is the task that we shall debate.

The 1990s were an era of "boom". A German banker commented earlier this year that, in his experience, booms diminish vigilance, induce complacency, make for sloppy thinking and, above all, lead to hero worship. Who are the heroes of the 1990s?

Mr Kenneth Lay, who regularly appeared before the United States Congress to demand deregulation, abhorred any public intervention into commercial

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activity because with deregulation and without public intervention they could set about their task of maximising shareholder value. The message was preached and we listened, but the time came when we realised that it was not the right message, and that the messengers were those who had given in to greed. By doing so, they had foregone the trust which it was their duty in corporate life to maintain.

Enron involved activities with five major banks. It led to the demise of Arthur Andersen and now involves law firms subject to civil and potentially criminal actions. It was followed by the very substantial accounting irregularities revealed by Xerox. A firm called Sprint was described by a Wall Street commentator as a "serial governance abuser". He was right, because the company spent its time creating stock options which, when thought not to be generous enough by the recipients, led to them demanding that the board reprice the options so as to make them more advantageous.

As for investment banks, the present chief executive officer of Credit Suisse First Boston described its activities in the 1990s as those of a "giant casino". It has suffered a 25 per cent drop in the discretionary funds given to it by outside investors, and it has made provision against action by the Securities and Exchange Commission and other claimants of 600 million dollars.

Companies, accountants, directors and banks all to some extent fell into the problem of greed and, as a result, trust was lost.

I hope that I have not exaggerated this history, nor would I wish to infer that it is representative of the way in which we think and act in this country. However, we cannot take matters for granted.

In Holland, a month ago, Royal Ahold, the third biggest food retailer in the world, declared accounting irregularities of around 500 million dollars. The share price has fallen by 60 per cent. Alltran in France has been threatened with prosecution for giving false information to the markets. Camroad in Germany suffered the indignity of a chief executive officer beginning a seven-year sentence for creating a balance sheet based on fictitious sales. Last year, Elan in Ireland suffered a substantial drop in its value because of off-balance-sheet activities.

Those actions, both in the United States and in Europe, are not separate from the community in which we live as ordinary people. They lead to pensions being lost, savings vanishing and jobs going. They lead to a substantial drop in the financial net worth of corporate activity and, above all, they damage investor confidence. That confidence must be restored; jobs and savings must be protected; and action is required, at least with regard to listed companies.

I accept the sense of the comment that nobody can completely eliminate the determined fraudster, and nobody can guard in every way against the ingenious mind that will find its way around regulation and voluntary controls. However, that does not mean that we should not try our best to ensure that it does not happen.

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If your Lordships will forgive the crudity of the introduction, I shall speak on the bosses and the books. I begin with the bosses and the issue of power. The role of non-executive directors, as envisaged in recent debate and by the Higgs report, is to ensure that three things are avoided: first, lack of independence; secondly, weak oversight; and, thirdly, excessive pay to executive directors.

Allowing for the debate that will take place about the Higgs report, one can crystallise the role of non-executive directors, briefly but accurately. Their central job is how to deal with the chief executive officer—how to choose him and, having chosen him, how to evaluate his or her performance continually, with an eye to good financial standards. That is a short but, I hope, appropriate encapsulation of the duties of a board.

Who would best fit that requirement? The objective observer would say that it would be the non-executive director, because he or she does not have an immediate interest in terms of compensation or career such as executives have. It is the non-executive director's role to make the balance between the entrepreneurial drive of the permanent staff, coupled with intelligent comment and, when appropriate, pointed criticism. Surely, that is what the Higgs report seeks to achieve. At least half the board should be non-executive; independence should be strengthened, and there should be a clear separation between the roles of chief executive officer and chairman.

The CBI's reaction to the Higgs report was a little disappointing. Of the 100 heads of the FTSE companies approached to answer the questionnaire, only 61 were able to do so. That is a low response from such a small number of companies to what is probably the most significant report about corporate life that they will face in the next few years. The response is in the form not of a report, but of a summary of a questionnaire reviewing the answers to four questions.

The response to two of the questions is an extreme reaction against two Higgs' suggestions. Respondents objected, first, to the suggestion that the nominations committee should be chaired by an independent non-executive director and, secondly, to the role suggested for the senior non-executive director in relation to the chairman of the company. The voting response showed a more balanced reaction to two other suggestions: first, that there should be a meeting once a year of non-executive directors without a chairman; and, secondly, that the roles of chief executive and chairman should be separated. As yet, we have no response in terms of CBI thinking about independence, systems of appointment, training or tenure. I hope that it will come soon.

The critical question that comes next after attempts to control the power of chief executives and chairmen is that of pay. Whatever we thought a few years ago about rewarding the entrepreneur, as we were told, "high payment required"—and looking to just the recent past—the fact is that the payments reached levels that could properly be described as grotesque.

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Share options are the vehicle for such reward. As one is maximising shareholder value, the inevitable temptation to any ambitious man or woman is to maximise the value of his or her share option. That objective is perfectly reasonable if it balances with the long-term development of the company. It is not reasonable if it becomes the primary objective.

