CONSTITUTION AND FUNCTIONS OF AUDIT COMMITTEES (Hansard, 26 February 1980)

HC Deb 26 February 1980 vol 979 cc1178-217 1178

§ "(1) If at an annual general meeting of a major public company it is resolved in accordance with the provisions of section (audit committees) to appoint an audit committee, such a committee shall (unless otherwise specified in the articles of the company), be constituted by the board of the company within three months of that meeting and shall be required by the board to function in accordance with the following provisions of this section:—

(a) the audit committee shall consist of such directors of the company as the directors shall determine but shall include not less than three non-executive directors;
(b) not less than half the members of the audit committee shall be non-executive directors of the company;
(c) the non-executive directors who are members of the audit committee shall nominate one of themselves to be chairman of the audit committee;
(d) the company secretary shall carry out the responsibilities of secretary of the audit committee;
(e) each member of the audit committee shall have a vote and in the event of an equality of votes the chairman of the audit committee shall be entitled to exercise a casting vote;
(f) the audit committee may act notwithstanding any vacancy in the number of its members;
(g) the chairman of the audit committee shall convene audit committee meetings not less frequently than twice between each annual general meeting of the company and shall preside at such meetings;
(h) the auditors of the company shall be entitled to receive notice of and to attend every meeting of the audit committee and to be heard thereat and the audit committee may require attendance by the auditors and every member of the audit committee and the auditors may require meetings of the audit committee to be convened, but the auditors shall not be members of the audit committee.
(i) the audit committee shall—
1. (i) undertake reviews of all audited or unaudited financial statements prepared by the directors before such statements are issued to members of the company or in any other manner published (and any such statement shall indicate whether or not it has been approved by the audit committee and any qualifications or reservations made by the audit committee) and of such data and estimates prepared by the company as in the opinion of the audit committee are necessary to allow a reasonable assessment to be made of the future profitability of the company and its ability to meet its debts as they fall due.
2. (ii) consider any matter which the auditors require to be brought to the attention of the board.
(j) the proceedings of audit committee meetings shall be minuted and a copy of the minutes shall be sent by the chairman of the audit committee to every director of the company within seven days of every meeting of the audit committee, but shall not be published, and the board shall consider at the first suitable opportunity the matters which have been examined by the audit committee and the opinions of the audit committee upon them;
(k) before any meeting of the company at which the appointment of auditors is to be voted on. the audit committee shall make a recommendation as to the choice of auditors and this recommendation shall be circulated to the members with the notice of the meeting;
(l) before any meeting of the Board at which the remuneration of the auditors is to be considered the audit committee shall make 1180 a recommendation as to the amount of such remuneration.

§ (2) The audit committee of a major public company shall continue in being and to function in accordance with the provisions of this section notwithstanding any change in the classfication of the company as provided in section 1 of this Act unless at a meeting of the company convened on special notice its appointment is revoked by extraordinary resolution.

§ (3) In all companies in which an audit committee has been appointed in pursuance of the provisions of this section:—

(a) the audit directors shall make a statement in each accounting reference period (to be known as the audit directors' statement) in which they shall say whether in their opinion the reports of the audit directors on the board were duly considered by the board;
(b) a copy of the audit directors' statement shall be attached to the balance sheet and read before the company in general meeting by the chairman of the audit committee;
(c) each audit director shall sign the audit directors' statement or resign from the audit committee;
(d) an audit director who has resigned from the audit committee for any reason shall give to the chairman of the committee and to the chairman of the company a statement in writing as to the reasons for his resignation and shall notify his resignation to the Registrar of Companies and such notification shall be accompanied by a letter confirming that there are no particular circumstances connected with his resignation which he considers should be brought to the notice of members of the company or the Registrar of Companies or, if there are any such circumstances, he shall require the company to have printed and circulated at the expense of the company to the members of the company a personal statement not exceeding one thousand words in length and a copy of any such personal statement shall be delivered by the company to the Registrar of Companies at the same time as it is circulated to the members of the company;
(e) an audit director who has resigned from the audit committee shall not thereby become ineligible for re-appointment as an audit director of the company on any future occasion and shall continue to hold office as a director of the company subject to the provisions of the articles of association of the company;
(f) an audit director shall be paid such additional fee, if any, as the members at each annual general meeting of the company shall determine in addition to the fees paid to him as a director of the company, notwithstanding the provisions of the articles of association of the company relating to the remuneration of directors;
(g) the directors' report shall state in respect of the accounting reference period to which the report relates—

(i) which directors of the company served as chairman or as members of the audit committee;
(ii) the name of any audit director who ceased to be a member of the audit committee; and
(iii) in the case of any director other than a non-executive director who served on the audit committee the nature of his other primary responsibilities to the company.

§ (4) In this section of this Act:— accounting reference period" has the meaning given in section 2 of the Companies Act 1976; audit director" means a director appointed to serve as a member of the audit committee of a major public company; auditors' report" has the meaning defined in section 14 of the Companies Act 1967; the Companies Acts" has the meaning defined in section 40 of the Companies Act 1976; directors' report" has the meaning defined in section 15 of the Companies Act 1967; non-executive director" means a director who is not an employee of and does not hold any other office or place of profit under the company or any subsidiary or associated company of the company in conjunction with his office of director or audit director of the company '.

