HC Deb 13 May 1977 vol 931 cc1833-55

Order for Second Reading read:

2.54 p.m.

Sir Brandon Rhys Williams (Kensington)

I beg to move, That the Bill be now read a Second time.

I introduced this Bill under the Ten Minutes Rule in January, but I have introduced a Bill in this or a similar form in every Session since 1969. I hope that in this series of company law reform Bills I have been successful in drawing the attention of the House, of the professions concerned with company law reform and of the public generally to the need to introduce certain reforms in the operation of the British joint stock company.

I have said a number of times, and I am happy to have this opportunity of repeating this afternoon, that the joint stock company is one of the finest British inventions for the creation of wealth. It is a system for organising human genius and material resources in the most productive way. Not only in this country and in Europe but all over the world, versions of the joint stock company have been adopted as the most widely used system for collaboration in the creation of wealth and the provision of services.

have said. If she is not prepared to do that, I believe that the House should reject it.

Question put, That the Bill be now read a Second time:

The House divided: Ayes 11, Noes 24.

Division No. 139] AYES 12.42 p.m.
Eyre, Reginald Montgomery, Fergus Young, Sir G. (Ealing, Acton)
Gardiner, George (Reigate) Renton, Rt Hon Sir D. (Hunts)
Goodhart, Philip Stanbrook, Ivor TELLERS FOR THE AYES
Langford-Holt, Sir John Steen, Anthony (Wavertree) Mrs. Jill Knight and
Mayhew, Patrick Viggers, Peter Sir Brandon Rhys Williams
Armstrong, Ernest Freeson, Reginald Madden, Max
Atkinson, Norman Gilbert, Dr John Mellish, Rt Hon Robert
Booth, Rt Hon Albert Harrison, Walter (Wakefield) Price, C. (Lewisham W)
Clemitson, Ivor Heffer, Eric S. Sedgemore, Brian
Cocks, Rt Hon Michael (Bristol S) Jackson, Miss Margaret (Lincoln) Spearing, Nigel
Cunningha, Dr J. (Whiteb) Jay, Rt Hon Douglas
Douglas-Mann, Bruce John, Brynmor TELLERS FOR THE NOES:
Eadie, Alex Johnson, James (Hull west) Mr. Thomas Cox and
English, Michael Kelley, Richard Mr. Peter Snape.
Foot, Rt Hon Michael McCartney, Hugh

However, although we can be so proud of the British company law tradition, we have to recognise that the British company as it stands today does not necessarily operate as efficiently as the companies in some other countries. We must be vigilant to ensure that our company law is fully up to date and in harmony with the social and technological situations in which people at all levels of seniority who participate in the work of joint stock companies have to operate.

The public are disturbed by the number of recent cases in which it has become obvious that large and medium-sized British joint stock companies have clearly fallen down and disappointed their shareholders, their employees and the public by a level of performance which was less than ideal or even less than adequate. From a study of the performance of many of these companies, I have certainly drawn the conclusion—I think that this is a majority opinion—that when problems develop in British joint stock companies, they do not seem to be cured in time.

All too often, when a company is brought to passing its dividend or actually has to wind up, one finds that the problem that has given rise to the difficulties is of some years', or even of many years', standing and should have been detected and acted upon long before by the management—or some other force acting upon the company.

If a fault develops in the operation of an engine, the sooner one can put it right the better. The same applies to a joint stock company. If there are the beginnings of trouble, the management, the directors, the auditors, the workers themselves, and possibly also the shareholders and the Press should know about it, and a remedy should be applied while there is good time.

However, all too often, when the fault is identified it is too late to save the business, or to do so without massive redundancies and major upsets—not only for the employees but for the customers. Customers may suddenly find that supplies of a product on which they rely have been discontinued because, surprisingly, the firm that has regularly produced them has had to close down its operations; it has suddenly been discovered that it is not profitable or that there are problems in relation to the product which could have been detected and corrected much sooner.

Thus I hope that I have been performing a useful function over the years in seeking to draw the attention of the House to the fact that quite minor reforms in the way in which we organise the forces engaged in working together in the joint stock company could help draw attention to the problems that undoubtedly develop from time to time at an earlier stage, while there is still good time for them to be put right.

I should like to pay tribute to some of those who have corresponded with me about the Bill over the years and who have particularly helped with its drafting. I can say without conceit that the Bill is well drafted, because the drafting has been carried out for me almost exclusively by experts in the subject.

