HC Deb 19 October 1981 vol 10 cc130-7

Appointment of an audit committee to be considered

'(1) The agenda of every annual general meeting of a major public company as defined in subsection (2) of this section shall include as a separate item consideration of the appointment of an audit committee of the board. (2) For the purpose of this section a major public company shall be a company registered in Great Britain whose shares are listed on a recognised stock exchange, if within a period of five years ending on the last day of its last accounting reference period, being a day not more than twelve months after the appointed day,—

  1. the amount of the turnover of the company in any accounting reference period of the company exceeded £200 million, or
  2. the balance sheet total of the company (determined in accordance with the provisions of section 8 of this Act) at any time exceeded £400 million or
  3. the number of employees of the company (being full-time employees of the company or any subsidiary company thereof) exceeded 50,000'.—[Sir Brandon Rhys Williams.]

Brought up, and read the First time.

Sir Brandon Rhys Williams

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

Mr. Deputy Speaker

With this we may discuss new clause 15—Constitution and function of an audit committee.

Sir Brandon Rhys Williams

My points need not be too long drawn out. This is not the first time that I have had the opportunity to raise these proposals in the House. In fact, on more than one occasion I have had the leave of the House to introduce a Bill which included this series of recommendations.

The style of management and the constitution of the board of public companies has moved on considerably since the great 1948 Companies Act which enshrined the wisdom of many experts on company law over the previous 100 years or even longer. But the character of society has changed so much since the 1948 Act was framed, and with it the nature of the board of directors, that we should take note of some of the pressures exerted on the boards, particularly in the largest companies, and on their professional advisers.

It is more common now than it was 40 years ago for the dominant role on the board to be taken by the heads of department who have risen through the business to the point where they are invited to become directors, rather than those other directors whose primary concern is to consider the efficiency of the company from the point of view of the investor or even the consumer, the work force or the public at large.

The change that has been taking place has been called the managerial revolution. Whatever name we give it, I believe that most observers would agree that the supervisory role of the board has diminished and that the majority of directors of public companies are now primarily concerned with interests based on their functions as top executives within their departments.

Another change has taken place, although the extent to which it has gone on is currently open to dispute. That concerns the nature of the owners of company shares. The institutional investors now control more than half the equity of our public quoted companies. The proportion is growing and is probably considerably more than 50 per cent. These investors are sophisticated professional people, and the board is often unable to provide the type of expertise in the analysis of its own affairs that professional investment studies require.

That situation puts pressure on the auditors. It tends to take them further in their study of client companies than their strict responsibilities under the present state of the law, but it does not give them the formal status or the agreed guidelines that would assist their operations. The situation is often an unhappy one in very large companies, where the auditors may well feel that they have no formal line of communication to the board on matters that are of great and sometimes urgent significance for top management.

There are also other problems of communication of data and advice which I shall not try to discuss further at this point, except to say that the non-executive directors of large companies are often in need of professional support, which they frequently do not receive.

My proposals are not new. They are, of course, derived from Canadian and particularly from American practice. Clearly, they have been drawn up on the advice of experts in the field, but they also owe something to my own experience of some 20 years in industry and industrial consultancy before I came to the House.

New clauses 14 and 15 are intended to be taken together and are largely a reprint of my Bill of 1977. At that time there was considerable discussion of the practice of the audit committee because it was decided, under pressure from the Securities and Exchange Commission, that the New York Stock Exchange should make it a requirement for any company seeking to be quoted there that it should appoint an audit committee.

I believe that this is a timely opportunity to raise the matter again because such a high proportion of American companies now appoint audit committees to the board and the practice, although still new, is generally regarded in the United States as a useful innovation. It is not just companies on the New York Stock Exchange or other stock exchanges where it has been made a listing requirement to appoint such audit committees that have adopted the practice. Many other companies, particularly the large ones, but also the smaller and smallest companies in the United States, feel that this is a useful thing to do and have now adopted it. In this country we cannot afford to be too smug about the performance of the private sector of industry. There are many reasons, of course, why that sector is going through difficulties just now. I am not saying that our managers are by nature second rate and that they fail to compare with the Germans or the Japanese or the Americans because of some personal characteristics—anything but. My own experience of industry and consultancy convinces me that there is noting intrinsically wrong with British management or with the type of people who rise to positions of responsibility on boards of directors. We are, however, plainly failing to organise those people in a way that enables them to function to their best capacity. If we sometimes do not operate as effectively as companies in the same line of business in other countries, we must be ready to ask ourselves why and to see whether we can learn something from the way in which other countries organise their affairs in the private sector of business.