Therefore, the recent Smith recommendations about audit and remuneration committees are surely unexceptional. The first recommendation is that they should be made up of entirely independent directors, one of whom should have relevant financial experience. The second is that they should monitor the performance of the company's auditors. The third is that they should exercise special care as to non-audit services. Europe will add to those recommendations. Internal Market Commissioner Bolkestein is about to issue voluntary proposals on corporate governance. The noble Lord, Lord Sterling of Plaistow, is reported in this morning's newspapers as saying that these proposals from Higgs—and others like them, I infer—

    "create mistrust, are highly divisive and will stifle entrepreneurial drive".

I disagree. As he said:

    "The objective of a board is based on trust",

but the higher objective is that the investor and the public should have trust in corporate integrity.

I am happy to say that I can be brief on auditing and accounting, because I understand that the major firms and the thinkers in this field have accepted the general thrust of the audit report of the Co-ordinating Committee and the new accountancy approach which has led to some significant proposals. Other changes include: Sir David Tweedie, a very persuasive and powerful proponent of UK practices, to be the new head of the IASB; by 2005, all listed companies within the European Union to follow the standards of that board; and by that year, if possible, convergence between us and the United States on accounting standards.

I conclude by suggesting that it will be good for corporate life and good for all of us if business schools emphasise the principles of good corporate governance as part of training and if we in Europe set up a European Centre for Financial Standards to investigate how they are presently working, how they might need to be changed and how corporate life can properly be educated about them.

The proposals in all these new reports, although they may be debated in detail, are surely tough and yet measured. There has to be a correct balance between rule making and playing by the rules. If you do not play by the rules, you cannot be too upset if you face some rule making. The question is how we strike the balance. In the debate which I hope that we will now enjoy, the balance must be determined by society, not by the corporate world. Democracy is the counterweight to capitalism. We in Parliament debate how that counterweight should strike the balance: the least amount of regulation, but the greatest amount of

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trust to be expected, all in the service of corporate profit and health, for the general good of the community. I beg to move for Papers.

4.24 p.m.

Lord Freeman: My Lords, I congratulate the noble Lord, Lord Brennan, on this important debate. It is almost one year since he introduced a similar debate and it is timely that we should return to the subject. He has painted skilfully on a very large canvas. In the limited time available to me, I intend to focus on just a few points. I agree with a good deal of what he said in specifics, particularly about the Higgs report. I shall come to that in a moment. I declare a number of interests which I have registered but in my judgment they are not relevant to this debate because I speak for myself and based on my experience.

In the debate 12 months ago, the noble Lord called for no complacency and for action. He pointed to the events in the United States to galvanise both public and private sectors in this country into action. That has happened. Thank goodness we had a co-ordinating group chaired by two very able junior Ministers to, as it were, look after the great number of reports that have been presented by both the professions and the public sector. I should like briefly to record some of the most important ones. There was the government review of the regulatory framework to which the noble Lord, Lord Brennan, referred; the report of the Office of Fair Trading; the Treasury Select Committee report; the Higgs report; the Smith report—and, incidentally, Sir Robert is the chairman of the Financial Reporting Council, the new regulator of the accountancy profession; professional guidance issued by the leading professional accountancy institute in England; and the Report on a Modern Regulatory Framework for Company Law in Europe, the chairman of which was Mr Jaap Winter, published just before the end of the year.

In my judgment, the response in the United Kingdom in the 12 months since our previous debate has been measured, proportionate and practical. There is much to be welcomed. I have four points to make in as many minutes. It would be helpful if the Minister responded to some or all of them in his reply. The first is on Europe. I think that it would be fair to say that the United Kingdom has had a record of leading reform of corporate governance ahead of other European nations. Looking back over the past 12 months, particularly to the recommendations on auditor independence from the European Commissioner last May, I think that the United Kingdom has responded well by accepting all the recommendations. Briefly, the recommendations are that the audit partner must rotate every five years; that there should be a cooling-off period, rather like that for the Civil Service, so that an audit partner could not work for his or her client within a period normally of two years; and tighter controls on the non-audit work done by auditors for their clients.

As the noble Lord, Lord Brennan, said, Frits Bolkestein, the Commissioner for the Internal Market, plans to publish an action plan, as he calls it, in May,

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to begin the process of setting common corporate governance requirements across Europe. That is to be welcomed, and I am sure that the United Kingdom will encourage the Commissioner in that endeavour. However, the Commissioner himself has quite rightly said that, as each nation has a different history of company law, each will have its own approach to corporate governance. That must be right. I think that his rather enlightened approach to this important subject is to be welcomed.

My second point is on the United States. Thank heavens that we have in this country an approach based partly on a voluntary code. Companies have either to comply with the suggested Higgs requirements on non-executive directors or with Smith on the audit report or explain why they are not complying. That approach seems better than the prescriptive, legalistic approach in the United States. Following Sarbanes-Oxley—the legislation governing the audit and accountancy professions—the SEC has produced literally thousands of pages of regulations, which are either already implemented or to be implemented. We have adopted a different approach, which I very much welcome.

There is a specific problem in relation to the United States which the right honourable lady Patricia Hewitt, the Secretary of State for Trade and Industry, is fighting together with Commissioner Bolkestein. I am sure that your Lordships will wish to encourage the Minister to raise it with the Public Companies Accounting Oversight Board—the oversight board—the new regulator in the United States set up by the SEC, because the Americans seek to regulate UK and, indeed, for that matter, European auditors and accountants if they carry out work for companies that are listed in the United States. So there is double jeopardy and double regulation, which I argue is unnecessary. I hope very much that the Minister will be able to confirm that the policy of Her Majesty's Government is to pursue with the SEC the need to recognise that other countries, particularly in Europe and above all in the United Kingdom, have high standards of corporate governance and regulation of auditors and accountants. The Americans should not seek to begin again the process of regulation of companies that are listed in the United States and audited in Europe.