First, I want to pay tribute to the invaluable help that I received some years ago from the Department, with an earlier version of the Bill. The fact that it has the appearance of a completely prepared Bill has attracted favourable attention to it and has led to its being taken more seriously than it would have been if I had drafted it entirely in my own inexpert way. I thank the Department for the encouragement it gave me at an earlier stage.

It would be only proper also to mention the name of Mr. David Morgan, in Jersey, with whom I corresponded and who gave me invaluable help, particularly in the recent stages of the Bill, in which I have incorporated recommendations about audit committees. There is not a line of the present text that does not owe something to his consideration. I pay the warmest possible tribute to his assistance and advice.

The Institute of Internal Auditors should certainly be mentioned in connection wih the Bill, because it was through studying papers that it sent to me about the operation of audit committees, particularly in Ontario, that I was able to draw conclusions about the way in which clauses could be drafted which would fit happily into the general context of British law. Had I not had access to those papers, I do not think that I would have learned so readily from any other source precisely the way in which the problems of the joint stock company were tackled, first in Ontario and later in other states in Canada.

I would like also to mention my old friend John Phillips of the Institute of Chartered Secretaries and Administrators, himself a notable enthusiast for company law reform and a great source of encouragement to people like myself who do not have his expert knowledge but are able to look to him for wise and kind advice, so freely given and so valuable. In this version of the Bill, Mr. Renshall, of the Institute of Chartered Accountants, also gave me most useful support and help. Indeed, many prominent firms and members of the profession have given me help and encouragement. I think it is true to say that many people concerned with the future of the accountancy profession would like my Bill to make progress.

I turn now to the Bill. I am glad to have the opportunity of dealing with it in some detail because I know from conversations I have had with others concerned about the future of the British joint stock company that the proposals that I am making have not been as fully understood as I would like. This is partly because in the early stages of my campaign I was proposing a somewhat different formula for board room reform, and it has stuck in the minds of people that I might, perhaps, still be recommending what I put in my first Bill, which, on reflection, I realise would probably be unworkable in many cases.

In my first Bill I was concerned to give shareholders, even a minority of shareholders, an easy opportunity of insisting upon some sort of company investigation that would he more thorough-going and wider than the conventional audit and yet not quite as drastic as turning to the Department and calling for the appointment of an inspector. I still feel that there is a gap in our procedures for supervising problem companies, or companies that are getting into difficulties. The gap lies between the operation of the conventional audit, as laid down in the Companies Acts, and the appointment of an inspector, which tends to be the seal of doom on a company, or at any rate to attract so much adverse comment and prejudice that it damages the company, even if it is a highly necessary intervention on the part of the Department.

It used to be the case, and I think it still is, that the Department was reluctant to proceed to the stage of appointing an inspector to investigate a company's affairs. This is understandable. There are problems connected with official inspectors' investigations of company efficiency, and, for that matter, the propriety of the conduct of directors and management, which will certainly require the attention of this House on another occasion.

I do not want to dilate on that matter now, but I entirely sympathise with the Department in its reluctance to appoint inspectors to carry out inquiries into this, that and the other company whenever a problem appears to be arising, because there are all too painfully obvious difficulties associated with such inquiries, and in many cases one must ask whether they have done more harm than good.

The gap between the audit and the Department's inquiry, which I attempted to fill in my first proposal to the House, remains unfilled, but I hope that a more practical, much easier and more acceptable way of filling it is to be found in the reforms I am suggesting in this Bill. I hope my suggestions will commend themselves as being unlikely to give rise to procedural wrangles or internal dissension in the company and, at the same time, offering an effective remedy in companies where all is not quite as well as it might be

Perhaps I am doing harm to my cause by laying too much emphasis on the problem company, because even an efficient concern needs a basic structure that is as near ideal as we can make it. The present status of auditors in British companies impedes them in working as effectively as they might and creates obstacles to the thorough understanding of the rôle of the auditor in the company. I believe it prevents members of the profession from contributing as much to companies as they might unless they overstep the strictly statutory functions laid down for them in the Companies Acts. I believe the Bill would help all companies, whether efficient, somewhat inefficient or rank bad, to operate better and more happily than they do. Therefore, I commend it to the House

Let me deal with the terms of the Bill. Clause I repeats the recommendation that I have made in former years that public companies above a certain size should have at least three non-executive directors. As before, I have suggested that companies of 1,500 employees, or with total net assets of over£5 million, should be required to appoint not fewer than three non-executive directors. I have chosen the number of 1,500 employees partly because the total number of businesses in this country with that number of employees or more is not so large as to be unmanageable. One does not want to create a crisis as companies search wildly for people to till the quota on boards and find that suitable people are not available.