§ Mr. Hooley
I venture with a good deal of diffidence into the thicket of company law, but I am encouraged that my new clause is accompanied by a new clause and an amendment in the name of the hon. Member for Kensington (Sir B. Rhys Williams) which touch on the same principle. He has a great deal more knowledge of these matters than I could pretend to have.
It is my belief that in Britain we should have a powerful statutory independent body to overview company law and the activities of companies, not dissimilar to the Securities and Exchange Commission in the United States. So long as we have a mixed economy, and private companies are as powerful and independent as they are at present, such a body should be created, and it should have extensive powers. The answer of the City to that argument has always been self-regulation and self-discipline. Let us look after those matters ourselves, and all will be well.
All is manifestly not well. By proposing the new clause, I have in a sense accepted the principle of the City's idea. We should build a mechanism into the 1182 behaviour of companies and company law which will make that self-discipline and self-regulation work. At present it does not.
I hope that the House will excuse me if I go into the background to the new clause, which is necessary to establish the case that I am putting forward. Over the past 10 years, and I suspect long before, self-regulation and self-discipline have not worked within the framework of company law. That company law needs some adaptation of new mechanism, which I have tried to provide, although I do not doubt that the Minister will attempt to pull it to pieces on technical grounds. The principle is nevertheless important. I shall listen with great interest to what the hon. Member for Kensington has to say. Although I disagree with certain details in his new clauses, they are closely connected with mine.
I wish to refer to an early-day motion that appeared on the Order Paper on 11 November 1975. It noted with growing concern the official inquiries being conducted by the Department of Trade into the affairs of private companies. It noted the chain of City failures, embracing some 30 secondary banks, property and insurance companies, including London and County Securities, Lonrho, London Capital Group, Nation Life, Vehicle and General, Fire Auto and Marine, Jesse] Securities and others. It noted the industrial failure of British Leyland, then private, Court Line, Ferranti, Alfred Herbert and others. It emphasised the damage caused to British manufacturing industry by Slater Walker. It called upon the Government to issue a statement on Haw Par and Spydar. It is almost a roll of honour of the City of London. That was in 1975.
In 1976, we had the famous or notorious report on Lonrho, which attracted a great deal of public interest and led to debates in the House. It caused the right hon. Member for Sidcup (Mr. Heath) to discover, rather late in life, the unacceptable face of capitalism.
In the Financial Times on 8 July 1976 there were reports on the behavior of the key figures in this dispute, which is probably the most famous punch-up on a board of directors, if not this century, at least since the war. One comment was: You are dealing with a man who had completely converted what was a sleepy, dozy 1183 company into something dynamic and who was a sort of tyrant and part madman to boot, but a brilliant one". It may be pleasant for companies to have tyrants and part madmen on their boards, especially if they turn out to be brilliant, but with such people in charge of company affairs, perhaps the miserable, non-tyrannical shareholders ought to have some protection against tyranny or madness, in case it goes beyond the bounds of reasonable behaviour.
The report goes on to quote what Mr. Rowland saw as the function of directors: In a letter to Angus Ogilvy in 1968: 'Lonrho is in my view nothing else but Alan (Ball), yourself and myself, combined in turn to give the company character and soul and constant and continuous drive and motion.' That was Mr. Rowland's version of how a company director should behave and use his power—the company consists only of himself and two other persons who happen to be directors. That was it.
Mr. Rowland made an even more startling and revealing comment: He had heard how Harley Drayton had managed his companies: 'Harley would say" Well, we are going to sell this, we are going to buy this, and incidentally he has got this, and I have done that," and this was the pattern and the right sort of behaviour, and the rest was a sort of Christmas-tree decorations.' What a delightful definition of the way to run a company! Certain directors do this or that in the interest of shareholders and employees—presumably all the business of audit, financial control and responsibility, legal regulation and company law—and the rest was "Christmas-tree decorations". That is the considered opinion of a man whom, with no disrespect, I would describe as probably the most outstanding tycoon of the past 20 years. It does not say much for the rights and powers of shareholders.
5.15 pm
A couple of days later, on 10 July 1976, The Economist commented: Easy money and easy morals upset Mr. Heath, and most people enjoyed a good dirty fight in the City. I am not sure what the word "dirty" means. I do not know whether it is supposed to include fraudulence, manipulation, swindling and cheating. I would not care to pronounce on the morals of 1184 the City, but it appears that a good dirty fight is acceptable.
The article went on—and this is perhaps more pertinent to the argument— Good business practice, only some of which is properly and clearly codified in law, sets bounds to the freedom of men who run companies. That is fair enough. If their companies have to survive them, they have to carry their board on major decisions; the board has to tell shareholders what it is doing with their companies. Mr. Rowland clearly broke those bounds". Some directors, including Mr. Rowland, clearly believe that it is not necessary to tell shareholders what is going on. Provided directors are dynamic and successful, they can do this and do that, and the rest is "Christmas-tree decorations". to use Mr. Rowland's agreeable phrase. The Economist believes that there should be bounds to the freedom of directors to do what they like. My new clause would provide a mechanism to make sure, within the bounds of human certainty, that there was a check on the arbitrary, tyrannical and perhaps sometimes mad behaviour of directors.
The article continues: there is the undesirability of directors making personal financial arrangements with a chief executive whose activities they were there not just to support but to monitor. That is part of the problem. In that case, the directors were manifestly not monitoring such activities or at least, when they attempted to do so, there was an almighty row in the board room, which ended up in the High Court and led to investigations by the Board of Trade.
The Economist comments further about those who practise such behaviour: Some have ended in the honours list, some in disgrace, some both. On one occasion someone ended up in both. There is the more recent case of Peachey Properties. I shall not go into the whole of that disagreeable business. However, it led once again to a formal investigation by the Board of Trade.
The inspectors found that the principal director had used the company as a private bank. He had spent company money as if it had been his own. He persisted in acting recklessly until he left the company. He apparently regarded it as quite proper to buy valuable 1185 jewellery without telling anyone. He had all sorts of dealings with other stockbrokers and with merchant banks. He failed to produce invoices for extremely valuable pieces of jewellery. He bought a silver model of Concorde costing £22,500 for display at the group's offices. That type of activity can be carried on by a director of an important company under present company law. However, in certain respects he clearly broke that law.
No effective check can be made by shareholders on such activity. That raises some disagreeable queries about the nature of the accountancy profession. I am particularly concerned about the work of professional auditors. They would appear to be rather casual, if certain revelations are correct.
Amendment No. 383 stands in the name of the hon. Member for Kensington. This clause and that amendment share the principle that a completely independent mechanism is needed. Mishaps, unpleasantness and malfunctionings have a long history. One need look only at the roll of honour of the past seven years for the City of London. Such mishaps have usually arisen as a result of improper behaviour by directors. By law, they are supposed to run the company in the interests of shareholders. Indeed, in general terms they should run the company in the interests of shareholders and of employees. Presumably they also have some responsibility to the community.
I part company with the hon. Member for Kensington, because his amendment states that: the audit committee shall consist of such directors of the company as the directors shall determine but shall include not less than three non-executive directors; That falls foul of the problem. Lonrho, Peachey Properties, Vehicle and General, London and County Securities and other companies have shown that this problem concerns the misbehaviour or incompetence of company directors. There is an apparent failure by auditors and shareholders to exercise an effective check. The clause is designed to provide a layman's idea of a mechanism by which the shareholders would have an independent instrument at their command to investigate and call to account the behaviour of the board or of its individual directors.
1186 I am no particular friend of shareholders as a tribe. I do not have any shares. The only shares that I hold are held indirectly through a couple of modest insurance policies. However, important share holdines are held by pension funds that act on behalf of thousands—if not millions—of ordinary people. Such funds act as trustees and they should have some effective means of safeguarding the interests of those for whom they act. Such institutions can exercise a fairly powerful influence if they so wish. However, they sometimes seem to be astonishingly reluctant to pursue obvious malpractices. They wait until they are totally out of hand.
There is now a new category of shareholders. Some of my friends, who are shop stewards, hold one or two shares in Johnson Firth Brown, a private steel firm in Sheffield. That gives them the right to appear at the annual general meeting and to speak on issues that they feel to be important to themselves and to their fellow workers. The law does not recognise the status that they have. However, the Bill will alter that to some extent.
There are therefore two categories of shareholders: pension funds and those individual workers who avail themselves of this technique. They should be able to check whether a director's behaviour is out of line. A director's behaviour may be irresponsible, or perhaps illegal. This clause is set out in layman's language. I am sure that it does not appeal to the gobbledegook of parliamentary draftsmen. However, I hope that it is understandable.
I suggest that the annual general meeting should appoint a special audit committee. I have suggested a company with a paid-up capital of £100,000. However, at present rates of inflation the paid-up capital may need to be £100,000 million. I shall take a chance. The sum of £100,000 is a good figure to argue about. If the clause is accepted and is debated in another place, the figure may be amended. It may become higher. I shall not quibble about the figure of £100,000. It acts as a marker.
The key point of the clause is that the directors of a company will be expressly 1187 excluded from membership of the special audit committee. No relative of a director shall have anything to do with it. The clause also states: nor any person holding shares in the Company. Perhaps that is a bit draconian. The object of the exercise is to ensure that the Committee will be financially independent of the progress of the company. It will have no financial incentive to condone or overlook any malpractice that might be justified on the ground that it is good for the company and, therefore, does not matter. Basically, that was the Lonhro defence.
5.30 pm
The other points are fairly straightforward. The committee will consist of three or four people, and not more than six. Obviously the shareholders must vote some money to the committee to enable it to do its work. (d) is the key paragraph in many ways in that it gives the committee an unqualified right at any reasonable hour—and by that I do not mean midnight, as we are not dealing with VAT inspectors—to examine any books, records, documents, vouchers, ledgers, contracts or any papers … relating to the business of the Company or the remuneration of any Director or employee of the Company". Then the committee will have the right to report to the shareholders and draw the attention of the Department of Trade to anything which it may think has gone wrong.
Hon. Members may ask me what is wrong with the auditors. I do not know why the auditors cannot do this kind of thing, but apparently they do not. Of course, the auditors have the drawback of being appointed by the board of directors and, therefore, there is a danger of undue or improper influence being brought to bear on them. In any case, auditors have basically the rather pedestrian function of ploughing solemnly through great masses of ledgers and computer print-outs, checking on all the tedious detail of the company's goings-on. What is needed is something with a rather sharper cutting edge—a small body or inspectorate which can come in at any time, go into the directors' office and ask for certain documents. It should be a body that can ask what amounts have been spent on certain items and demand to see the bank statement for any par- 1188 ticular date. It must have an unqualified right to inspect at any time.
Also, the key factor would be that this committee would be responsible to the shareholders, and the board of directors would have no control over it whatever. If the directors sought to interfere, the committee itself could immediately refer the matter to the Department of Trade.