My proposals are devised to apply only to a small number of very large public companies. I have suggested that they should catch companies with a turnover of more than £200 million per year or with a balance sheet of more than £400 million or employing 50,000 or more employees. I suggest that in the first instance the proposals should be confined to that small number of very large companies because, since the etiquette of the performance of audit committee functions is not yet well understood, I think that large companies, which are most likely to do it well if they institute the practice—as, indeed, they are doing in some cases—should set an example from which smaller concerns may learn and, I hope, fruitfully copy.

The proposal is that such companies as are caught by the Bill should consider the appointment of an audit committee at each annual general meeting. That is a modest recommendation. Some have considered it so modest as to be almost unsuitable to be included in legislation. However, although the requirement would not be obligatory except to perform the small function of including an item on the agenda at the annual general meeting—namely, the consideration of the appointment of an audit committee—it need not be merely a useless formality. Indeed, it ought not to be if the institutional investors are doing their bit.

My particular recommendation for this formula is that it would ensure that any shareholder who sought to raise the matter at an annual general meeting would be in order in doing so. He could not be dismissed by the platform on the ground that his recommendation was out of order. Secondly, the members of the board would always have to be sure in preparing themselves for the annual general meeting—particularly the chairman—that they were ready to make a statement of their view about the possibility of appointing an audit committee. If I could achieve that, I would achieve my purpose for the immediate present.

The aim of new clause 15, which is a highly detailed recommendation, is to provide a kind of table "A" that companies can refer to if it is decided to set up an audit committee and they are seeking guidelines as to what constitutes accepted good common practice. However, even there I am not suggesting that it should be obligatory for companies to do precisely what I recommend. In individual cases companies would adapt the procedure in ways perfectly suitable for the circumstances that they have to meet.

The functions of the audit committee could well include all the items on a list that I have derived from the Staff report on corporate accountability of 4 September 1980, which I was given by extremely courteous advisers in the Securities and Exchange Commission whom I visited two or three weeks ago in Washington in preparation for this debate. It listed as functions for the audit committee the selection of independent auditors, the review of the plan of the audit, of the results of the audit, of the internal controls of the company and of interim financial information, press releases, special investigations, internal audit functions, codes of conduct, providing information to the board—which I would myself wish most to emphasise—and proposed legislation. The report is a detailed one and if my right hon. and hon. Friends in the Department have not studied it they should do so. I should be happy to lend them my copy. I quote only one paragraph at this stage which makes an excellent point: The existence of audit committees in a significant majority of publicly held companies has caused several commentators to speculate that companies without such committees will have some explaining to do to shareholders, investors (especially institutional investors), fellow executives and directors, as well as to the courts. One comment on the audit committee quoted in the report is also apposite: directors of public companies should ask themselves the question, 'If you can establish an audit committee and you don't what are you going to use for an excuse?' It is easy to foresee the problem of a board that has not established an audit committee (or exercised such functions) in defending itself if the company suffers a loss because of inadequate internal accounting controls. Unfortunately, in this country there are all too many cases of companies suffering losses. One suspects that part of the reason is inadequate internal accounting controls. I recommend my right hon. and hon. Friends to consider seriously the advantages of encouraging the adoption of the practice of appointing audit committees at a much faster pace than at present.

11.15 pm

The Government may not agree that this is a matter for legislation and would prefer a suitable term to be included in the Stock Exchange listing agreement. But this matter has been under discussion now for several years, and not enough, in my opinion, is being done. I hope that I have served a useful purpose by drawing attention to it once again and getting my specific proposals back into print.