But, in addition, the figure of 1,500 employees represents a crossing point between the small and intimate business—normally a family business, where there is close contact between management and employees—and the larger concern, where routine relationships must be put on a more formal basis and where the personal contact that can be a delightful feature of a small business—in which everybody understands the position of other members of the company and is able to enjoy easy access for the exchange of ideas—becomes impossible and it is necessary to devise a more rigid structure to ensure the exchange of ideas and performance of different rôles.

Therefore, I am sticking in this Bill to my former recommendation that public companies with 1,500 employees or more should be required to appoint at least three non-executive directors. This is not a particularly exciting or revolutionary proposal, because the great majority of companies quoted on the Stock Exchange already have non-executive directors on their boards. By far the majority have at least one. Most of the others have two, three or more non-executive directors. Therefore, to require such companies to appoint at least three non-executive directors would not lead to a scramble to find suitable people or to any revolutionary change in the appearance and operation of the board—at least, not in the first instance.

I am nervous of companies which appoint non-executive directors without any clear idea about their role. What we call the managerial revolution has so much changed the nature of British board room practice in the last 30 or 40 years that the old concept of the board of directors as a supervisory body watching the management of their company on behalf of the shareholders has almost died out.

I hope that there is time to draw contrasts between the way that we organise our companies in Britain and the way that they are organised on the Continent, particularly in Germany. German company law has grown up on a different basis from the way that company law has developed in this country. The non-executive director is a survivor of the Victorian board of management. I believe that if a survey had been made, it would have shown that the boards of public companies that existed even up to and during the war comprised a majority of non-executive directors. I am sure that that would have been found to be the case if a survey had been made.

But one can imagine the friction that grew up between heads of departments—the senior management engaged in the day-to-day running of a business—and the non-executive directors, who, perhaps, grew increasingly out of touch with what was going on and found it difficult to comprehend and sympathise fully with the increasingly difficult problems of modern management.

I am not trying to start a managerial counter-revolution in favour of the reintroduction of non-executive directors who would be latter-day replicas of the pre-war type of company director. He probably came to the job without any specific training in business and without any close technical knowledge of the procedures of the company. Nowadays, few companies in this country have a majority of non-executive directors on their boards. Surveys have shown that most public companies have at least one, and the majority two or three, among the other directors. But the practice of appointing to the board the members of the senior staff who have become heads of department has become so widely adopted that the non-executive directors are nearly always in the minority.

The situation is different in the United States. The majority of public companies there are still run by boards that are mainly or wholly non-executive in character. It is worth considering this difference, because in the United States one also finds the unitary board, which is the essence of British company practice. The fact that it is composed quite differently from the way in which the unitary board is composed in this country leads one to investigate the reason.

In North America it is fashionable to attract to company boards men who are currently engaged in the executive management of other companies, even in competitive companies in the same line of business. The non-executive director of an American company is likely to be a man who is engaged for the rest of his time in executive functions in another firm. It would be less common than it is here to find non-executive directors who are virtually professional supervisory directors, who have prepared themselves for that function and who are not bringing to the board of the company on which they serve the expertise they derive from their current direct involvement in the work of another business with related activities.

I should gladly welcome the development in this country of the concept of appointing to companies non-executive directors who have executive functions in other firms. There is no substitute for knowledge derived from current activity and responsibility. It keeps one more up to date than a professional background, which inevitably is based on studies undertaken many years before, or at least some years before, or on impressions of company practice that inevitably grow obsolete as the experience on which they are founded recedes into the past.

I am not too optimistic, however, that the practice will develop in this country overnight of releasing full-time executives, who are busy and effective at the heads of their companies, to serve on other companies to fill the non-executive gap. I would not anticipate that companies, if they decide to comply with the recommendations in the Bill or if the Bill becomes law and they are required so to comply, would be successful in filling all the vacancies by getting executives from other firms to carry out the non-executive rôle

It is more likely that companies will have to look to men who have the time to spare to carry out a non-executive director's function. I should certainly welcome the development, in due course, of a profession of non-executive directors, which might even be subject to professional rules of conduct and, ultimately, to examination.