§ Mr. Archer
Does my hon. Friend agree that his committee might be able to do what auditors are not normally called upon to do—look at the company not only from the point of view of honesty but also from that of effectiveness in management?

§ Mr. Hooley
I would in no way dissent from that very sensible suggestion. I am a little surprised that Conservative Members, who are always talking about efficiency audits of public corporations, seem not to be so enthusiastic about efficiency audits of private companies. That is another point.
I emphasise that I am entirely a layman in this matter. I am not an expert in any sense on company law. However, I am profoundly uneasy about a great many of the scandals which have occurred and which have involved a lot of money for shareholders. Also, serious failures can involve not only loss of money but also the loss of jobs, which means a complete loss of livelihood for thousands of innocent workers who had no means of knowing that the affairs of the company were not being properly conducted. For this reason, I put forward this new clause and I look forward to hearing the Government's response.

§ Sir Brandon Rhys Williams
I am delighted to find that the number of hon. Members interested in audit committees has doubled since I began my campaign. At this rate we shall soon have the whole House on our side. Perhaps my optimism is running away with me, but one needs to be pretty optimistic to continue the struggle year in and year out for company law reform, which is by no means one of the major enthusiasms of hon. Members.
A number of points have been made admirably by the hon. Member for Sheffield, Heeley (Mr. Hooley) in moving this new clause. I would not wish to comment on his remarks, because grouped with his proposed new clause are a 1189 number of detailed proposals of mine. I shall not bore the House by going over familiar ground in detail which is altogether too minute, but there are some points that should be made about the proposal to move in the direction of establishing audit committees and about the whole role of the non-executive directors and the ways in which they may be helped to operate more effectively.
The audit committee, as developed in Canada and North America, is a subcommittee of the board which is of particular concern to non-executive directors. It is welcomed by the non-executive directors because it provides them with a real function and necessary access to data. It also gives them the standing on the board that they might not otherwise have among their executive collegues.
We must consider whether we should make the practice of appointing audit committees mandatory and, if so, in what classes of companies. I am increasingly inclinde to the view that an audit committee is appropriate only in very large companies. The etiquette of operating an audit committee is not by any means established, either among boards of directors or among auditors, but there is a general feeling that a need exists for closer co-operation between the auditors and the directors, particularly in large and complex organisations.
We have the example of the New York Stock Exchange, which has made having an audit committee a qualification for having a company's shares quoted in New York. Many companies in this country are becoming familiar with the idea and would like to explore its possibilities.

§ Mr. Robert Maclennan (Caithness and Sutherland)
The hon. Member will recall that during the passage through the House of the last Companies Bill I had some responsibility for the matter. Is the hon. Member in a position to inform us whether, since that time, there has been any shift of opinion in the securities industry towards his proposals, which were debated at some length then? At that time I recall that there was a certain reluctance—I put it no higher than that—to see his proposals made mandatory. However, there was an acknowledged interest in the general principle.

1190

§ Sir B. Rhys Williams
I acknowledge the force of what the hon. Member said. With the study of the practice of the audit committee there have grown up some doubts as well as some enthusiasm. I hope to visit New York again this year in order to make inquiries among those who take a particular interest in these aspects of company law and to learn what I can from the blunders and mistakes or wrong directions in the operation of audit committees over the years in these large American companies.
I stress the fact that in the United States audit committees operate only in very large companies. The New York Stock Exchange is really concerned only with very large enterprises. It is not like the London Stock Exchange, where the share of quite small companies may be traded along with the very largest. Therefore, to say that one must have an audit committee to be quoted on the New York Stock Exchange does not imply that the generality of American companies are necessarily appointing audit committees.
I feel that there is a general trend in favour of strengthening the relationship between auditors and non-executive directors. If audit committees are to exist and to grow in importance, the House must ask what their legal standing would he. If this is a phenomenon that is beginning to develop in British company practice, how do we deal with it from the company law point of view, if at all? What provisions should be included in company law to help companies in this respect of their work?
In my new clause 29 it is suggested that in very large companies the practice should be considered of appointing an audit committee at the annual general meeting so that the subject is kept alive and a shareholder who chose to raise the subject could thus never be deemed to be out of order at an annual general meeting. I hope that that suggestion will be thought a useful device whereby the thoughts of management will be directed towards the advantages or disadvantages of appointing an audit committee and that management should have to be ready with its thoughts on the subject without being obliged to hurry faster than its shareholders would like.
Suppose that they decided to set up an audit committee. What next? All to 1191 few companies have established audit committees in this country and few people know exactly how to go about setting one up. What is likely to prove successful in one company may be superfluous or a blunder in another. In order to set down some suggestions-1 always try to be absolutely specific—in my new schedule listed as amendment No.:383 I have had printed what I hope is a useful code of practice. It is an attempt to produce the draft equivalent of table A in so far as the conduct of an audit committee may be organised.
In order to guide people towards the successful operation of an audit committee we should also make sure that companies that are bent on fraud do not set up such committees as a front organisation in order to deceive shareholders into believing that their interests are being properly looked after when they are not. I believe that it would be good to have a detailed code of practice set down somewhere in company law but to leave it to the shareholders to decide whether their companies should adhere precisely to that code or be free to vary the method of operation to suit their own circumstances and experience. The device that I recommend in my new clause is that shareholders must be informed if the company's practice, when it sets up an audit committee, differs from the norm as laid down in the Act. I hope that the Department will think that this is a useful way forward.
I have not asked for separate votes on my new clauses or my schedule because I think that they have to be regarded as tentative and a possible basis for consultations. I hope, nevertheless—though I am quite willing to express my diffidence about them—that they will serve a useful purpose and will not die with tonight's debate.
I turn now to the issue of non-executive directors. Once again I have only provided that it should be mandatory on companies to consider the appointment of non-executive directors if they do not have as many as three already. I believe that this should be a regular item on the agenda of the annual general meeting. We have heard increasingly about the importance of non-executive directors, and I believe that many people are interested in the status and the possible role of such directors. I do not claim the credit for my campaign, but I believe that an in- 1192 creasing number of people are concerned with the health of private companies and have discerned that non-executive directors could be more useful than they currently are.
There is also a sense of uneasiness where companies are known to have no outside directors.
We should ask what is the status of the non-executive director, who is often called the outside director. The implication is that these are people who do not quite belong to the company. The words "outside director" suggest in some way that outside or non-executive directors do not fit in quite as well as the other components of management.
The weakness of the non-executive director is a relatively new feature in British company law. Before the war, and certainly in the nineteenth century, the vast majority of boards consisted of non-executive directors only. It is only in relatively recent times that the managerial revolution has changed the character of boards so that now the majority of directors of British public companies are the heads of department and only a minority survive from the pre-war boards which used to be entirely made up of outsiders who were there to look after the interests of the shareholders and to keep an eye on management.
In British companies non-executive directors are now almost always in the minority, and though only rarely does one find a board of directors actually proceeding to a vote—except in times of serious trouble or contention—the minority element is at a disadvantage.
My second point about non-executive directors is that they do not always have access to the facts, because they are unable to insist on having all the facts. That inevitably weakens their argument when they are dealing with heads of department who may have spent 20 or 30 years in becoming familiar with the company and its ways in terms of their particular functions. Such heads of department can silence criticism by demonstrating an absolute mastery of the company's practice and interests. That mastery nevertheless can fail to grasp some essential point of value that an outside director is trying to make. We should sympathise with the ineffective non-executive directors, because not only are they in a minority but they cannot 1193 be sure whether they are right when they try to take a stand.
5.45 pm
My third point about such directors is this. When they try to take a stand, what are they able to achieve? Company law does not give such a director any responsibility or function that would enable him to throw his weight about on the board. If he does not like what is going on, he can acquiesce notwithstanding his anxieties—many non-executive directors do that—or, if he is very unhappy, he can resign quietly, in which case his going will not be noticed. It will be assumed that he has reached the normal age of retirement, that he is withdrawing because he has new commitments or because there is a natural reason why he chooses not to present himself for re-election. Such a resignation is unlikely to attract the attention of the shareholders or the press, or, indeed, of anyone else.
However, the non-executive director who chooses to resign may force a major row and make a statement as to his reasons for resignation. He can try to alert the shareholders or in many other ways try to attract attention to his point of view and thus force a confrontation with his colleagues. Almost always the non-executive director who chooses that cause is ill advised. His action will damage the company without his having made his point, and he will then probably be regarded as a dangerous person who flies to conclusions without knowing what he is saying and will damage any company that he is supposed to serve.
That is the difficulty of the non-executive director if he tries to be an effective director. I believe that we have to solve this problem if we intend to cure a major deficiency in British company law. I believe that this is a matter for the House of Commons. I do not think that we can leave it to outside influences to deal with this problem quickly enough.
Over the years I have tried to suggest various ways in which outside directors could be given the necessary status to enable them, while in a minority, to make a useful contribution. I believe that such directors should be given more information as a statutory right. That 1194 was provided for in one of the clauses that I proposed in Committee.
I think that it would be helpful if outside directors had to make some kind of written return or were given some obligation to appear at the annual general meeting and to make a statement—even if only an oral statement—that would come from them in their capacity as supervisory directors. However, I realise that as soon as we give non-executive directors a role that is different from that of other directors we have started to make them into a different type of director from their fellows round the boardroom table.
I do not feel that this is a particularly heretical move, because they are different from the heads of department in so far as they are non-executive directors. I think that shareholders are entitled to know, from the list of directors with which they are provided, who their outside directors are. Normally those directors are not clearly identified.
At the annual general meeting, the outside directors should do something to justify their existence. I should like them to be required to make some sort of statement to the shareholders, which would correspond to the statement made by the auditors. The auditors are obliged to state on the balance sheet that they consider that the accounts present a true and fair view. It would be quite appropriate for the outside directors to make a statement such as that they have confidence in the management or that they consider that the assets are being properly employed.
The advantage of that sort of statement is not that people would rush to read what they have said year after year, because it would tend to be taken as read, but that in the course of the preparation of the balance sheet the non-executive directors would be able to tell their colleagues, if they were unhappy with the way that things were being run, that they would have to qualify their report to the shareholders unless more attention was given to their point of view. The threat of the qualification of the non-executive directors' statement would provide a necessary element of discipline without resulting in any leaks, boardroom splits outside the company, or friction and disunity within the board.
1195 At the moment, non-executive directors are tolerated by the heads of department provided that they do not have views of their own and do not rock the boat or exercise their supervisory role in an effective way. Once they begin to exercise a supervisory role, I recognise that we have set out on the road towards the creation of a two-tier board. Of course, that is an immensely controversial question, partly because it is completely misunderstood. As soon as a two-tier board is mentioned, it gives rise to the suggestion that the idea is being promoted of worker directors. People in this country are nervous about such a development. I believe that industrial democracy is inevitable and right and that we should seek to encourage it in every way that we can. But it would not encourage or help the development of worker democracy to force the pace. The inevitability of gradualness is a necessary slogan when dealing with company law reform. However, at least we should know where we are going. I believe that we should strengthen the supervisory element so that in due course—it might be in 30 or 50 years' time—British company law will look much more like Continental law and there will be an identifiable supervisory team supervising the policy and not only the auditing of a company. That would be desirable.