Mr. Eyre

All hon. Members will, I am sure, agree when I say that we are indebted to the tireless efforts of my hon. Friend the Member for Kensington (Sir B. Rhys Williams), who has tabled a number of suggestions, some of them new, designed to promote the wider spread of non-executive directors and of audit committees. I shall outline why I do not think that the business community needs or is now ready to accept his proposals on audit committees and why I cannot recommend their acceptance to the House. I wish to make it clear, however, that I pay tribute to my hon. Friend for ensuring that these important issues are kept before the House and therefore brought to the attention of business leaders and the wider investing public and, indeed, for playing a crucial part in the public debate that has taken place on them in recent years.

The increasing acceptance of the view that the boards of public companies should contain a substantial proportion of independent non-executive directors is in no small measure due to the persistence and influential advocacy of my hon. Friend. I should like first to deal with the proposals on audit committees. My hon. Friend expressed deep concern that our performance in large industrial and commercial companies should match that of German and other foreign competitors. I agree with his philosophy and aims in that respect. Similar proposals on audit committees were discussed in detail during the Committee stage of the Bill that became the Companies Act 1980. I do not, therefore, propose to go into the technical details inherent in them.

I would, however, stress that although my hon. Friend suggested an interesting constitution and set of functions for an audit committee, the evolution of the audit committee is in its early stages in the United Kingdom. There is no agreement among business men or professional bodies on the purpose of such a committee and on the way in which a statutory provision would detract from the responsibility of the board of directors as a whole with regard to the management of the company.

Many companies have sub-committees of the board which, in effect, carry out the functions that my hon. Friend suggests should be executed by audit committees. The Government's general view is that it is right to leave companies to develop the organisational forms that they find best suited to achieve commercial success, but I remember the point made by my hon. Friend about comparative success. He referred to his visit to the United States and to the document that he received setting out the functions of the audit committee as seen there. I ask my hon. Friend whether he will be kind enough to lend my Department a copy of the document. We would like to study it. I should like to see it myself.

I understand the emphasis that my hon. Friend places on the need for a quicker pace in advancing the development of audit committees. I shall be interested to examine the document that he will kindly make available.

I welcome experimentation in companies. I have referred to the development of sub-committees with a similar purpose and I see no reason to place difficulties in the path of such useful and valuable experimentation, which is what I fear would happen if there were a requirement that companies should consider adopting an audit committee on the lines specified in the new clause.

I ask my hon. Friend to consider withdrawing his proposals, but I should like to say a few words about the consultation with a wide range of interested parties that the Department conducted during the summer on my hon. Friend's proposals on the circulation of a statement on the eligibility of candidates for a directorship and on the requirement that a general meeting should give consideration to the appointment of non-executive directors at any general meeting at which the election of a director is to take place.

I hope that my hon.. Friend found the results of the consultation illuminating and encouraging, because there was some degree of support for the ideas underlying these proposals. But, quite apart from the considerable technical problems, there was little support for recourse to legislation because there was little evidence of any abuse that required to be put right and that, if further stimulus were required, voluntary codes of practice would be more appropriate.

I should, however, add that recent surveys have shown that most large companies have non-executive directors and that the proportion has been growing in recent years—a fact not unassociated with the praiseworthy pertinacity with which my hon. Friend has pursued this cause. Although I cannot stray too far from the clauses before the House, I am sure that my hon. Friend will be pleased to hear that discussions have taken place among a group of leading institutions, including the Bank of England, in order to establish an agency to promote and facilitate the election of non-executive directors by companies that have not hitherto appointed non-executive directors to their boards. An announcement about the details will be made later this autumn.

My hon. Friend probably has a long way to go on audit committees in his missionary zeal to develop a better acceptance of his view of their importance, but there is no doubt that there has been considerable progress on non-executive directors. His efforts have played a considerable part in that, and the process is continuing in a way that I think he will welcome.

I express my gratitude to my hon. Friend for putting the proposals forward and giving the House a further opportunity to consider these important issues.

Mr. Clinton Davis

I think that the Minister has been to the supermarket to buy a vast quantity of soft soap. I do not believe that he can have satisfied his hon. Friend the Member for Kensington (Sir B. Rhys Williams) with his bland reply to the important points that the hon. Gentleman raised.