It often surprises people to be reminded that it was only in the Companies Act of 1948 that it was made obligatory that the auditors of a company should be men with professional qualifications. Before that the auditor did not have to be a qualified person. I suppose that if non-executive directors had to be appointed to British companies it would be impossible in the early stages, and perhaps even for many years, to insist that they should be men with particular training, or belonging to a particular institute, or subject to a particular professional discipline. Nevertheless, if that were the way in which the rôle of non-executive directors developed, I should not regret it.

The type of person who might be able to carry out the rôle does not seem to me to be in short supply. A number of people who have discussed my Bill with me have been afraid that they might find it difficult to secure the services of men who would add to their company's strength and who would be willing to meet all the responsibilities laid upon them by the Bill, which I hope the House will allow me to come to quite shortly. But I would maintain that supply is not a difficulty, provided that sufficient time is given to allow people to groom themselves for the non-executive director's rôle. In the course of management selection work, I have found that there seems to be a large supply of men in their 40s or early 50s who are seeking anxiously for a change of responsibility.

It is not that they are becoming obsolete or waxing second-rate in the firms in which they have been working as the years go by. It is because there is a different demand for older than for younger executives. The majority of British companies, being organised on a pyramid basis, are unable to offer careers to many of their brilliant and successful executives that make full use of their experience and capacity after they come to middle life. This is true of the Civil Service as well.

If we have a surplus of people who may have entered industry from university or after technical training with first-class qualifications and have then spent 20 years in practical responsibility in industry in different roles, and are then actively looking for new opportunities in the second halves of their lives, we will not be short of people from among whom we shall be able to select a large number to carry out the supervisory director's rôle.

But such people have to learn to see the rôle of the supervisory director as a satisfactory and honourable second career, and, since this second career at present hardly exists, at least in the form in which I envisage it in the Bill, people do not come forward to fill the vacancies. It is a "chicken and egg" situation, which would rectify itself quite quickly if it became obvious that companies were on the look-out for men, preferably in their 40s, who would be able to carry out the non-executive director's rôle.

I envisage that it could become a satisfactory source of income, and rightly so, for men of the right type. I do not consider that the work of the supervisory director, as suggested in the Bill, could be carried out for more than three or four companies. Otherwise, a man would inevitably begin falling down on his duties and would be unable to go in sufficient detail into all the work of each of the companies in which he served.

One has often heard of non executive directors belonging to the boards of 20 or 30 companies. They seem to me not to be non-executive directors of the type I am locking for. But if a professional man in his forties were to secure three or four non-executive directorships, each of them bringing in, perhaps,£5,000 a year, that would be an extremely satisfactory second career.

Moreover, such a position would give a man sufficient independence to speak as an independent member of the board. The rôle of the non-executive director has to be a challenging one. He has to be someone who will take a stand if he feels that a stand is needed. It is no good asking a man to act in accordance with his conscience if colleagues whose opinion he values are against him and if, by challenging them to the point of open dispute, he lays himself open to being voted off the board and putting himself in financial distress.

Obviously, in an ideal world there would be no shortage of people willing to take any risk for what they believed was the good of the company, but we have to be practical in our approach to company law reform and realise that it is no good asking the impossible of human nature. Therefore, non-executive directors, if they are to perform a useful function, must be men of independent means and confidence, men who can win the respect of their colleagues and whom their colleagues can recognise as men who will stand up for what they believe in if a really serious dispute develops.

Clause 1, therefore, repeats my recommendation that companies employing more than 1,500 people or with total net assets in excess of£5 million should appoint not fewer than three non-executive directors. In their case, I have not sought to specify more particular reponsibilities. For the somewhat larger company, however, the company with more than 2,000 employees or total net assets in excess of£10 million, I have gone on to make further recommendations, and I turn to these now.

In my view, the practice of appointing an audit committee, which has encountered such success now in the United States, ought to be copied in this country. It does not require an Act of Parliament. Company managements are perfectly free to appoint audit committees now, and I believe that an increasing number are doing so.

I hope that this movement will gather momentum. It is likely that it will, because in recent months the New York Stock Exchange has issued a circular making it obligatory for American companies, if they wish to be quoted on that exchange, to appoint audit committees by the end of 1978. If it becomes commonplace for American companies to adopt the audit committee as part of their regular structure, British companies will soon learn the technique and become familiar with the way in which the audit committee operates through the natural contacts engendered in the course of business. As American companies, often acting in a highly competitive atmosphere, tend to be efficient and go-getting, many British companies may well feel that it would be advisable to watch closely what they do and to imitate this development.