Thirdly—here I find myself in agreement with the noble Lord, Lord Brennan—the Higgs report is to be welcomed in its entirety. I think that most fair-minded people reading the many recommendations—frankly, many of them have been misunderstood by colleagues in industry and commerce and, indeed, by some newspapers—will recognise that they are prudent and sensible. All of them should be welcomed. The Secretary of State for Trade and Industry is right to welcome the report. I mention one of the many recommendations; namely, that the nominations committee should not be chaired by the chairman but by an independent director, with the chairman sitting on that body. That seems to be a sensible way forward

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in terms of best practice as one is thus better able to widen the pool of non-executive directors who wish to serve on the boards of companies.

However, there is one problem with the Higgs report and that is the speed with which it seeks to be implemented—a few months after its publication is far too short a period. When changes were made to the codes 10 or 15 years ago there was a much longer period of consultation and explanation. I plead with Mr Howard Davies of the FSA—the body ultimately responsible for the introduction of the code—to take a few more months to ensure that the code can be explained fully to the companies it covers.

I agree with the noble Lord, Lord Brennan, that the Smith report is excellent. Let us have its recommendations introduced immediately. I have heard no criticism, either within the world of audit and accountancy or in business, of the recommendation that audit committees—we touched on that matter in the debate last year—should govern appointments, pay and the non-audit work of auditors. I hope that when the Minister replies to the debate he will be able to give some indication of when the Companies Bill might be introduced and whether draft clauses could be discussed by your Lordships and another place before we get that Bill. Frankly, a Bill in draft, discussed by your Lordships and another place before it is introduced, is much to be preferred. We have only to compare the recent examples of the Communications Bill discussed in another place and the Licensing Bill to appreciate that argument.

4.34 p.m.

Lord Sharman: My Lords, before I begin I must declare an interest. My business interests are set out in the Register of Members' Interests. Particularly relevant to the issue we are debating is the fact that I sit on the boards of three listed companies in the UK and I am the former chairman of KPMG where I continue as a paid adviser.

I should like to thank and congratulate the noble Lord, Lord Brennan, for the opportunity to debate once more the issue of corporate governance—a year ago we discussed the Enron collapse—and the issues affecting corporate governance and audit and accountancy. A number of inquiries have taken place which I shall not list, as the noble Lord, Lord Freeman, has already done so. The reports, certainly as regards the UK—I echo the noble Lord's comments in that regard—have proceeded on the very well proven approach based on broad principles rather than strict rules. To my way of thinking that has the great advantage of recognising the critically important point that no two boards of directors are the same or operate in the same manner.

Mr Higgs is to be congratulated on the approach he took in understanding that good governance is concerned with the behavioural aspects of boards as well as their structure. The Higgs report—I wish that more people had read it in total—makes clear that he takes that into account in making his

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recommendations. I believe that is important as at least part of the reason for the failure of Enron, WorldCom, and other companies to which the noble Lord, Lord Brennan, referred, was due to the fact that they operated in an environment with a strict set of rules for auditing, accounting and governance. Strict sets of rules generate an industry composed of accountants, lawyers and investment bankers who design schemes to get round the rules. It is much easier to overcome the objective of the rules than to circumvent a principle based approach.

As the noble Lord, Lord Freeman, said, it is also worthy of note that by and large the reaction of the market-place to the reports is positive. The reports have been well accepted, particularly as regards the recommendations on auditors, audit committees and accounting and their regulation. It is important to recognise the way in which the market-place and the system of regulation work in this country. In that regard credit is due to some of the institutional shareholder associations. Back in April/May of last year the ABI wrote to the chairmen of all the audit committees of the FTSE 100. It followed that up with a subsequent letter to the chairmen of the audit committees of the FTSE 250. In that letter it drew attention to developments in audit committee practice, procedure and policy. It specifically drew attention to the examples of two companies—Unilever and Rio Tinto Zinc—that had addressed those issues in their annual reports. The ABI asked that all FTSE 100 companies should consider doing the same thing. Some time later, Phillips, an international company based in the Netherlands, published its own audit committee charter or terms of reference and policy on auditor independence. That was published over the web and was a first.

As a result of those initiatives audit committees and boards started to re-evaluate their own policies and procedures. As a result best practice was quickly disseminated. I am therefore not surprised that many of our larger companies will have no difficulty whatever in complying with the recommendations of Sir Robert Smith.

I wish that I could say the same about the Higgs report. There has of late been somewhat more noise as regards the recommendations of Mr Higgs. The concern seems to be that the Higgs recommendations will undermine the role of the chairman. Although that is a concern that is easy to understand, particularly if one is a chairman as I am, Higgs makes it very clear in his recommendations that that is not his intention. He says that the chairman,

    "has a pivotal role in creating the continued conditions for individual director and board effectiveness".

It is worth remembering that of the 55 or so recommendations that Higgs makes only some six or seven are the cause of the noise. Like the noble Lord, Lord Freeman, I believe that we should accept the report. There are, however, three issues on which I wish to comment as they constitute anomalies.

