§ Order for Second Reading read.
§ 5.9 pm
§ The Minister for Industry and the Regions (Jacqui Smith)
I beg to move, That the Bill be now read a Second time.
The Bill comes to us having been thoroughly and expertly examined in the other place. Their lordships debated the Bill for some 27 hours and made 67 amendments, many of which were, at least in part, in response to points made by Opposition parties. I hope that this House can continue to deal with the Bill in such a constructive manner.
Good company law needs to provide the framework for enterprise—to provide a legal form for organisations to help them to do business, to build prosperity, and to create jobs and opportunity in our economy. Company law has a long history. Before Gladstone's Joint Stock Companies Act was passed in 1844, it was very difficult to form a company as a body corporate. Once it became possible to incorporate a company simply by registration, and especially when limited liability became available a decade later, the company form very quickly gained in popularity, and today there are some 1.8 million companies on the register in Great Britain.
We all need to feel confident in our dealings with business. As investors, creditors and consumers, we need to know that our money is secure, and to have trust in corporate Britain. Our company regulation is designed to balance the freedoms that promote enterprise and wealth creation with the necessary minimum safeguards to protect investors, creditors and others who do business with companies. The law therefore requires companies to comply with certain requirements and make available specified information. Almost all companies also opt for limited liability, meaning that if a company becomes insolvent, its shareholders are liable only for the amount that they have agreed to invest in the company. Limited liability companies must therefore provide additional financial information, so that those doing business with them can judge their soundness.
A sound system of company regulation is an important source of competitive advantage. By matching the degree of control to the amount of risk to the economy and society, a good system will encourage business start-ups and minimise regulatory burdens. It will ensure confidence in companies and financial markets and thus lower the cost of capital.
Company law not only sets out the conditions for incorporation and limited liability. As the author of one book on company law puts it, there arearguments for state-provided default solutions, so that each set of contracting partiesdoesnot have to re-invent the wheel".The Bill sits firmly in the tradition of statutes that facilitate the framework for enterprise and set the terms of the company bargain. Part 2 creates a new type of 636 company, the community interest company, as a tailor-made vehicle for social enterprise—for businesses trading with social objectives rather than to make private profit. We believe that social enterprises can play a distinct and valuable role in creating a stronger, sustainable and socially inclusive economy. They can help to drive up productivity and competitiveness, enable individuals and communities to work towards regenerating their local neighbourhoods, develop new ways to deliver goods and services, and encourage active citizenship. Social enterprises also help to drive innovation, not only in relation to their products and services, but in relation to the way in which they operate.
Research by the Small Business Service found that social enterprises made both a substantial contribution to local economic development, with 86 per cent creating additional jobs, and a wider social contribution—for example, involving volunteers and providing training and experience for socially excluded people. Social enterprises include Bulwell Hall Community Garden, a business that provides training opportunities for the long-term unemployed and work placements in gardens and allotments; at the same time, it grows and sells healthy produce and creates community space. Bulwell Hall supported the principle of the community interest company and agreed that it would help to raise the profile of the sector and help others to understand social enterprises. That organisation and others in the social enterprise sector told us that they wanted the advantages of the company form but found it difficult and expensive to set up a company with the special features that they needed, such as safeguarding the company's assets. Thus, we are doing exactly what the textbook prescribes and providing a default solution so that people who start a company for social enterprise do not have to reinvent the wheel. That will make it easier to set up social enterprises and will, over time, encourage the development of the social enterprise sector, which has much to offer our communities and economy.
The community interest company will be a new and additional choice for social enterprises. It is not meant to replace other options such as charities, or the industrial and provident society, which is the form used by many co-operatives. Indeed, the Government are committed to modernising all legal options used by voluntary and community organisations and helping people to choose their most appropriate option. The special value of the community interest company is that it will offer the flexibility of the company form, yet be more suitable for many social enterprises than existing types of companies. Responses to consultations show that there is about 80 per cent. support for the idea of the community interest company, and it is supported by bodies including the Social Enterprise Coalition, the National Council for Voluntary Organisations and the Association of Charitable Foundations.
Again, the community interest company is based on the idea of a bargain, and part 2 of the Bill creates the legislative basis for that balance. The people who run a community interest company will voluntarily accept certain constraints and a higher level of supervision and, in return, the company will acquire a status that signals to customers, investors, employees and bankers that the business is run for the benefit of the community, that its profits are wholly or largely applied for the benefit of the 637 community, that its assets are protected for the benefit of the community and that it is subject to oversight from a regulator. The regulator will have the task of maintaining confidence in community interest companies and will also promote awareness of the potential of the new type of company.