It is apposite at this point to quote from a letter dated 4th November 1976 by Mr. William Batten, Chairman and Chief Executive Officer of the New York Stock Exchange, to chief executive officers of listed companies. From that letter, headed "Audit Committees" I wish to quote only the following paragraph: In its current deliberations, the Board considered the fact that a significant majority of listed companies have, or plan to appoint, Audit Committees that would meet the proposed policy. And there is evident support from a large majority of you that the Exchange should adopt a requirement along these lines. Additionally, the Board feels that codifying what has become a generally accepted practice is in keeping with the self-regulatory scheme envisioned by Congress when it framed the securities laws and is a practical means of addressing an issue that might otherwise result in further direct government regulation. I quoted that paragraph because it takes me to the point that I should now like to make, that although it might not be thought desirable for the Government to rush into legislation on audit committees there is no reason why we should do nothing. I am bound to express the wish that our Stock Exchange authorities in London could be as vigilant in considering the reform of company law as are their counterparts in the United States. It could well be that the best approach to the practice of appointing audit committees in this country would be for the Stock Exchange to encourage its members to take up the practice rather than for the Department of Industry to do so. I hope that my words will reach some of our authorities in the City and that they will give further thought to the possibility that this may indeed be a matter for them.

I should like now to deal with the composition of the audit committee. This might well be considered a Committee point, and I hope that in due course I shall have the opportunity to exchange views with colleagues in Committee about detailed questions of composition. I believe at this stage it is sufficient to suggest that at least half the members of the audit committee should be non-executive directors and that three—no doubt in most cases the same three non-executive directors as we have insisted must be present on the board—should be members of the audit committee.

It is not so much the composition of the committee that concerns me as its functions. At one stage I considered the possibility that the auditors themselves might be represented on the committee as full members. This leads us into deep waters, partly because the particular partner or employee of the auditors who would appear on the committee would obviously require to be selected by someone, and that might lead to controversy or embarrassment.

I think it better to state, as I have in the Bill, that the auditors should be able to be present at all meetings of the audit committee or to initiate meetings of the audit committee, though not to be voting members of it.

As to the duties of the audit committee, I have specified that it should meet at least twice a year. That is the minimum, and in a large company, or a company where circumstances change very rapidly, one would expect that meetings might be a good deal more frequent. But we must remember that in company legislation we are dealing with companies of all kinds and that the different activities and circumstances of companies can be such that what is appropriate for a typical company is otiose or unnecessary as a routine for companies of a non-typical kind. We should not cause problems to specialised firms by ill-considered legislation. But one has to generalise, and to specify meetings twice a year is not unreasonable.

I think that it should be an entitlement of the auditors that they may require the committee to be convened. I hope that the auditors would avail themselves of this opportunity. One often hears complaints from them that talks with senior management and the board itself are limited or are so formal that they do not give an opportunity for a deep analysis of the company's problems and questions about the future and its profitability. Auditors would be glad to discuss these things with management, but often they go undiscussed because there are no openings for the auditors to reach those who are responsible for the management of a company and to give them their recommendations.

The audit committee is the obvious channel of communication between auditors and the board. Many auditors will welcome this formal channel. The profession has come under criticism in recent years—some of it quite unjustified—because the supervisory job that the auditors have to do does not seem to have been carried out as effectively as it should. I am extremely sympathetic to the auditors in British joint stock companies because they find themselves blamed on occasions when they could not have done anything else in the circumstances to put matters right.

In accordance with practice that is becoming general in North America, I suggest that the audit committee should review all financial statements before they are issued to the Press or the public—whether they are audited financial statements or otherwise. Members of the public, the Press and investors generally would welcome the confidence derived from the certainty that whatever statement emanates from the company will have had the approval of the auditors and the non-executive directors who are members of the audit committee.

At times of crisis or at takeover times the management, directors and others are under considerable pressure, and they tend to rush into ill-considered and possibly even misleading statements. I do not want to use an emotive word like "misleading" in an attempt to attack all the management which make statements that are ill advised. Very often they make them in quite good faith; such statements simply indicate that all is not well in the company and that the management is not aware of circumstances, which perhaps may have changed at the last moment, and that they were genuinely mistaken in the way in which they were running the business.