I beg to differ with the noble Lord, Lord Freeman, on the nominations committee. It is illogical to expect the chairman to carry out that pivotal role and yet at

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the same time not chair the committee. We should remember that the committee is not solely concerned with the appointment of non-executive directors. It appoints the chief executive and chief financial officer. In many cases, it appoints the key executive directors. The chairman has to work with them as a team.

Higgs's recommendations on the interaction of the senior independent director and other non-executives with the shareholders has also created some disagreement. It is accepted by most people that involvement of the institutional shareholding bodies with the companies in which they invest would be desirable. We want to see more of that. The only issue that arises is how we do that and who does it. Higgs recommends a role for the senior non-executive director that is beyond question. He is a backstop. That is Higgs's principal recommendation. If no one else can deal with the problem for the shareholders, the senior non-executive director should.

How do we then understand the themes and concerns of the general body of shareholders? It might well be preferable to suggest a similar approach to that which Higgs suggests between the chairman and the chief executive. Who is responsible for what in the board should be defined, reduced to writing and agreed by the board. With it, there should be the objective that the whole board should understand the themes and issues important to its shareholding base.

The final area about which I am worried is that the chairman and chief executive have no provision for rotation, yet the suggestion is that individuals on the non-executive body rotate every six years. I am not sure that having a rotating body of non-executives every six years, with the chairman and chief executive semi-permanent, will increase the effectiveness of corporate governance. More stability in the body might be desirable.

We have before us the results of a considerable body of work. I am confident that if we proceed along the route of tried and tested approaches of principles followed by "comply or explain", we will make good progress in further developing effective corporate governance. Let us get on with the implementation. We do not need any more reports.

4.43 p.m.

Lord Haskel: My Lords, I congratulate my noble friend on introducing the debate. His timing is excellent. The consultation on the Higgs report ends on 14th April, and surely a debate of this nature must be a helpful contribution to the consultation.

I wonder if my noble friend has visited Halifax. In the 19th century, Halifax prospered through business and industry and, after Sir Charles Barry had done a pretty good job building the Houses of Parliament, the people of Halifax decided to engage him to build a town hall to celebrate their commercial success. The phrase "corporate governance" had not been invented then, but the citizens of Halifax decided that they wanted the key to their prosperity to be written on the front of their town hall. The two-word inscription is still there and reads, "Act Wisely". To me, the simple

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principle that action and wisdom go together describes corporate governance perfectly. It also deals with the greed and trust mentioned by my noble friend.

I can look back on a career of 30 years in the textile business, which is how I know Halifax. In spite of the list of wickedness given by my noble friend, in this country it has always seemed to me that poor strategies have been a bigger destroyer of businesses than wickedness. Business is a pretty risky affair. Action without strategy or direction rarely succeeds in doing the things that really matter and make a lasting difference. That is why corporate governance is about involvement in a business, not just policing it. I therefore agree with Higgs about enlarging the role of non-executive directors, but I would also like to see it deepened.

Of course it is right that companies should state their values, which will indicate how they will deal with people, conduct their business and behave in their relationships with other stakeholders. However, that has to be more than mere words. No one could argue with a company that stated its core values as respect, integrity, communication and excellence, but those were the stated core values of Enron. They were the words on the banners outside its offices in Houston. They are a modern version of the inscription on Halifax Town Hall, I suppose. The point is that simple compliance with having core values is not enough. Non-executive directors have to be sure that those values are part of a company's culture, and have a part in how a company operates. That needs deeper involvement. Corporate governance is about involvement, not just rules.

I agree with the noble Lord, Lord Sharman, in that we should not run the risk of a prescriptive rulebook becoming a barrier to innovation. Innovation is where our future lies. We cannot hold back technological change. We cannot and should not try to slow the growth of developing countries, and we cannot compete solely on the basis of costs. Our response to faster change and greater competition cannot be protectionism. It has to be innovation, and that is encouraged not by policing behaviour but by getting the strategies right. That is the task of the directors.

I agree with Higgs that non-executive directors have a role to play in instilling a culture of integrity. However, others have an even greater role, such as the professional institutions, particularly the accountants and also the lawyers and bankers, who lowered their standards and allowed themselves to become poachers. They must raise their standards once again so that they become gamekeepers.

But other professional organisations such as engineers, human resources, technologists and designers have an important role to play in addition to supporting their members in their professional work. They agree with me that, in addition, they must give their members the comfort and support of decent values and high standards of integrity to help and support them through the market-driven turmoil of their daily work. At a time when the public are wondering how much they can trust business, it seems

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to me that in that way they can perhaps give confidence to the public and comfort to those who have to work every day in the rough and tumble of a difficult business environment. Extending corporate governance to the professions in that way would do a lot to raise ethical standards, which is one of the purposes of the Higgs report.

I also agree with Higgs on the need to widen the pool of non-executive directors and to introduce new blood. We need more, because Higgs is asking for more of them and I am saying there should be deeper involvement. Directors understand that they owe a duty to the company. They are accountable to the shareholders and indeed are responsible to all the stakeholders. To fulfil those duties fully, a director needs to be involved in a company's reputation, its key relationships and its innovation as well as the financial risks. There are many courses, seminars and meetings to explain and discuss all those tasks. However, it seems that we have not seriously set about increasing the pool of non-executive directors and ensuring their professionalism, especially if we are to have senior non-executives.