§ Bob Spink (Castle Point) (Con)
Of course we are all in favour of social enterprise and want the new CICs to succeed. How many of the new companies does the Minister expect to be formed over the first year and over the first five years? What will be the cost of the regulator for such companies?
§ Jacqui Smith
I genuinely do not know how many companies will be formed over the first year or five years. However, we have already received general support for the measure and from the sector, and specific requests for information from enterprises that think that the provision might be appropriate for them. Such enterprises range from educational companies to companies that provide community services, such as community transport companies. Many bodies think that the measure will be beneficial. As we made it clear in the regulatory impact assessment—I will correct myself if I am wrong—we suggest that the set-up costs will be about £500,000, that the cost of the regulator will be about £150,000 a year and that the cost of setting up an individual community interest company will be about —40.
Part 1 of the Bill will strengthen existing provisions on company accounts and audit, on the regulatory system for auditors and on company investigations in the wake of the Enron and WorldCom scandals. Although those scandals occurred in the United States, they raised fundamental questions about the reliability of the accounting and auditing system. However, we did not rush to legislate here. Instead the Government, acting jointly with business and the accounting profession, reviewed the whole British system of controls on financial reporting in the light of lessons learned from the American problems. We reviewed our corporate governance, company law and the role of the auditor in a measured and inclusive way. We consulted widely, listened to experts and set up the co-ordinating group on audit and accounting to consider issues of financial reporting and auditor independence. Of course, our system comprises not only company law itself but those parts of the financial services regulatory system that set standards for companies listed on the stock exchange. The FSA's listing rules give legal force to the Financial Reporting Council's combined code on corporate governance, which was revised last year, with the Government's full support, following reviews by Sir Derek Higgs and Sir Robert Smith.
Sir Robert Smith's report called for the strengthening of the role of the audit committee. In addition to recommending that all members of the audit committee be independent, Smith recommended that at least one member should have significant recent and relevant financial experience. Those recommendations, along with Sir Derek Higgs's proposals on the role and 638 strengthened effectiveness of non-executive directors, provide a sound basis for improvements in audit and in our boardrooms.
§ Mr. David Drew (Stroud) (Lab/Co-op)
If my right hon. Friend does not mind my saying so, something is missing from the Bill, as the administration process needs to be made more transparent. Accountants and auditors play a specialist role in running companies in difficulties, but the lack of transparency means that the companies, their workers and pensioners are completely in the hands of the administrators. Would my right hon. Friend care to look at this matter to see if we can open up that secret garden, as insolvency practitioners can do enormous damage to our country—let alone individual companies?
§ Jacqui Smith
My hon. Friend is right that that is not within the remit of the Bill, but I, like him, have dealt with constituency cases that demonstrated that we need to shed light on the process for the sake of people's jobs. I cannot undertake to look at that matter in this Bill, but as is the case in a range of areas in corporate governance and financial reporting, we will ensure that the greatest amount of transparency and information are provided so that we can serve the best interests of businesses and the people who depend on them for their jobs and livelihood.
I was outlining the review process, which confirmed that the British system of company regulation was fundamentally sound. The priorities for change, however, were to build independence, transparency and high standards of corporate governance to keep Britain at the forefront of company regulation. Many of the recommended changes were aimed at companies and accountants and did not require legislation. Audit firms, for example, have agreed to rotate at regular intervals the lead and other audit partners working on a company's audit. Non-legislative changes, including the reform of the combined code I mentioned earlier, work with the targeted statutory provisions in this Bill to create a measured, well-considered and thorough response to the problems highlighted by Enron and WorldCom. The review ensured that there was wide consultation leading to much consensus, both on what should be done and how it should be done. In particular, there was much agreement that, wherever possible, transparency was preferable to inflexible rules.
§ Lynne Jones (Birmingham, Selly Oak) (Lab)
The Bill merely proposes rotating the partners of an auditing company. Is my right hon. Friend satisfied that that is sufficient, as it is hardly likely that a partner who replaces his colleague as auditor will criticise him?
§ Jacqui Smith
We started from the belief that auditors are professionals who are committed to their responsibilities to company shareholders. My hon. Friend may be suggesting that an alternative is to make it a statutory or compulsory requirement to rotate the firm. No other European country has undertaken to do that.