§ Mr. John Patten (Oxford)
Will my hon. Friend extend his argument about the proper role and possible statutory provision for non-executive directors to making some sort of statutory provision for the formation of audit committees within companies?

§ Sir B. Rhys Williams
My hon. Friend may not have heard my earlier remarks on this point. I commend him to Hansard in order to pick up some of my views on that subject.
It is necessary for us to identify our aim. That aim should be that the supervisory board and the executive board should have a somewhat separate existence. In this country we suffer from a lack of knowledge about the way that things are done in Germany. In that country two-tier boards have been normal practice for 100 years. They were developed there long before anybody thought of worker participation at board level. It may be that the success of the 1196 Germans in introducing worker directors was due to their having the two-tier board as an established and well-understood practice long before they thought of bringing in worker directors for the supervision of the management.
I shall not digress too far on what, inevitably, will be the subject of future Companies Bills. I hope that when my hon. Friend the Minister winds up the debate he will indicate that he is giving serious consideration to the sort of reform that I have advocated before and which I am advocating in these new clauses. How can the necessary changes in the British private sector company be stimulated from outside? Should we leave that to the press, the Stock Exchange, the institutional investors, or even the pressure of increasingly organised middle management? All those forces can be healthy within the private sector, but Parliament must not abdicate its responsibility.
In this country we have a glorious tradition of company law. In the nineteenth century it was far ahead of that of any other country, and it set a tremendous example to trading and manufacturing communities all over the world. Parliament must not abdicate and leave our company law as it is. We have to admit that it is now obsolete and inadequate.