Among the duties of the audit committee will be that of considering any other matters which the auditors feel require the attention of the board. That is why I think it right to proceed in this way. In talking to non-executive directors of companies and to institutional investors—the people who are responsible for placing funds in shares of joint stock companies—I find a certain reserve about the possible rôle of non-executive directors. By definition, they are not engaged in the work of the company every day and they suffer from the disadvantage that they cannot know what is going on all the time. Their opinions in any clash at board level may not be as well founded as those of heads of departments who can draw on the services of staff and have personal day-to-day observation to support their arguments.

There is also a lacuna in many companies in that they do not produce data or forward estimates which are completely up to date. This stems possibly from the fact that our company law requirements only require audits to be retrospective There is no statutory obligation on companies to keep their data completely current. They are obliged only to keep data referring to the past year. Thus, boards can often blunder on from month to month and quarter to quarter without knowing exactly what is going on.

In management consultancy I have sometimes found heads of department who recognise that they have no way of convincing the board that something needs to be done, because they cannot produce estimates or data based on the facts. They have had to make their recommendation on hunch, and boards are not convinced by their hunches. I hope that it will be thought a useful recommendation in the Bill that data and estimates should be kept up to date so that they may be used by the audit committee in formulating its opinions.

I have accordingly quoted in the Bill the well-known phrase that audit committees should have data and estimates sufficient to allow a reasonable assessment to be made of the future profitability of the company and of its ability to pay its debts as they fall due.

Who will lay down what data and estimates the company is to prepare? Some companies are different from the average run of companies. It is a matter for each company to decide on what data it prepares for the guidance of the committee. Who will lay down what is to be done? I cannot think of anybody better than the audit committee itself. It would act on the advice of the auditors, but its members would be members of the board. Therefore, it would combine practical knowledge of the business with the professional expertise of the auditors. This should be a suitable basis on which to decide what sort of information the company should be producing.

I turn now to the duties which will be put by the provisions of the Bill on audit directors. I have tried to find some function for the non-executive director of the company which will give him standing and influence on the board. I envisage that non-executive directors will continue to be in the minority, so that if it ever came to a vote on the board the now-executive directors would be defeated. If they are confident that they are right but are still certain to be defeated, it would mean that their work was bound to be futile. They must have some statutory support, as non-executive directors, to enable them to make their point even if they are outnumbered by the heads of department represented on the board. Although what I have devised might not be the best possible answer, it is a recommendation which I have followed consistently for a number of years. I have never been convinced that it is not workable, and I believe that it is the best recommendation I can make to solve this difficulty.

I recommend that the audit directors should make a report in each accounting reference period—that is, broadly speaking, each year—to be attached to the balance sheet. In other words, I am suggesting that their report should be available to all the shareholders. Firstly, they must confirm that the data and estimates provided under Clause 3 are properly prepared. It is no good the audit committee's calling for facts about company performance or asking for estimates to be prepared as to where a company is likely to be heading bu then to be served up with half-baked, inaccurate or ill-considered data. Thtey must have some sanctions so that they may insist that this work should be properly done. This should not mean that companies would be forced into endless, meticulous and fruitless preparation of useless figures. On the contrary, in many cases the requirement to produce data for the board, and for consideration by the directors and auditors alike, would be an extremely healthy discipline.

I have another proviso. The audit directors should state whether the report of the audit directors to the board has been duly considered by the board. It may take me a few moments to explain why I have come to that recommendation, which perhaps would not seem to go far if the non-executive directors had decided to take their dispute with the other directors to a wider audience.

However, I have come to this recommendation because I do not wish there constantly to be trouble within companies, with leaks to the Press and matters coming out at shareholders' meetings. I wanted a formula that would lead to board room tensions being resolved long before they erupted into public issues. We must also remember that the audit directors are members of the board and that collective responsibility is a principle of board room practice. We certainly do not wish to create a two-tier board sitting round the same table.

Among the criticisms of the Bullock Report was that it would mean setting up a board with a structure that would almost inevitably result in factions on the board being continuously at loggerheads. That would be highly undesirable. I did not wish accidentally to make the same mistake in my Bill.

If the audit directors brought up a point for discussion at a full board meeting, or even at successive meetings, and yet did not win their point, they could say that the company's top management had been made fully aware of their point of view and reservations. The audit directors would have the option of deciding whether that was sufficient, even though they might not have won their point, and being reconciled to defeat because the board had given the point a thorough airing. That would be a useful half-way house for the non-executive directors. But should they feel that the board had not given due consideration to their representations, they should be in a position to say so. That would immediately attract the attention of the institutions, the Press and the shareholders, and it would be likely to lead to the whole issue being taken up on a wider scale.