The emphasis on good practice already adopted by the profession, such as rotating the audit partner, is likely to bring about improvements. My hon. Friend says that that is the only thing the Bill does, but that is 639 not the case. We have taken non-legislative action, as well as legislative action in the Bill, to create a comprehensive range of improvements with respect to audit, in terms of the independence of the regulation of auditors, the recommendations that Sir Robert Smith made in his report, which are now enshrined in the combined code, and the rotation of audit partners, as I outlined. All those together help to build the improvements in the quality of audit which—I agree with my hon. Friend—we want to see.
§ Bob Spink
With all due respect to the right hon. Lady, I hardly see how she can pass the Bill off as providing a comprehensive range of solutions to the problems in company law. The Bill simply tinkers at the edges. It would be far better to tackle the wholesale reform of company law, rather than introducing piecemeal solutions such as the Bill.
§ Jacqui Smith
The hon. Gentleman accuses me of doing something that I do not think I did. I did not say that the Bill was a wholesale reform of company law. I said that, together with the non-legislative measures taken following the reviews that the Government carried out, it brought about a comprehensive change in the system of audit regulation and independence. That is what the Bill focuses on, particularly the role of auditors. It is right that we did that in response to the concerns raised internationally and certainly in the House after the Enron and WorldCom scandals. As I suggested, there is a fundamental need to ensure that we have faith in our financial reporting arid our corporate governance. Of course it is important that we also take action more broadly on company law reform. That is why we instituted the company law review and why we will introduce more fundamental legislation as parliamentary time allows.
To build on what I was saying to my hon. Friend the Member for Birmingham, Selly Oak (Lynne Jones) about the scale of what is being changed with respect to audit, the Bill, in line with the principle of transparency, extends the requirements for disclosure of the non-audit services that a company buys from its auditors. It completes the review process by giving legal underpinning to many of the changes that have already taken place.
§ Lynne Jones
My right hon. Friend is correct—as she would be, being the Minister in charge of the Bill—that there are many measures in the Bill, but are not most of them very weak? Again she mentions non-audit activities. The United States legislation passed in response to the Enron scandal, the Sarbanes-Oxley Act 2002, prohibits certain non-audit functions or requires the rest of them to be authorised by the audit committee. Why are our provisions so much weaker than those in the US?
§ Jacqui Smith
Given the experience of the US and the fact that the Enron and WorldCom scandals happened there, it can hardly be argued that the basis of our regulatory system is much weaker than theirs. It is true that the changes made in the Sarbanes-Oxley legislation with respect to non-audit services took a different route 640 from ours. That Act lists a range of non-audit services which it would be illegal for the auditor to provide. Interestingly enough, the list is not as wide-ranging as some believe—it does not include tax advice, for example. That is not forbidden in the Sarbanes-Oxley legislation. We took a different approach, in line with our principles-based approach to company legislation, so that, for example, under the new ethical standards drafted by the Auditing Practices Board and currently out for consultation, it would not be appropriate in this country to provide alongside audit many of the non-audit services that are contained in the Sarbanes-Oxley Act. Alongside that, we have clarified the detail that companies must provide to their shareholders on types of non-audit services and money spent on non-audit services.
§ Jacqui Smith
I shall give way in a moment.
We can take one of two approaches to audit regulation. We can take a rules-based, legislative approach, which was adopted in the United States, or we can build on the principle-based approach that we already have in the UK. My hon. Friends push for more legislation, but I ask them to consider which of those approaches has been most successful up to this point.
§ Mr. Deputy Speaker (Sir Alan Haselhurst)
Order. It would help if the right hon. Lady gave an indication.
§ Mr. Cousins
The Minister knows that the Sarbanes-Oxley Act does not contain a system of exemptions for British companies that are registered and quoted in the United States, so the provision about the separation of audit and non-audit services will be imported into the British system by that route. Has she closed her mind to a statutory provision on the separation of audit and non-audit services, because possible conflicts lie ahead if she has?
§ Jacqui Smith
We have not closed our minds to anything, which helps us to improve confidence in both financial reporting and the quality of audit. My hon. Friend is right that the Sarbanes-Oxley Act has implications for the operation of UK companies, and it has potential implications for UK audit companies operating in the US. Nevertheless, that does not mean that the US and the UK must take the same approach to delivering the same objective. As I suggested earlier, evidence suggests that our approach has successfully achieved the objectives of effective auditing and confidence in financial reporting. Confidence in the quality of auditing depends on high standards for the training and supervision of auditors, high standards of practice and ethics and an independent system for investigating and disciplining auditors who fall short of those standards.