§ Mr. Clinton Davis
I begin by congratulating my hon. Friend the Member for Sheffield, Heeley (Mr. Hooley) on an excellent speech about which he was far too modest. The draftsmanship of the clause has been extremely competently done and I hope that he will take some comfort from that view. The importance of his tabling the new clause was to direct attention to the important issue of the appointment of non-executive directors and the role of audit committees, although I dare say that if he had not tabled the new clause we would still have debated the issue. We might have relied on the hon. Member for Kensington (Sir B. Rhys Williams) to ensure that.
My hon. Friend approached the matter from an important angle—the protection that might be afforded in the reputation of companies to shareholders and those interested in fair dealing. For that purpose he drew attention to certain City scandals and company investigations, some of which I had a hand in setting up. An interesting feature of the sort of companies that are subjected to that sort of 1197 behaviour is that they are rarely, if ever, companies that are involved in making things—in manufacturing. They are companies which are involved in property dealing, speculation or financial manipulation. Such companies are sometimes susceptible to the sort of behaviour that gives rise to the need for investigations to be carried out.
My hon. Friend was absolutely right to point out that recent experience over the course of the last two weeks has shown that everything is not manifestly well in connection with the system based on self-regulation. He said that his purpose was to make self-discipline work in practice.
I also pay tribute to the hon. Member for Kensington, who, over a long period of time, has fought to some extent a one-man campaign to cause Governments to embark upon the process of reform about which, once again, he has spoken so eloquently today. He said that he was gratified that his support in the House seems to have been doubled by the recruitment of my hon. Friend the Member for Heeley. However, that is an injustice to me—I have always been a friend of his on this issue. Therefore, we have trebled our numbers.
The concept of including the question of the appointment of the audit committee on the agenda of every annual general meeting is one that I commend to the Government on the basis that it was commended by the hon. Member for Kensington. Indeed, he founded his other notion on a similar basis which provides for flexibility of a company. It does not make it a statutory requirement that a company must have non-executive directors and an audit committee but it does provide for a company to ensure that it will deal with the matter at the appropriate time.
What the hon. Member for Kensington did was to urge the Government to embark upon a process of consultation on that basis. I support him in that. I hope that we get a response, from whichever Minister replies, similar to that which we announced during the process of our bill in 1978, which was that we would enter into consultation. Indeed, that took place and I will refer to it in a moment.
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I hope that the consultation is more specific this time and does not deal so much with whether it should be a statutory requirement as with whether the concept embraced by the speech of the hon. Gentleman might form a more satisfactory way of proceeding in the course of the next few years.
I agree that non-executive directors need to be provided with some greater weaponry and armour to fulfil their duties of independent scrutiny more effectively than the law provides at present. I will not say anything about the two-tier board at this stage because that will be the subject of separate debate later in these proceedings.
At this point I want to refer to our approach in 1978 following the consultation that we set up, about which I received a letter from the Minister today. That indicates that he is falling behind with all the work that he has to do, because he promised that reply in Committee. I do not blame him too much for the delay. It was helpful to have my attention drawn to the comments and research published in the Bank of England Quarterly Bulletin of December 1979, to which I will also refer in a moment.
In his letter the Minister pointed out to me—this is evident from the replies that he received—that there was a great deal of support for the concept of non-executive directors among the many who were canvassed. It was felt that it would be conducive to the best interests of a company to have non-executive directors, but there was considerable opposition to the idea of making them a mandatory requirement.
I dare say that if company directors in the United States and Canada had been similarly canvassed the answers would have been predictable. I am sure that they, too, would not want a mandatory system of audit committees imposed upon them. But the audit committees came about as a result of pressure from the Securities Exchange Commission; and the New York Stock Exchange, as has been said, decided to make them a listing requirement.
I believe that very few people in the United States today would want to put the clock back. Throughout North 1199 America the system is proving to be a distinct success. It has not been an unqualified success, because it has its blemishes and there are anomalies attached to it. But overall it has been a distinct success.
If we could have more rapid knowledge about the practice that goes on where companies have embarked upon this idea, I believe that people would more readily entertain it. However, there it is. I do not think that the Minister favours the idea of a mandatory requirement, and no doubt he will tell us that today. Many of those who were canvassed pay lip service to the benefits of these two concepts but do not want to see too much progress.
When I made the statement about consultation I remember saying that if the voluntary method failed we would have to look carefully at the need to impose a legislative requirement, and I see no cause to dissent from that proposition today.
In Committee the Minister also supported the concept. He had something very interesting to say about it. He said: I believe that this is a subject to which we should return on the Floor of the House so that the whole House should have an opportunity to say something about it". As we all know, this very full House is avid in its interest in the subject and no doubt we shall have hundreds of speeches on the topic later.
The Minister also said: The difference between my hon. Friend and myself is simply the question whether we impose these things by statute at this time."[Official Report, Standing Committee A, 6 November 1979; c. 35.] I emphasise the words "at this time". So the Minister does not seem to be ruling out the possibility of legislation if progress cannot be made swiftly enough. But still he believes in the principle of voluntarism when it comes to this concept.
The Minister has said that more and more companies now recognise that non-executive directors are important and are appointing them, and we must look at the scale of advance that has been made. I hope the Minister will—not necessarily today—seize the opportunity to publish the information about the progress that has been made so that not only I but others receive it. Is there sufficient 1200 evidence to support the conclusion that the voluntary approach will succeed over the next five years or so? What time scale do the Government think is appropriate to test this matter out properly? If progress within such a period is inadequate, should we not review, once again, the acceptance of the voluntary approach?
My hon. Friend the Member for Swansea, East (Mr. Anderson) pointed out that the Government were placing entire reliance on voluntarism in this sphere of economic activity but yet denied that when it came to the trade union sector. I think that that nonplussed the Secretary of State. He was clearly stumped for an answer at the time and almost conceded that.
What I commend to the Minister is that we should, at the very least, undertake a more coherent study of this matter. The prime purpose of having non-executive directors and audit committees, as I see it, is to encourage companies to be more responsive to change, to encourage greater efficiency and to keep them more in touch with what is happening in the world outside, and also to act as a balance to the overweening influence of members of the board. That is a subject to which we shall return later and something that was well illustrated by the recent Newman Industries case.
All this, in every respect, is designed to assist and protect shareholders and at the same time those who are engaged as members of the work force in the progress that a company should be making. For the same reasons, I believe that it can act as a barrier against fraud and abuse.
The paper submitted to me by the Minister and which was published by the Bank of England is very interesting. It certainly shows that there has been some progress since the Bullock committee conducted a survey into the application of the idea of non-executive directors and audit committees. An interesting fact was reported in the survey—namely: About one-quarter of the companies in The Times 1,000 are controlled by foreign shareholders. That is about one-quarter of our top companies. The survey states: This presents certain difficulties both in compiling and in interpreting the figures of non-executive directorships. 1201 It is much more than that. It presents all sorts of problems for the application of other aspects of company law. The survey adds: The mere presence of non-executive directors on company boards does not, of course, ensure that they will be active in their role of independent critical advisers, nor that companies will use them in this way. That is one of the difficulties to which I alluded in my remarks in Committee. There are some matters which the proponents of non-executive directors and audit committees must deal with adequately.
It would be fatally counter-productive if non-executive directors were chosen, or if their choice were influenced, by a powerful chairman or other board members who wanted cronies to help to camouflage and thus institutionalise existing inefficiency, malpractice, misfeasance and perhaps deceit and fraud.
A compliant non-executive director manipulated by an authoritarian chairman, or by others on the board wielding such influence, would contribute to the death of this important idea. The selection of non-executive directors and audit committees should be independent of the sort of influences to which I have referred.
The idea of non-executive directors must not be seen as a substitute for the concept of industrial democracy. I think that the hon. Member for Kensington recognises that. It is to be viewed, however, as a spearhead towards it. Essentially non-executive directors must be active, critical and independent if they are to be of value to the company and the concept, otherwise they will become discredited.
The Stock Exchange has suggested that it might be possible to recommend that the concept be included as a listing requirement, a suggestion which did not receive wild acclamation. It is one of the ideas coming out of the Stock Exchange which I find interesting and progressive I hope that the Stock Exchange will not abandon it.
In the Bank of England Quarterly Bulletin, to which I have referred, it is suggested that the survey which the Bullock committee carried out, and which was followed, should be undertaken at 1202 intervals to check developments. That is something that the Government might well undertake. As the hon. Member for Kensington said, it is a concept with which the Bank should be intimately concerned and connected. I hope that it will feel it appropriate to carry out a survey at intervals to check developments. That is incumbent upon it if it is not merely to pay lip service to an idea which the hon. Gentleman has caused to flourish and which I hope will be brought to fruition in the not too distant future.

6.15 pm

§ Mr. Maclennan
I intervene briefly. The hon. Member for Kensington (Sir B. Rhys Williams) made his plea for non-executive directors and audit committees, but he did less than justice to the degree of support which his ideas on this subject have enjoyed not only in the course of this debate but in the course of the debates that preceded it during the abortive passage through the House of the Labour Government's Companies Bill. He suggested that the supporters of the idea in the House can be numbered in single figures.
I recall vividly putting to the hon. Gentleman the Labour Government's view, which was strongly sympathetic to what he had in mind. However, I made it clear that there appeared to be considerable opposition to the proposal on the part of those most likely to be closely affected by it. It was for that reason that I thought it right to announce in Committee that wide consultation would be initiated by the Department of Trade. My hon. Friend the Member for Hackney, Central (Mr. Davis) has referred to that.
In my brief intervention I asked the hon. Gentleman whether he was aware of any change in opinion since the days of the Labour Government. Although he acknowledged that I had a point, he did not altogether answer the question. I hope that the Minister will help to clarify the position. There has been an exchange between the two Front Benches on this issue to which the House would like to be privy.
There has been some desire, perhaps, to interpolate into the discussion on the attractiveness or otherwise of non-executive directors and audit committees some consideration of whether this approach 1203 might lead to two-tier boards or whether the concept has some relationship to industrial democracy. If we are to tackle either of these concepts, they must be tackled directly and not by an indirect process.
If these proposals are meritorious, they are meritorious in themselves and not for what they might lead to ultimately. There is widespread support for the establishment of audit committees. That support was strongly expressed by the Governor of the Bank of England, Gordon Richardson, in a powerful speech which caused something of a flurry in the dovecotes at the time.
Some people may have wrongly taken the view that the Governor was calling for the introduction in a statute of a mandatory requirement that audit committees be established as part of our company law. I think that the Governor had no such intention. None the less, the idea is finding increasing favour.
I was interested to hear of some of the facts that my hon. Friend the Member for Hackney, Central quoted from the Bank of England Quarterly Review. In the last analysis we should not place too much weight upon the possible value of non-executive directors in all companies. That essentially is what the hon. Gentleman's proposals are designed to lead towards.
I acknowledge that, as the hon. Gentleman has couched his proposals on this occasion, they are to some extent permissive. They merely require the issue to be raised at every annual general meeting and to be considered. The question whether non-executive directors are serviceable must depend upon their quality. The mere presence of non-executive directors on a board is no guarantee that they will be any more effective than executive directors. One of the general complaints about the proposition that they should be required to sit on every board is that there is a shortage of people with suitable talent. I know that the hon. Member for Kensington does not take that view. However, it is an argument that weighs against them.
Some of the company directors with whom I have talked have considerable hostility to the idea of swelling their ranks with non-executive directors with no particular knowledge of the business 1204 that they are required to supervise through their role, and they regard the whole concept as an unnecessary appendage.
That view is held strongly by those who would be most affected by any suggestion that the requirement should be mandatory.