How is that done elsewhere—in the Civil Service, the police or the Army? How do they promote the meritocracy that Higgs seeks? The answer is that they have a staff college. In this country, we have more than 50 business schools. For some time, I have been suggesting that one of them should turn itself into a staff college for non-executive directors. I refer to a college where people can enter themselves or be sent for a part-time or full-time course to acquire or polish up the skills and knowledge that they need to be an involved non-executive director; a college that can be at the centre of excellence for best practice; and a college that can be part of active share ownership. Such a staff college could borrow the words from Halifax town hall because its task would be to equip non-executive directors to act wisely.

4.50 p.m.

Baroness O'Cathain: My Lords, like previous speakers, I thank the noble Lord, Lord Brennan, for bringing this interesting subject to our attention. In doing so, I must declare an interest. I have been on boards of FTSE 100 companies for 20 years and for many years a member of audit committees.

I have lived through all the developments since then, which have been classified by some as the "bad old days". As in every part of life—be it corporate, political, national or even international—there were, and probably are, bad practices. I welcome any suggestions guaranteed to improve the perception that our corporate governance can be relied upon to be honest and transparent. In terms of our reputation, both nationally and internationally, nothing else is acceptable. I deliberately use the word "perception". The word haunts us all the time but it has become central to so much that we do, even here in the House of Lords.

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As we are time limited I shall not dwell on the current "perception" of the operation of boards of directors. We have had masses of negative comment. I accept the old adage that there is "no smoke without fire". However, in my experience, boards of directors have worked very hard to fall in line with the demands of successive reports—Cadbury, Greenbury, Hempel and now Higgs—not to mention the continuous recommendations relating to other business issues such as accountancy. The latest recommendation is the Smith report on audit committees and the combined code of guidance.

Boards of directors of all the companies of which I am aware have examined those reports and given a big welcome to much of the content. There is undoubted value in the reports but I fear that we are now getting to the point where boards spend more time making sure that all the corporate governance proposals are met than dealing with very important issues such as strategy. The noble Lord, Lord Haskel, mentioned strategy, and I thought that I would repeat it.

All these proposals are of a "best practice" nature. They are not encapsulated in law. However, the concept of "comply or explain", which has now been brought to the fore by Higgs, seems exceedingly prescriptive. I know there is a feeling, which is quite widely felt, that it is only a matter of time before we are presented with a raft of draft legislation. That will prove exceedingly lucrative for squads of lawyers, as the Higgs report is proving to be to consultants who are peddling advice to boards, and to headhunters already rubbing their hands in glee in anticipation of a huge demand for new independent directors. However, is it going to improve overall performance of British companies and, by extension, the performance of corporate Britain?

Before dealing with the points that concern me greatly I believe that it is not frivolous to point out that the stream of reports on the subject of corporate governance resulting in the "something new" part in each succeeding report has two results. First, proposals have become so numerous that they could well act as a deterrent to truly independent, experienced directors of proven expertise who decide that the approach is becoming just a box-ticking exercise that limits their input to the board by virtue of the preponderance of "measuring up to the best practice" proposals. One company secretary sent me 16 pages of changes to existing practices which must be considered and, fortuitously, today gave me a further checklist of how best we can carry out the proposed evaluation of the board. I refer to paragraph 11.22 of the Higgs report. The latest document he has presented me with is composed of two parts. The first deals with the performance evaluation of the board and consists of no fewer than 62 questions, each of which requires comment, not just box-ticking. That is in line with the guidance in Annex J of the Higgs report. The second part deals with the performance evaluation of independent directors. There are 10 questions requiring detailed comments on each individual independent director. In the case of this particular board, there are eight independent directors, so I have

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to ruminate at length on the answers to 70 questions. Unfortunately, I cannot fill in my own evaluation. The costs of running the board could well escalate to such a level that shareholders would be quite within their rights to object.

Let us not forget that the business world has been inundated by prescriptions to improve corporate governance. I shall give a few examples. In the US, there is Sarbanes Oxley, which is the only one encapsulated in law; in France there are two reports, Vienot in the late 1990s and Bouton this year; and there are also all of our reports, which I have already listed. My slightly facetious mind is reminded of a song from "Annie get your Gun"; it is, "Anything you can do I can do better". The process is in danger of taking over. Business entrepreneurship, creativity, the ability to be light on one's feet in grasping opportunities and the ability to compete worldwide could be hampered by concentration on that process.

The really serious points, which have already been mentioned, include the recommendations relating to the choice and role of the chairman. It is crazy to suggest that the chairman should not be chairman of the nominations committee. I am afraid that I cannot agree with the views of my noble friend Lord Freeman on the nominations committee. The proposal is just crazy. The operation of the board depends so much on the chemistry of the board, as demonstrated by the ability of the chairman to have respect for, and trust in, all the directors. How could that be achieved without the chairman's input and, indeed, leadership in the final selection of a proposed independent director? After all, as has been said, that is a pivotal role. A pivotal role not being chairman? How?

Secondly, the only situation in which it would be in the interest of the company for the senior independent director to approach the shareholders would be in the case of a weak chairman who was not up to the job. In such a situation, that should be done by the whole board, not just by the senior independent director who might have a not-so-hidden agenda. That would also result in a two-class board, signalling demise of the unitary board. I believe that most people in British industry and commerce would agree that that is a good thing. A pivotal role for the chairman? I think not.