If the non-executive directors were really disgusted by the performance of their colleagues and felt that their position could never be reconciled with that of the majority of the directors, they could resign. In the Bill I have tried to lay down a procedure for the resignation of a non-executive director. It is intended to ensure that there could be no question of his being hustled into going quietly if he had a real and serious reservation that could not be resolved.

The unity of the board is now a particularly topical subject, largely because of the attention that has been drawn to the subject by the Bullock Committee's proposals. The Department is being rather unfair to my Bill in insisting—as it seems to have been doing recently—that my proposal for the appointment of audit committees could be examined only in the context of the wider studies of company law in relation to the Bullock proposals that are now being carried out. As I said when the Bill was read a First time, its proposals are not in conflict with the Bullock proposals and they are not subsidiary to them. I wish briefly to draw attention to the way in which my proposals could fit into whatever may come out of the Bullock Committee's recommendations in due course.

I do not want to take up time in discussing the Bullock Report. I hope that in due course an opportunity will be provided for all concerned to make a proper contribution on that matter. But the Bullock Committee has taken hold of the Continental idea that there should be a 2X-plus-Y structure on the board—namely, representatives of the shareholders and of the work force and a third force, or Y element, not specifically inclined towards the interests of either the shareholders or the employees.

I think that it would be disastrous if unitary boards were reorganised in that way. However, we have much to learn from the Continental practice of worker directors appearing on supervisory boards. Unfortunately, we are not familiar with the etiquette of running the supervisory board separately from the executive board. It seems that the Bullock recommendations for splitting the unitary board into 2X-plus-Y are not only premature but completely wrong-headed.

Whether or not the 2X-plus-Y formula is eventually adopted in a unitary or in a supervisory board structure, we need to look more closely at what the Y element will be. On the Continent, particularly in Holland and, I believe, Denmark, the idea of the Y element has been made statutory. We can learn something from the way in which the Dutch now operate their joint stock companies.

I believe that this non-committed element should be as professional as possible in the way it operates and that it should have the necessary data on which to form an opinion which would enable it to come forward in the board room with a distinctive contribution. If it is to reconcile the different positions of the representatives of the stockholders and of the workers, it must do so on the basis of its own strength, not on the capacity to reach a reconciliation by manipulating its voting power. We want the board room to be a place where live disputes are based on conscientious exposition of points of value, which in turn are drawn from real knowledge of what goes on in the company and in the wider economic scene.

I should like the Y element to be composed of people with strong professional associations. Who better to provide that professional guidance than the auditors, who draw on knowledge which possibly would not be so readily available to other members of the board? This Y element would correspond to the audit committee members, and it should be able to call for accurate data on lines suggested in Clause 3.

We should recognise that there is a malaise in the accountancy profession. I believe that we can identify the reasons. It is partly because the audit is inevitably a retrospective function. Auditors are required to look at what the company was doing last year: they are not obliged to look at what is happening now and certainly not to study the future of the business. If something goes wrong, however, the auditors are often involved in the general avalanche of criticism which follows. The audit is almost inevitably limited in scope because it has to deal with the financial situation and cannot deal with other aspects of company management which do not derive directly out of the financial position.

For instance, if it is clear that a firm will run into difficulties when its patent expires and that the board is giving insufficient attention to the sales strategy which it will have to follow after the appearance of competition at the end of the patent period, this could have a significant bearing on the performance of the firm. Yet the auditors, however clearly they can see the problem, have no right and no means to express their reservations.

One could also imagine difficulties arising when companies have not recognised the cost of replacing their existing machinery. Inflation accounting is still, unfortunately, a matter of dispute. The auditors must often be well aware that when machinery comes to be replaced its cost will be so phenomenal by comparison with the historic costs of the machinery already in use that the firm will be in the greatest embarrassment but has no knowledge of it.

One can think of many other cases in which practical economic circumstances or technological changes impinge on the likely performance of a company, but although the auditors can see the problem they have no means of getting it remedied.

There is also the problem that the auditors are rightly recognised as an outside force by the directors and not as members of the management team. After all, the auditors are a supervisory element elected by the shareholders over the heads of the board to look at certain aspects of the company's financial probity.

Company law does not provide for regular contact between the auditors and top management. It has to be incidental or contrived, sometimes even clandestine. I have heard of one or two cases in which, although the auditors felt that it behoved them to get a point of view across to top management, they had no means of doing so. It is no good simply criticising our auditors and making it impossible for them to function effectively. We must reform the law, and we must reform it quickly.