§ Sir Brandon Rhys Williams
I am in considerable agreement with almost everything that the hon. Gentleman said. Does he agree that it is precisely those managements that are opposed to the idea of making room for a supervisory element beside them on the board table that are possibly most in need of just that element?

§ Mr. Maclennan
I do not agree with the hon. Gentleman. I hesitate to name names. However, as I was challenged I will say that one of the directors of the company to whom I spoke was named either last year or the year before as The Observer's business man of the year. He expressed strong hostility to that idea. He has a proven track record as an exceedingly successful business man. I cannot accept the general view of the hon. Gentleman.
The willingness of the Stock Exchange to consider this matter seems to me to be a significant development. It will be of interest to hear from the Minister what is his reading of this development. No doubt he will give us the benefit of that advice. Important though the idea may be in the United States context—and it is interesting to learn from American experience—it is important to remember that just as German experience of two-tier boards is foreign to our present company law system, so the highly regulated American system is also foreign to our system. Perhaps we should move in the direction of the German and American systems. We should not tackle this problem through the side door. We should face these issues squarely. Indeed, some of the later clauses will give us a chance to do so. We should not seek from the proposals anything more than a modest change in the structure of boards and in the degree of supervision that would come about.
I am hostile to the idea of introducing any requirement for mandatory non-executive directors without very much more evidence of the effectiveness of the role that they could play, not merely in 1205 respect of some but in respect of all companies—because we are legislating for all companies.

§ Mr. Ernie Roberts (Hackney, North and Stoke Newington)
Previous speakers referred to the fact that there was growing support for audit committees. The difference comes about when we discuss the composition of audit committees. The hon. Member for Kensington (Sir B. Rhys Williams) referred to the proposed provision that (a) the audit committee shall consist of such directors of the companty as the directors shall determine but shall include not less than three non-execuive directors". They will still be judge and jury in their own cause. My hon. Friend the Member for Hackney, Central (Mr. Davis) referred to an audit committee that was independent of the board. It would be able to give a better, clearer and fairer judgment of the situation.
Non-executive directors are no alternative to alert, alive and questioning shareholders and shareholders' meetings. They have the responsibility to ensure that the directors keep on the straight and correct line. Strong chairmen of companies have a great deal of their own way. They may quite easily choose yes-men as non-executive directors.
In Standing Committee one hon. Member said that he was a non-executive director of a number of companies but had little time to go into the detailed control of them. In other words, non-executive directors may be just decorations on the board to give the impression that things are all right and that there are experts on the board who are helping the company with its business. The trouble with directors and directorships is that some persons have too many directorships. Their interests are spread far too widely. They cannot give sufficient time to the business of the companies of which they are directors.
The national press has referred to comments about executive directors. A newspaper quoted the opinion of a well-known national trade union leader of such directors as "titled idiots". A well-known member of the other place summarised the functions of non-executive directors in this way: For £500 a year he turns up once a month, says 'I agree' twice, utters a thought- 1206 ful 'I don't think so' once, and then goes off to a good lunch. It is like a permanent hot bath. It is undeniable that some outside directors are appointed purely for prestige purposes. Some are friends of the chairman to be relied on for their votes in case there is a split. Some are retired company lawyers, merchant bankers, accountants or former executives of businesses acquired in takeovers, or they might even be civil servants. The appointment of non-executive directors will not cure companies' problems or render the companies any more efficient. There is no guarantee of honesty by the remainder of the directors. This is not a solution to the problem of democratisation of companies. It will not lead to industrial democracy for employees of companies. Such directors are appointed to companies to counter the criticisms made of the autocratic nature of directorships.

§ Mr. Nicholas Baker (Dorset, North)
I am grateful for the opportunity to intervene briefly in the debate.
Audit committees are discussed frequently. I pay tribute to the work done by my hon. Friend the Member for Kensington (Sir B. Rhys Williams) on this matter. However, we should proceed carefully before accepting this concept. New clause 3, which was persuasively introduced, outlines some of the dangers. It does not start by saying what an audit committee should do. There is no limitation on the powers of the people appointed to it. It gives them the right to inspect the books without notice. That reminds me of inspections by Customs and Excise officers, to which many people object. This is a serious innovation. It could damage companies.
The clause refers to the employment of professional staff. I declare an interest as a practising solicitor. I am not keen on clauses that encourage the greater employment of professional staff, which again is a way of increasing companies' costs.
More seriously, I feel that such a committee, once appointed, between its appointment and the next annual general meeting would have a free hand to range round the company and contribute not so much to industrial democracy as to industrial warfare without any remit and without any set objective.
1207 6.30 pm
New clause 29, propounded by my hon. Friend the Member for Kensington, covers some of those points. It specifically states what audit committees are there to do. That clause, I believe, muddles or muddies the two distinct jobs that some people feel have to be done. The first is that directors responsible for management need greater control and greater advice in the management of companies. The second is that the role of auditing watchdog—the job that auditors of companies are supposed to do—should be carried out to a much greater extent. We should try to distinguish between these two objectives and not muddle them.
I am sympathetic to the idea of non-executive directors. I do not go along with the faint praise that has been given to this concept. I believe that, if voted upon by the shareholders, they would be some protection in the management of the company at board level and a guarantee, to some extent, to the shareholders that objective standards of behaviour were observed by management in the course of running a company.

§ Mr. Parkinson
The hon. Member for Sheffield, Heeley (Mr. Hooley), who opened the debate on his new clause 3, would, I think, be the first to admit that he rather overstated his case. The picture that he painted was of a company law structure that no longer works, that is collapsing and that gives rise to permanent trouble. I should like to put his complaints into perspective. Over 700,000 companies are registered. There are very few complaints of the kind to which the hon. Gentleman referred. The problems that occur from time to time in individual companies are not the norm, as he tried to suggest.
We are talking about the way in which to deal with problems that arise in a tiny minority of registered companies. They are serious problems, but they are not widespread. I do not think that the hon. Gentleman helped his case by pretending that they were. He suggested that absolutely nothing could be done at present if a company got into the wrong hands. He obviously does not understand the role of the auditor, who appoints him and to whom he reports. I should like to explain briefly. The shareholders have a person 1208 to do the job that his special audit committee would do. That is the auditor, who is appointed by the shareholders. It is his duty to report to them how the directors are handling the assets of the company. That is his job.
The auditor does that job through the annual audit report and also by appearing at the annual general meeting and reading his report. I do not believe that the present position of the auditor is wholly satisfactory. I prefer, however, to concentrate on trying to improve his position and his role rather than to create a body that would simply duplicate that job. Nothing that the hon. Gentleman says justifies the creation of a new body. We should perhaps find ways to make the existing official—the auditor—more responsive to those to whom he is due to report. I do not believe that putting this new clause on the statute book would do anything of the kind. The role of the committee, as my hon. Friend for Dorset, North (Mr. Baker) said, is extremely ill defined. One would merely be creating another body to do the job that an official already exists to do.
I should like to explain to the hon. Gentleman one of the powers of the auditor. Section 14(5) of the 1967 Act states: Every auditor of a company shall have a right of access at all times to the books and accounts and vouchers of the company, and shall be entitled to require from the officers of the company such information and explanation as he thinks necessary for the performance of the duties of the auditors. So the auditors have the powers that the hon. Gentleman says that his special audit committee needs. I do not believe that he has established the case for creata new body. His new clause perhaps reflects his lack of understanding of the existing law and the existing powers of the auditor and the duties of that official.