The third serious point is that the cost of all of this has so far been passed over. What about the additional reporting requirements—chunks of it—in the annual report? What about the costs of consultants to assist in carrying out the performance review? I have already alluded to costs of headhunters. Costs, cost, costs, my Lords, just at a time when we are all struggling to survive.

The definition of independence makes passing reference to a person being,

    "independent in character and judgement".

Those are pretty fundamental personal characteristics, which are so basic that they are unlikely to be diminished in any way irrespective of whether the person sits on a board for six years. That period actually equates to a period of 72 days if one measures the contribution and effectiveness of the director by

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attendance at and contribution to board meetings. The noble Lord, Lord Haskel, said that integrity should be introduced. Does he mean that people should be trained to have integrity? Surely people either have integrity or they do not as a basic personal characteristic. If the director has that independence of "character and judgement", how come he or she is in danger of losing those basic characteristics to a point that they,

    "could affect, or appear to affect, the director's judgement"?

I quote from lines four and five on page 37. In my personal experience, the longer that one is on the board the more independent one becomes. Let us remember that to lose the services and contribution of an experienced director on the spurious basis of lack of independence, based on a fallible description of independence, is unjustifiable in fact. If it works, do not fix it.

In the time available to us—I am about to overrun—we are certainly not in a position to enumerate concerns or to consider more carefully the more positive points. I hope that if the Government feel minded to encapsulate the recommendations of the Higgs review, they will think long and hard and give your Lordships' House much more time to consider the matter further.

4.58 p.m.

Lord Holme of Cheltenham: My Lords, in thanking the noble Lord, Lord Brennan, I point out that I intend to concentrate more on the values that inform the policies and practices of public companies than on the structure of governance. Before doing so, I apologise to the Minister and to your Lordships' House that, not knowing that there would be a Statement this afternoon, I find myself in the situation of having to be at a long-standing commitment in Greenwich at seven o'clock. I may have to leave shortly before the winding-up speeches, for which I apologise.

Ideally, the values of companies should work together with the right structures of governance. However, my point is that to concentrate exclusively on codes, rules and regulations can easily miss the point. After all, the old Soviet Union had, on paper, a most impressive constitution of checks and balances. The Germans, as always, have a word for what I want to talk about—the issue of values. They speak of the Geist—the spirit—which is necessary to bring to life the bare bones of formal institutional blueprints. The noble Lord, Lord Haskel, has already referred to that.

Companies are human institutions like any other. They are not value-free, except perhaps in the minds of academic economists. Rotten leadership produces rotten companies, as Enron and others have recently reminded us. Conversely, integrity produces good companies.

First, I shall say a brief word on Higgs. Much of the report is timely and good common sense, and I welcome that, but I find two of his conclusions dubious. Here, I declare an interest as a former member of the board of Rio Tinto, a FTSE listed company, with a continuing role as adviser to the

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chairman. Although I believe that it is right to identify a senior independent director and right that institutional investors should, at times of crisis, have access to him—in practice, they do anyway—I consider it entirely wrong that he should beat a path around the City confusing everyone as to the company's normal investor relations.

Incidentally, I believe that one useful and appropriate function for SID—perhaps we should call him El Cid to distinguish him from the British Gas shareholders—might be to make him the ultimate destination for internal whistle-blowers who cannot find satisfaction for their concerns through the specified channels. That would be a proper check and balance for SID.

Then we come to the issue of the chairmanship of the nominations committee. Here, I agree with the noble Baroness, Lady O'Cathain. I can see no case for taking this pivotal role out of the hands of the chairman, one of whose key responsibilities is to build and balance a team. Indeed, the more the chairman is placed, a la Higgs, in a quasi independent mode—non-executive only, not having been a former CEO of the company—the less easy it is to see why that responsibility should be taken away from him.

I now want to revert to the question of sound values, which should be reflected in the way the company is managed and how it does its business. I believe it is idle to pretend that the leaderships of large companies do not face a significant deficit in trust and public confidence. It is often said that we have moved from a "tell me" world to a "show me" world. A great deal of urgent thought is going on in a number of leading companies as to how, by a clear demonstration of the right policies in action, confidence can be earned and trust restored.

That requires leadership from the top of the company—the boardroom. But, if it is to be more than public relations, it also requires ownership on the part of all the employees, and it is noticeable that one of the key drivers to improvement in corporate standards is the wish of able young people to join companies which they feel they can respect. A recent survey by Environics International, the global research company whose advisory board I chair, showed that 83 per cent of employees of large companies believed that the more socially responsible their company was, the more motivated and loyal they were.

Therefore, the key desirable characteristic of a healthy corporate culture is responsibility. By that, I mean that, without diluting in any way the accountability to the shareholder for the creation of long-term value—and how difficult our financial system makes it to keep eyes fixed on the longer term—the company should seek to exercise care, consideration and high standards in all its key relationships with consumers, customers and suppliers, host communities and, above all, its employees. Power in a democratic society—large companies do have power—should always be exercised accountably and responsibly.

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That is why the publication on corporate social responsibility, Making Good Business Sense, which I co-authored with Sir Philip Watts, now chairman of Shell, on behalf of the World Business Council for Sustainable Development, recommended that every company should set out clearly what it stands for and the standards of conduct by which it should be judged and then get on with living up to the commitment. A growing number of companies have joined Shell and Rio Tinto in doing exactly that.