641 A clear recommendation from the reviews was that the regulatory regime for the accountancy and audit profession could be simplified, improved and made more visibly independent by combining the bodies under the Accountancy Foundation with those under the Financial Reporting Council. That has created a single, independent group of organisations responsible for the recognition and supervision of the professional accounting and audit bodies, the preparation of accounting and auditing standards and for ensuring that major companies' accounts comply with the law and accounting standards.
That reorganisation has already taken place with the profession's full involvement and the Government's full support. The Bill makes the necessary amendments to legislation to support those organisational changes and bolster the independence of those arrangements. In particular, it requires that ethical standards, quality control and disciplinary action for audits of public interest companies be independent of the professional bodies themselves.
The Bill also contains measures to help auditors do their jobs properly and effectively. It extends the range of people from whom auditors are entitled to obtain information and, in effect, requires directors to state that they have not withheld relevant information from auditors. We redrafted that provision in response to concerns expressed while the Bill was in another place, and it now sends a clear and useful signal to directors and auditors, while avoiding placing an unreasonable duty on, for example, non-executive directors.
In addition, the Bill contains important clauses aimed at strengthening compliance with the law and standards on accounts, which, again, largely involves implementing recommendations from the post-Enron reviews. The Bill strengthens the body responsible for compliance—in practice, the financial reporting review panel, which is part of the Financial Reporting Council group. It will, for example, enable the Inland Revenue to pass to the panel information to help it in its function of securing compliance with accounting requirements. The panel will also be able to require information to assist it in its inquiries, and its scope will be extended to cover interim as well as annual reports.
Of course, the vast majority of British companies conduct their business honestly and produce accurate financial reports. They will seldom, if ever, be subject to enforcement action by bodies such as the financial reporting review panel or the DTI's companies investigation branch. However, a very small minority of companies do seek to abuse the system and we need to take firm and effective action against them. Their misdeeds can harm not only their own customers, suppliers, employees, creditors and investors, but confidence in companies generally. That is why the Bill contains some amendments to the powers of company inspectors and investigators.
In a typical year, the companies investigation branch receives more than 5,000 complaints about companies. All are examined to see whether they merit formal investigation. Some are passed to other bodies, such as trading standards authorities, the Financial Services Authority or the police. Each year, the DTI itself investigates some 350 companies out of the total of 1.8 million. Where an investigation reveals significant wrongdoing, further action can be taken. In 2002–03, 642 following DTI investigations, 80 companies were wound up by the courts, 17 directors were disqualified, and seven individuals were convicted of offences. Moreover, my right hon. Friend the Secretary of State can disclose the otherwise confidential information resulting from investigations to a regulatory or professional body, such as the FSA, the financial reporting review panel or the Accountancy Investigation and Discipline Board, so that it may take action where appropriate.
The amendments in the Bill to increase investigators' powers—for example, to enter and remain on premises and require documents and information, including from third parties—are modest and remain subject to safeguards to protect human rights, legal privilege and banking confidentiality. But they are necessary to prevent a very small number of people from exploiting limitations in the existing law so as to frustrate investigations. That small minority gives companies a bad name. Indeed, victims are often other companies, as well as other organisations and individuals. These changes are therefore necessary and urgent, and it is right to include them in part 1, which is about maintaining and improving standards of financial reporting and preventing abuse.
I turn to the subject of director and auditor liability, on which the Government published a consultative document in December last year. That was in response to calls from some quarters to change the law dating from the 1920s that prohibits companies from agreeing to limit the liability of their directors or auditors. We received more than 120 responses to the consultation, from a wide cross-section of British business. The Government are grateful to all those who took the time and trouble to respond to the consultation. My right hon. Friend the Secretary of State set out our response in a written statement this morning. I do not intend to repeat that statement, but it explains that we propose to table amendments in Committee to tackle concerns that good candidates for directorships are being increasingly deterred by the risk of lengthy and expensive legal proceedings. I shall ensure that hon. Members on both sides of the House receive those amendments as soon as possible.
The statement also explains why the Government do not propose to introduce a cap on auditor liability. However, we remain committed to improving the operation of the audit market. We will continue to consider any proposals, including the possibility of limiting liability on a proportionate basis by contract, which can be demonstrated significantly to enhance competition and to improve quality in the audit market. We urge auditors, business and investors to work together to examine whether proposals for a system of proportionate liability via contract are practical and desirable.