§ Mr. Hooley
The Minister must explain to the House why these massive scandals have occurred. It seems to me that if the auditors had been exercising all the formidable powers that the hon. Gentleman has outlined, they would have come upon these malpractices much sooner. Does he not realise that in the period 1973–74, now happily behind us, the malpractices that occurred nearly brought down our banking system? Is he dismissing that as a matter that should have been dealt with by auditors?

1209

§ Mr. Parkinson
No. I am saying that the hon Gentleman's suggestion would have done nothing to help deal with the problem that he thinks he identifies. How did a number of these scandals come to be known about? The answer is that the auditor, having conducted his investigations, qualified his report. Again, under the Companies Act my Department has power to appoint inspectors. Having learnt from those inspections, the House has the power to amend the law.
I should like to refer to part IV of the Bill, which we shall be discussing later. That is specifically designed to deal with some of the problems that emerged as a result of the work of the auditors and the inspectors. The Bill makes illegal some of the things that happened and makes sure that when these things happen they are revealed to the shareholders, so strengthening the power of the auditor.

§ Mr. Clinton Davis
In fairness to my hon. Friend the Member for Sheffield, Heeley (Mr. Hooley), it must be said that the assertion that many of the scandals came to light through auditors qualifying their reports is not accurate. The auditors have been criticised in virtually every report.

§ Mr. Parkinson
The hon. Gentleman is saying that there was a duty on the auditors that they did not carry out properly. That does not destroy my case. To give an ill-defined duty to a group is an interesting idea, but it is very badly defined. There is already a person with clearly defined duties. Where there are weaknesses in the law, the House has the capacity to deal with them. That is what the Bill is about.
For the reasons that I have given and some of those at which I have hinted, the Government do not find new clause 3 acceptable. I hope that the hon. Member for Heeley will be partially reassured by my informing him of the powers that already exist and the ways that we are seeking to strengthen the arm of the auditor and to make sure that such practices come more readily to light. If we are to deal with this problem—to strengthen the power of the auditor and make sure that shareholders get a better report on the activities of directors—I must say that I prefer the approach of my hon. Friend the Member for Kensington (Sir B. Rhys Williams).
1210 I prefer the way in which my hon. Friend has modified his approach since we discussed these matters in Committee. He now seeks to put into company law the right for the shareholders to decide whether they should have these bodies. That is a major improvement on his previous idea, which sought to impose on every company of a given size a number of non-executive directors and the requirement to have an audit committee with the clearly defined duties contained in amendment No. 383.
Early in 1979 the previous Government conducted a survey of 20 bodies representative of both sides of industry, the professions and securities interests. They found support for the idea that companies that wished to do so should experiment in this way, but they found unanimous hostility and opposition to the idea that non-executive directors and audit committees should be statutorily imposed on the boards of companies.
I still take the view that that is the best way to go about these matters, although I accept that there is a growing interest in the subject, thanks to the activities of my hon. Friend the Member for Kensington, and consultations on this subject will continue. The approach that my hon. Friend is now making, of not seeking to impose this requirement on every company but to give a company's shareholders the option of having such a body and non-executive directors, and defining their duties if they choose to have them, is a major step in the right direction.
I deal now with the question raised by the hon. Member for Hackney, Central (Mr. Davis) and mentioned by the hon. Member for Caithness and Sutherland (Mr. Maclennan), whom I welcome to our discussions. He and I sat facing each other for 23 happy Committee sittings in the previous Parliament, and it is a great pleasure to see the hon. Gentleman taking part in our debates. I agree very much with his analysis of the problem and his approach to its solution.
As the hon. Member for Hackney, Central said, I wrote to him and sent him a copy of an extract from the Bank of England Quarterly Bulletin stating the progress that is being made by companies in appointing non-executive directors. It will not waste the time of the House if 1211 I give two or three figures from that report. It compares the results of a survey carried out about three years ago for the Bullock committee with the position that emerged when the Bank carried out its own survey three years later.
Three years ago, at the time of the Bullock survey, 75 per cent. of the top 1,000 companies had one non-executive director or more. Three years later that figure has risen to 88 per cent.—a substantial increase. The number of companies having three or more non-executive directors has risen from 36 per cent. to 53 per cent., so there is a substantial move towards the appointment of non-executive directors and a growing awareness of their importance. On behalf o f the Government, I welcome the decision by companies that it is in their interest to have non-executive directors in ever-growing numbers on their boards.
May I say in a joking spirit that the hon. Member for Hackney, Central slightly dented his formidable credibility by the warmth of his compliments to his hon. Friend the Member for Heeley on the new clause and by adding 1 to 2 and saying there had been a 300 per cent. increase in the number of people in favour. He is a lawyer and not an accountant, so we will forgive him for that slight failure in his arithmetic.
6.45 pm
The Government's approach to this problem is to continue consultations on the subject of the audit committee and the non-executive director. We welcome the growing number of appointments of non-executive directors. We hope that more British companies will experiment with the audit committee and find out whether there is a place for it in our company law and whether it has a worthwhile contribution to make.
I am a supporter of the concept. There is a need to strengthen the position of the auditor. Far too frequently the auditor is reporting to the directors, the very people about whose activities he should be reporting. We must encourage the strengthening of the links between the auditor and the shareholders and find ways of doing that. There is a need to build up the position and the independence of the auditor and to make sure that he reports more directly to the shareholders.
1212 I hope that the House will feel that we have had a worthwhile debate on an important subject and that the hon. Member for Heeley will not seek to press the clause.