In my view, alongside responsibility, the other two cardinal virtues are transparency and a sense of proportion. The merit of greater openness, subject to reasonable commercial confidentiality, should be obvious. Transparency on the part of a company removes suspicions; it allows boardrooms to learn from their mistakes; and it promotes greater confidence all round.

As for a sense of proportion, perhaps I may mention one issue to which the noble Lord, Lord Brennan, referred in his introductory speech. It is an issue where reason seems to have fled from some boardrooms—that of grossly excessive remuneration. It is what Warren Buffett, the sage of Omaha, two days ago called "obscene pay". This contagion has spread from the United States, often carried on the wings of so-called "remuneration consultants" whose recommendations, curiously, always seem to ratchet package levels upwards and never downwards.

Of course, the world of senior executives is internationally competitive and of course exceptional performance should be commensurately rewarded. But what, in some cases, seems merely to be excessive greed, in bad times as well as good, must be curbed if the social acceptance of the useful role of business in society is not to be fatally damaged.

Others have spoken eloquently about setting the right framework. That is important. But if we are to have more than a culture of box-ticking—bare compliance, as it were—and if we are to have a culture of compliance-plus, it is also important to build on the wish of companies themselves to do better in restoring trust. Therefore, my plea for responsibility, transparency and proportionality is in that spirit.

5.6 p.m.

Lord Fyfe of Fairfield: My Lords, I, too, congratulate my noble friend Lord Brennan on initiating this debate. Inevitably my contribution is conditioned by my own personal experience. I want to concentrate on the Higgs report.

Until I retired from full-time business around two-and-a-half years ago, I was chairman of the Co-operative Group, the CWS, chief executive of the Midlands Co-operative Society, a director and vice-chairman of the Co-operative Bank, a director of the Co-operative Insurance Society, and the chairman of a footwear multiple. Therefore, I believe that under those circumstances I have breached several provisions of the Higgs report.

Frankly, at the time I undertook those responsibilities, I did not feel that there was a risk of any conflict of interest or, indeed, of my

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responsibilities being excessive. But, with the benefit of hindsight—we all have that—I believe that perhaps there were occasions when I took on too many responsibilities and perhaps, at times, there were areas of conflict. Therefore, I believe that Higgs has much to contribute in that sphere. Now I have learnt my lesson. Since I retired, I have confined myself to the chairmanship of the Unity Trust Bank.

The debate on chairmen and chief executives has been fought and won and very few large companies now embody both roles in one individual. From my own personal knowledge, a chairman requires a chief executive and a chief executive requires a chairman. But I want to focus on several items in the Higgs report which some may consider relatively trivial in the scheme of things.

First, I turn to the subject of the ubiquitous SID—the senior independent director. This paragon will attempt to resolve concerns that have not been satisfied by consultation with the chairman or the chief executive. I submit that if that process is necessary, there is something wrong with the chairman or the chief executive, perhaps both. If such a matter arises, surely it is a concern for the board as a whole and should be tackled as a whole. It may demonstrate that something is lacking in the ability of the chairman or the chief executive to solve the problem. In my opinion, SID could become a glorified complaints officer or a focus of discontent. That could lead to disruption in the boardroom and to politics in the board. From my experience of boardrooms, some directors are much more adept politicians than many of the inhabitants of the Westminster village.

I take issue with some speakers on the nomination process for non-executives. If a chairman elected by his peers as capable of chairing a company is not capable of or responsible for chairing the nominations committee, I would submit that a problem exists with that chairman who in those circumstances, as has been said, has a pivotal role. Who should serve that function? Does the ubiquitous—I should not have used that word because it is too complicated—SID come into the scheme of events once again to perform that function and so exaggerate his own importance?

Incidentally, it is not easy to recruit non-executive directors. Capable people with the time, the sense of responsibility and the knowledge to undertake the functions do not grow on trees. Thank heaven that the days have gone when simply by being a Peer or a knight one could be granted a relatively easy passage to a boardroom.

Tenure of office concerns me. While two three-year terms may be appropriate for some companies, the Higgs proposals do not appear to have regard for the size and complexity of some businesses. I speak from personal experience. I was chairman of the Co-operative Group which covered a wide sphere. Overall, all directors were responsible for retailing, farming, travel, funeral, banking, insurance, manufacturing and other sectors. Could any non-executive director entering such a job attempt to master the complexities of that business in two three-year terms? My experience is that non-executive

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directors become of real value only when they have had considerable experience of a large business and have become involved in it.

On the remuneration committee, Higgs makes the passing comment that the chief executive's opinion and the chairman's opinion should be taken into account. I do not believe that that is strong enough. The chief executive should always be in attendance. He does not necessarily have to be a member of the remuneration committee but he should always be in attendance at the remuneration committee meetings when the remuneration of his executive colleagues is being discussed. Who better to measure the strengths and weaknesses of his executive colleagues than the chief executive who works with them on a daily basis? Of course, he should not be involved in deciding the remuneration of the chairman or the non-executive directors.

There are many depressing aspects of corporate greed and downright incompetence in British business. I shall not go into them; it is not part of the Higgs remit. I hope that many of the sensible comments that he makes can go some way to alleviate that. I welcome many parts of the report, but there is little point in companies heading for Carey Street—I am being old-fashioned—or heading for Canary Wharf protesting that they have ticked all the right boxes. That would be no consolation whatever to shareholders. Business has failed to regulate itself so often that governments must act, but at the same time they must create the environment in which business can prosper. There should be sensible, although not necessarily benign regulation but not over-prescription. While the report has much to commend it there are some areas in which it lacks practicality and common sense, but common sense is not very common.