§ Mr. Cousins
I apologise for interrupting my right hon. Friend's flow on an important point, which is at the heart of the Bill. She has outlined a system whereby audit liability could be limited by contract. That was in this morning's important statement. Do I understand correctly that any reflection of that in legislation will not be for the Bill but for a future date and that her 643 assurance that the Government have no proposals on restrictions or caps on auditor liability will remain in full for the lifetime of the Bill?
§ Jacqui Smith
I said that we would not want to act unless there was evidence that that would improve quality in the audit market or support competition. However, the ball is now in the court of the auditors, business people and investors to ascertain whether that would be desirable or practical. The speed of the considerations and those of Government would determine when, if and in what legislation the proposal was presented.
§ Mr. Mark Hoban (Fareham) (Con)
I am grateful to the Minister for clarifying the statement that the Secretary of State made this morning. Could she set out more clearly whether, if industry and the professions come together and reach a consensus on how to limit liability by means of proportion, the Government will accept their conclusions, subject to their being capable of translation into law? Is it down to professions and the industry to drive the process forward? Will the Government accept their conclusions?
§ Jacqui Smith
I do not believe that the Government would ever give carte blanche and simply accept conclusions without careful consideration. We would want to put our objectives at the centre of that consideration. They are that companies in this country can find and get access to suitable audit, that the audit quality continues to be driven up and that we improve the competitive position in the audit market. If it is possible for us to find a route that enables us to deal with the auditors' concerns and support could be built for it with business and the investor community, I have undertaken to consider how, when and if it could be included in legislation.
§ Mr. Andrew Mitchell (Sutton Coldfield) (Con)
I want to cover the matter in my remarks later. However, in view of the comments from the hon. Member for Newcastle upon Tyne, Central (Mr. Cousins) and my hon. Friend the Member for Fareham (Mr. Hoban), will the Minister explain why this morning's statement contained no clear analysis of the responses that were received to the consultation process? Will she make available to hon. Members an analysis of all the responses so that we can judge whether there might be the sort of agreement to which both hon. Members referred?
§ Jacqui Smith
I shall ensure that, in the next couple of days, an analysis of the responses to the consultation is made available to all hon. Members. It is worth saying that the option was not presented in the consultation, but it has now rightly been proposed, so we need to examine it in detail. I undertake to ensure that the analysis of the consultation is made available to all hon. Members as soon as possible.
Company law is fundamental to our economic success. It is a large and complex subject that has developed somewhat haphazardly in the past 150 years. It has been further complicated in recent years by the 644 addition of European legislation on some aspects, and the task of updating and, wherever possible, simplifying that body of law has proved challenging. We are now close to completing it and we intend to restructure the law in line with the principle that we set out from the beginning: think small first. Instead of complex and detailed provisions, coupled with exemptions and relaxation for smaller companies, often hidden away in different parts of the legislation, the law will start with the basic requirements for all companies and subsequently set out any necessary additional requirements for larger companies. That will help to make the law clearer and more accessible for all, but especially for smaller companies and their advisers. It will be a valuable reform and a good example of better regulation.
As I suggested earlier, we are working to modernise company law in the light of the recommendations of the independent company law review. We intend to publish a draft Bill for consultation and then introduce it as parliamentary time allows. We are already consulting on a key element of the modernisation proposals, namely powers to reform and restate company law so that it remains flexible and accessible to business, especially smaller companies. We have also consulted on many other elements, as did the company law review itself. Topics include directors' duties, annual general meetings and the requirement for company secretaries, and we intend to consult on a new additional element, namely the implementation of the EU takeovers directive.
The Bill makes some important improvements, facilitating a new type of company and giving further opportunities to the social entrepreneurs who are doing so much to build new ways of providing services and doing business. In improving our audit regime and our investigations powers, it will help to maintain and improve the integrity of financial reporting, further underpinning confidence and trust in markets, with higher standards and, importantly, an effective enforcement regime for when things go wrong. It will build on the remarkable success of the company form, which is the keystone of economies throughout the world, and ensure that this country's corporate structures and regulation remain one of our key competitive advantages. I commend the Bill to the House.
§ Mr. Andrew Mitchell (Sutton Coldfield) (Con)
I draw the House's attention to my interests, which are clearly laid out in the register.