Audit committees in the United States are coming into being and perhaps already are so widely established that in North America it is not necessary for them to be established by law. Among those whose help I would like to recognise I would warmly mention Korn/Ferry International, which produced an invaluable report called "The Outside Director of the Public Corporation" in May last year.

On page 22, that report says: The audit committee is rapidly becoming a standard board of directors institution. Although as recently as the Conference Board's 1973 Report fewer than 50 per cent. of the companies studied had appointed such a committee, the Korn/Ferry Survey of 1976 disclosed that by 1975 the percentage had risen to 89 per cent. The appointment of an audit committee is not a requirement of the law. However, the Securities and Exchange Commission, which has recommended the use of the committee, requires that absence of an audit committee he disclosed in the proxy statement; it is thus likely that companies will choose to appoint such a committee rather than make what is probably viewed as an unpleasant disclosure. In addition, the fact that the Commission, the New York Stock Exchange and the American Institute of Certified Public Accountants have all recommended the institution of audit committees can make their absence at least embarrassing if it is discovered that false or misleading financial statements have been issued.

That quotation from an admirable report gives a clear picture of the way in which the audit committee has been brought into current practice in the United States. I hope that the lessons will be drawn by companies in this country.

Audit committees are coming into being anyway, but the process here needs to be accelerated by the Department, by the Stock Exchange, by professional bodies, by shareholders or by joint action of all the people and all bodies concerned with the health of the joint stock company in this country. I know from parliamentary replies that I have received and from contacts with Ministers that it is likely that the subject of the audit committee will be touched on in the forthcoming White Paper on the Bullock Report.

I look forward with the greatest possible interest to what the Department has to say on this subject. I hope that it will be favourable to the idea. I hope that the White Paper will be couched in such language that firms can see that the practice of appointing audit committees will become normal in this country by one means or another, so that they will take the idea seriously and prepare themselves for this innovation. I truly believe it will be enormously in the interests of management, workers and shareholders and will make an invaluable contribution to the British economy as a whole.

3.56 p.m.

The Under-Secretary of State for the Environment (Mr. Ernest Armstrong)

I am sure that the whole House has followed with avid attention the detailed exposition of this important Bill by the hon. Member for Kensington (Sir B. Rhys Williams). I am only sorry that the House will be deprived of my full reply. Nevertheless, we shall convey to the hon. Member the Department's full comments in clue course.

I know that the lion. Member and the House will understand that the unusual circumstances surrounding today's business have meant that my hon. Friend the Under-Secretary of State for Trade with responsibilities for companies, aviation and shipping, who would normally have spoken from the Government Front Bench in the debate, is not able to be present. This is because of other longstanding official commitments in Wales. I assure the House and the hon. Member that I shall personally convey to my hon. Friend the substance of what has been said. I have no doubt that he will follow closely in Hansard the hon. Member's detailed exposition.

I begin by congratulating the hon. Member for Kensington on his persistence. I understand that the Bill is the ninth on this issue which the hon. Member has introduced. It makes provision for the appointment of non-executive directors to the boards of large companies. It is also of interest because it goes on to require certain companies to establish audit committees.

This is a matter which has attracted growing interest in this country recently. The practice of establishing such committees in publicly-owned corporations widespread in North America, with legislation in Canada going back to 1970. Recently, the New York Stock Exchange has introduced such a requirement for all companies listed on that Stock Exchange. They must comply by June next year, although I understand that approximately 90 per cent. of such companies already have an audit committee. Furthermore, I gather that in recent years there has been a pronounced movement in such companies towards the appointment of a significant number of outside directors to their board, often a clear majority. This, of course, is important since an audit committee can be no better or no more independent than the non-executive directors who are available to serve on it.

This brings us back to the rôle and function of non-executive directors in this country. Such directors often have an important part to play in providing a genuine and effective independent element on the board, to assist and guide and, in some cases, restrain the executive directors who can all too easily dominate the board in an undesirable fashion. As hon. Members will be aware, there have been a number of cases recently where non-executive directors have not met this need and have been dominated by the management of the company.

However, the rôle and function of non-executive directors cannot be seen in isolation from the basic question of the structure of companies, including the composition and function of the whole of the board of directors. This vital question was, of course, at the heart of the report of the committee of inquiry under Lord Bullock into industrial democracy, and is now the subject of a fundamental reappraisal by the Government—

It being Four o'clock, the debate stood adjourned.

Debate to be resumed upon Friday next.