We had from the Under-Secretary a regurgitation of the same reply as we have received every time that the argument has been raised by the hon. Member for Kensington, with some support from me. It is extremely disappointing.

We were told in our previous debate on the subject that most companies behaved benignly, that legislation was to be opposed, and that if we relied on the voluntary approach everything would come right. Now we have the new consultation that has taken place—with precisely the same results as were announced before. We were told that there were technical problems. We were told before that there was little support for recourse to legislation. All that the hon. Member for Kensington is seeking is a perfectly reasonable proposal, to be advanced at every annual general meeting of a major public company as defined in his new clause. Whether the exact definition is right is by the way. We are now discussing the principle.

What can possibly be wrong with leaving the matter for determination by the annual general meeting? The Minister conceded the whole case. He said that the general view was that it was best to leave companies to develop the organisational forms that they deem best suited to delivering commercial success. Well, here is the opportunity. It is best left to the annual general meeting to determine the matter. If the matter does not appear on the agenda, it is never likely to get off the ground. In my view, the hon. Member for Kensington is right in arguing the case again and again, but it is a pity that he does not derive rather more positive support than has been evinced by the Minister tonight.

That was not quite the response that I gave the hon. Gentleman when I dealt with these matters. I took the view that his arguments were extremely persuasive. Of course one must consult, and of course one must try to arrive at a consensus on these matters, but I am not satisfied with the Minister's bland assertion that spectacular progress has been made over the past few years because of the hon. Gentleman's diligent efforts, speaking occasionally at half-past eleven at night or at some other unpleasant hour, and that it is this that has caused a dramatic change in our corporate affairs. Life is not like that. I am second to none in my admiration of the hon. Gentleman's dedication to this cause and the way in which he has put it before successive Committees dealing with company legislation, but I do not believe that even he would claim that this superhuman effort could be achieved by him alone, or by managing to electrify company directors all over the country into the belief that, reading his words in Hansard—which I am sure all of them do—or in some other esoteric magazine, somehow the situation will be changed. As I said, life is not like that. However, that does not mean that I am urging the hon. Gentleman to give up. One day he may persuade a Minister at the Department of Trade to do something about it.

In my view, this is a modest but desirable new clause, at least in principle. I am not in a position to determine whether the exact wording of new clause 15 is wholly appropriate. However, I wish that the Minister had said "There is a case for this. I shall do it, perhaps not in this Bill—we are not having a Bill next year—but in the next Bill. I really want to do something along these lines." Instead, the Minister has said the same old thing—"Leave it to companies to determine the matter voluntarily, and everything will turn out all right." I regret that that is not so.

When the Minister says that a growing proportion of companies are applying the principles of the audit committees, it is just an assertion. It is not backed up by fact. I only wish that it were true, and that most companies were dealing with matters along the lines suggested by the hon. Member for Kensington. I give him my support, for what it is worth at 11.30 at night, but I am saddened by the fact that the Department of Trade does not seem to be advancing along that route nearly quickly enough.

11.30 pm
Sir Brandon Rhys Williams

With the leave of the House, may I say that naturally I proposed the clauses in the hope that the Government would accept them? I think that the formula that I have adopted is so moderate that even the people who are instinctively against further legislation on board practice and the functions of the auditors, and so on, would say that this was a useful innovation which might do good in many cases and would do harm in none.

I am reminded of a famous quotation from Bryce: But while they talked the heavens darkened, and the flood came and destroyed them all. I am afraid that while we are talking about the possibility of introducing audit committees in many of our large companies they will go bankrupt, or the whole social scene will change so much that the issue will die on its feet. Although I have had the assurances of Ministers and experts—Establishment figures particularly—that everything is going along quite all right and that there is no need for legislation, I do not think that there is any evidence that we are making significant progress in this area.

So, although I shall not press the House to divide on these clauses now, in view of what my hon. Friend said—and I appreciate the approach that he has adopted, because he intends to commend what I am recommending to management and would like to see progress on these lines—I am not satisfied that we are making sufficient progress simply by voluntary effort. Some stronger form of encouragement, if not compulsion, is needed, and I shall return to the matter again.

Question put and negatived.

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