§ Mr. Archer
I was interested when the Minister of State at the end of his speech announced his conversion and publicly came to the penitents' form. I have been persuaded to join him in the course of the debate, so the hon. Member for Kensington (Sir B. Rhys Williams) would be entitled to speak of a super exponential growth in the number of his supporters.
What is in issue is not whether it would be worth while experimenting with non-executive directors and audit committees. The necessity for that seems to be agreed. I should be surprised if there were an issue as to how far my hon. Friend the Member for Sheffield, Heeley (Mr. Hooley) overstated his case when he spoke of the reasons for anxiety which had arisen over the past few years. If I may venture a modest note of criticism, I thought that the Minister of State was a little less than fair to my hon. Friend. It does not require a majority of companies to give rise to anxiety to cause us to wonder whether something should be done. For many years we have been talking about a crime wave. That does not mean that the majority of our citizens are criminals. We need to have only a fairly substantial minority to give a reason for thinking more about these matters.
The issue is not whether we should proceed with this kind of experiment. Even the Minister of State recognised that audit as we have known it has at least two limitations. The auditors are appointed by the company, and that usually means that they are appointed by the very people whom they are set to report on. Most auditors are capable of standing up to pressure from directors. Certainly there is no reason to think that it is a widespread and worrying aspect of audit that auditors are always under the thumb of directors. But we cannot be sure that all auditors are always capable of withstanding pressure, and that has been borne out by a number of events in the past few years, particularly when there is a strong personality on the board.
1213 I should be the first to agree with the Minister that we should look for ways of making audit as it is at the moment more effective and strengthening the hand of those auditors who want to stand up to that kind of pressure. I am not sure that these are alternatives. I do not understand why that would necessarily exclude the proposals of my hon. Friend the Member for Heeley and the hon. Member for Kensington.
The second difficulty about audit at present is that it is usually confined to examining first for dishonesty and secondly to ensure that where the resources of the company have been dealt with in a certain way proper authority was given according to the proper procedures. And I think that auditors are considering increasingly whether a company has received value for money.
I declare an almost historic interest. I began my working life as a temporary boy clerk on the staff of a district auditor. But I am not sure that, even now, they test the effectiveness, imagination or energy of management. They do not necessarily look for the backing away from a challenge or for a missed opportunity.
I hope that I am not minimising the effective work carried out by many auditors. Where they do not function fully, why should there not be a long stop? What is so wicked or wasteful about that? There are aspects of the role of considering a company's performance that audit committees may be better fitted to deal with than auditors as we have them at present.
As my hon. Friend the Member for Hackney, Central (Mr. Davis) said, where the experiment has been tried extensively in North America it appears to have been generally regarded as worth while. Of course, as my hon. Friend the Member for Caithness and Sutherland (Mr. Maclennan) said, no one pretends that the mere fact of appointing non-executive directors, or of incorporating them into an audit committee, will necessarily ensure improvement in every company. Obviously, it depends on the quality of the non-executive directors.
I agree with my hon. Friend the Member for Hackney, North and Stoke Newington (Mr. Roberts). It depends on whether the non-executive directors devote 1214 a meaningful proportion of their time to the job. As my hon. Friend the Member for Hackney, Central said—the Hackney twins were effective on this aspect of the matter—it depends on whether the non-executive directors are in the pocket of the chairman.
What is at issue is whether this worthwhile experiment should be allowed to continue as an experiment or whether it should be made mandatory. It is true that many of the best and more progressive companies are experimenting in that direction, thought I would not wish to define an unprogressive company as one which at the moment is not persuaded. But we are not legislating for the best and most progressive companies.
It is a story that has been repeated time and time again. It arose in the case of employee protection. It arose in the case of industrial safety. There were those who said that the best companies were doing it already, so why impose the straitjacket of a statutory, mandatory responsibility upon them? It is now accepted that, for many companies, it is essential and that there is nothing especially restrictive, frightening or wasteful about it.
Perhaps the real question is whether we wait for the tide—as the Minister pointed out, the tide appears to be flowing in that direction—or whether we help it along a little. I was a little disappointed that the Minister did not respond to the suggestion of my hon. Friend the Member for Hackney, Central about the possibility of conducting further surveys to discover in which direction, and how quickly, the tide is flowing.
We have to consider a series of choices about the way in which an audit committee would be constituted. Would the committee include any of the regular directors? My hon. Friend the Member for Heeley said "Certainly not". My hon. Friend the Member for Hackney, North and Stoke Newington supported him. The hon. Member for Kensington thought that it should. I am not clear why he thought that. He did not state why he parted company on that issue with my hon. Friend the Member for Heeley. Presumably, it was because he did not want the tide to flow too quickly but to progress a step at a time. Both agreed that an effective audit committee should include some non-executive directors who were not part of the establishment.

1215

§ Sir Brandon Rhys Williams
If the right hon. and learned Gentleman considers the precise terms in which I have drafted my proposed new schedule, he will see that the non-executive director element has to be in a majority, even if only through the exercise of the non-executive chairman's casting vote.
I believe that in North America it is normal for the committee to consist entirely of non-executive directors. That is in the context of an American board. In British companies, where there are so few non-executive directors, I thought that the necessity was to strengthen the audit committee with non-executive directors.

§ Mr. Archer
I am grateful to the hon. Gentleman for elucidating that aspect of his thinking. At this stage, I would not wish to declare an option one way or another. That is one of the issues on which we may have to make up our minds.
The other issue is, perhaps, more immediately important. It is how one ensures that the non-executive directors are not in the pocket of an over-authoritative, over-paternalistic chairman. The hon. Member for Kensington would prefer to see the non-executive directors constituted by the board. At least, that is the way in which the audit committee would be formed. My hon. Friend the Member for Heeley said that they should be elected by the shareholders at the annual general meeting. As my hon. Friend the Member for Hackney, Central said, it is important, if they are appointed by the board, that great care is taken to ensure that they are not in the pocket of an over-authoritative chairman. We may have to build in some institutionalised safeguards against that possibility.
The next question in which I am interested is how detailed these proposals have to be. There are two proposals to make it mandatory by statute that there should be an audit committee. My hon. Friend the Member for Heeley left his proposal fairly broad, with the detail to be filled in later. That was a sensible approach. He does not have to apologise for his draftsmanship or for intervening in what is so often the prerogative of company lawyers. He more than justified himself.
In Committee, the Minister was slightly critical of the hon. Member for Kensing- 1216 ton because his requirements were too detailed. He said that they were not flexible enough. The hon. Member for Kensington is unrepentant. Once again he spelt out his proposal in detail. The House should be grateful to him. Whether his proposal is incorporated in the Bill is a different matter. At least, it enables us to understand how these proposals will function.
It was interesting to note the reaction of the hon. Member for Dorset, North (Mr. Baker). He finds it all slightly suspicious. He believes that an audit committee would take on the role of a snooper. He said that he was interested in the experiment and was prepared to see it go further but that it was dangerous unless kept in a clearly defined role. He is suspicious of my hon. Friend the Member for Heeley's proposal because it was not sufficiently spelt out. He joins issue on that matter with the Minister.
What are to be the powers of non-executive directors? Clearly they will require to have a right to information. I was interested in the proposal of the hon. Member for Kensington that they would report to the annual general meeting. Such a report may have to be qualified.
The hon. Gentleman has not resolved one question that I tried to put to him in Committee. If a non-executive director finds that he cannot sign a report which has been prepared by the majority of the audit committee, the hon. Gentleman said that he should resign. I am not sure why anyone who wishes to produce a minority report should, for that reason, be required to resign.
I accept that this is not a situation that will frequently arise or that the hon. Gentleman envisages mass resignations. But if there is to be provision for it, it ought to provide for a minority report which does not entail the resignation of those who make it.

§ 7 pm

§ Sir Brandon Rhys Williams
The right hon. and learned Gentleman is tempting me to intervene at too great a length. Briefly, what I am trying to avoid is a situation in which a non-executive director decides to acquiesce with the majority of the board when in his conscience he knows that it is wrong. I would rather that he had the courage of Mr. Angus 1217 Murray, whose conduct has been so highly praised in connection with the Newman scandal, and that he should speak out or resign in the hope that he would rally the support of a big institution or of public opinion.

§ Mr. Archer
Again, I am grateful to the hon. Gentleman. I can see that there may be a situation where, in order not to institutionalise the faults of a company, a director might feel impelled to resign. I would not wish to discourage him. What troubles me is the imposition of an obligation to resign. But that is a matter which we may have another opportunity of discussing at greater length. Of course, there will be other opportunities to discuss a number of aspects that have arisen in this debate, such as the question of industrial democracy and two-tier boards.
It is for my hon. Friend to decide whether he wishes to divide the House, but I am sure that the House is grateful to him, and to the hon. Member for Kensington, for initiating the debate even though it may not bear fruit today. I suspect that the Minister will get his way today, but history may tell a different story.

§ Mr. Hooley
I thought that the Minister rather gave the game away in his closing sentences when he admitted that the powers of existing auditors needed to be refined, strengthened or beefed up in one way or another. The discussion has been useful, and I have no desire to divide the House. Therefore, I beg to ask leave to withdraw the motion.

§ Motion and clause, by leave, withdrawn.