5.15 p.m.

Lord Stewartby: My Lords, I join other noble Lords in thanking the noble Lord, Lord Brennan, for giving us this timely opportunity to debate a topical subject. Like others, I must declare various interests. Perhaps I may do so in an omnibus way. My current commitments are listed in the register, but at one time or another over the past 30 years I have been a non-executive director of 10 public companies. Currently I am chairman of the audit committee of two financial companies and, for my sins, senior independent director. Not surprisingly, in the past few months my workload has increased exponentially.

There is a great deal of sense in the Higgs report. Inevitably, public comment on it will have focused on those areas where there is a case for disagreement. I do not propose to run through a catalogue of points about which I am a little unhappy. I certainly shall not open up the subject of the senior independent director, because I believe that it has had more than enough attention outside this Chamber. On a personal basis I am a little anxious about what it may imply.

I want to comment on one or two points to illustrate where I believe that Higgs has become too prescriptive. Independent non-executive directors feature

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prominently in the scheme that is now being developed and I wonder whether public expectations of the capacity and effectiveness of non-executive directors are being exaggerated. They play an important role that must be undertaken properly, but some discussions on the subject seem to imply that they can sort out everything on their own, which of course they cannot because they are part of a unitary board. Nevertheless, Higgs has bravely offered a definition of "independent". Most elements that he quotes are entirely reasonable—for example, a conflict of interest in a business connection with another company or a former employee—although a couple appear to me to be arbitrary and not entirely realistic, at least in the light of my own experience.

The first is that if two members of the board of company A are also members of the board of company B, they are both deemed not to be fully independent on either board. I do not believe that that is necessarily sensible. The right kind of people will not be contaminated by having a connection with someone on another board. As the noble Lord, Lord Fyfe, has said, these days it is not easy to recruit good non-executive directors and particularly ones who are willing to serve on audit committees and remuneration committees. I believe that we should limit by an artificial criterion the factors that enable one to qualify. In my experience, one of the most useful ways of judging whether someone will be a good contributor to a board is to have some experience of how he or she already performs on a board. Therefore, knowing his or her performance in another context is a positive advantage.

Sometimes the press give the impression that directors are recruited on a golf club buddy basis. That is far from my experience. These days, most large companies use head hunters because the role of a non-executive director is very complex and responsible and it is not easy to find people capable and willing to carry out such a role. That area makes me uncomfortable.

Another part of the definition of independence relates to the time that board members have served. Six years is far too short for many businesses. That issue needs to be addressed. Anyone who sits on a board for 10 years and at that point ceases to have independence of mind should probably never have been on it in the first place. If one cannot handle that kind of experience, how on earth can one have the independence of mind needed to make the necessary contribution?

One or two long-serving directors on a board are very useful. Not only do they have historical perspective and know what arguments were previously brought for and against when business issues arise, but over time they can acquire a feel for a company and a feel for the way that the board and the management operate: they get a "nose" for things. If one cuts them off just after they have become really useful, one tends to harm the effectiveness of the board. Certainly, that has been the case in all the companies that I have served.

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Both the points which I have raised by way of illustration could be markers for careful reappraisal. If they were, rather than a description of what is expected to be normal practice, it would be valuable. I do not see why they should not be seen in that light. That brings me to the final key point about comply or explain. There is already in the corporate governance industry—because one has to call it that—a tendency towards box ticking. Corporate governance is becoming an industry in its own right. The pressures will be towards compliance rather than explanation, even when compliance may provide a less suitable answer.

I believe that a company should have a board that it needs for the proper direction and management of its business. It should be very sensitive to the Higgs requirements, but it should not be in any way ashamed to provide a robust justification of where it does not comply.

In conclusion, one of the best things about Higgs is that it recognises that detailed legislation on all these subjects would not be in the interests of the process we are all trying to promote. It is important that he and the Government have reached that view. But it will be absolutely essential, if the Higgs formula is going to work well, that companies that are well run and properly governed should not get black marks for choosing explanation rather than compliance where they think that that is the proper course.

5.23 p.m.

Lord Marsh: My Lords, I say at once how much I enjoyed the noble Lord's remarks. I was becoming increasingly depressed by what seemed to be moving towards an uninterrupted "love-in" over a document which I think is significantly flawed.

I declare my interests. I have been a director, as have all speakers in the debate, of 18 companies. I was chairman of 10 of them. They were based variously in Toronto, Montreal, New York, Paris, Hong Kong and London. So I am interested in what goes on elsewhere. I should also declare that I am not only currently the chairman of an investment trust, but that it happens to be a split-capital investment trust. It has paid off all its zero dividend preference shareholders everything they expected on 20th December last year, which was when they expected it. I get that matter out of the way before someone goes to the Library.

The noble Lord, Lord Brennan, opened the debate, as always very effectively, by listing all the terrible things that have happened. They were concentrated understandably very much on what has been happening relatively recently in the United States. I shall come on to that. I say in passing only that he listed the various professions that were usually to be

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found involved in these activities. But I could not understand why he left out the lawyers, some of whom played a prominent part in the Maxwell debacle.

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