In her most interesting speech, the Minister inadvertently emphasised the fact that this is a very disappointing Bill. In opening, she referred to the joint stock company and to what Gladstone had said about it. When the Bill received its Second Reading in the other place, Lord Sainsbury, quoting a recent publication, said that the joint stock company wasthe greatest single discovery of modern times".—[Official Report, House of Lords, 8 January 2004; Vol. 656, c. 258.]It is certainly true that the company has a claim on such an accolade, but it has been severely let down by this Government.
As my hon. Friend the Member for Castle Point (Bob Spink) asked in an intervention, where is the long-promised, comprehensive and much-needed reform of 645 company law? Did not the distinguished men and women who made up the company law review produce and deliver their two-volume report to the Department as long ago as 2001? Why are we abusing the parliamentary timetable with this partial and emaciated little Bill? How long does she think it will be before her Department is able to secure once again parliamentary time for such matters?
The Bill in no way provides the comprehensive, much-needed and long-promised reform of company law. Despite the Secretary of State's assertion thatthe law needs to change. It needs to modernise and reform. It needs to be fit for the twenty-first century and beyond",the Government have instead chosen to amend and add yet another layer of complexity to existing company law while tackling only a very small area of reform. Despite the excellent work of the 15 members of the company law review group, the Government have failed to tackle wholesale reform as promised.
If the Government had devoted sufficient resources following the presentation of the report in July 2001, we would not now be debating the Bill. Instead, we would be tackling a Bill that would streamline procedures for all companies, especially smaller companies, making the law clearer, more accessible and responsive to developments, strengthening trust in UK markets and its companies and developing an even more effective UK corporate law and governance regime. Instead, more than three years later, we are dealing with a Bill that cobbles together bits and pieces and adds yet another layer of complexity and confusion.
I draw the House's attention to page 19 and clause 15, which tackles theApplication of provisions inserted by sections 11 and 12 to bodies appointed under section 14".The entire page is comprised of references to the Companies Act 1985. It does not read as prose, but as a series of numbers so complex and inter-related as to obscure the implications and meaning.
The second key point about the Bill is equally worrying. We remain concerned that the Government have no concept of the damage excessive regulation and bureaucracy do to UK plc and of the difference between the two separate concepts of fraud and risk. As a result, Labour continues to impose burdens on business that frustrate the honest and may not much impede the dishonest.
Where the Government are targeting fraud and wrongdoing, we will, of course, support them, but when the Bill imposes burdens on business that are little more than box ticking and that discourage entrepreneurs and entrepreneurialism, we will oppose them.
During the recess, hon. Members may have enjoyed a series of articles about the British economy by Anatole Kaletsky. He explains how its current strength is derived from a number of reforms, made principally, it has to be said, by the last Conservative Government, but also by this Government. However, with words that the Minister would do well to heed, he warns that red tape and bureaucracy—hugely increased and promoted by this Government—are seriously damaging the British economy, saying thatproliferating regulation, especially employment regulation, is now probably the greatest threat to the long-term growth of living standards in Britain. Over-regulation is also a greater handicap for 646 exporters than the value of sterling, the scale of the consumer boom or any of the other macroeconomics 'blunders' attacked by the manufacturing lobbies. Anyone concerned about the sustainability of Britain's balance of payments should forget about the Bank of England and Gordon Brown and worry instead about the threats to Britain's export earnings from heavy-handed regulation.Anatole Kaletsky is entirely right.
The Government's failures in those two areas—delivering on company law reform and understanding the damage to business caused by excessive regulation and bureaucracy—are matched in part 2 by our third major concern, which is the cack-handed way in which they are seeking to introduce the community interest company. This new legal form for charitable and not-for-profit enterprises is peculiarly tacked on to an audits and investigations Bill, rather than forming part of the long-awaited Charities Bill, which is due to come before Parliament this very autumn and is now receiving pre-legislative scrutiny.
It would have been far better to allow the major debate on charity law reform to run its course before engaging in this minor debate on CICs. We do not even know how CICs will fit into the new regime once major reform has taken place. I commend to the Minister the opportunity to study the charitable incorporated organisations—the CIOs—planned for the Charities Bill. This is yet another example of the cart being placed before the horse.
I have the honour to sit on the Committee of both Houses that is examining the draft charities legislation under the able chairmanship of the right hon. Member for Darlington (Mr. Milburn). I hope that we can improve the draft legislation that the Government have helpfully already published, so what a remarkable decision it is to introduce the CIC in this Bill and at this time, rather than wait until the eminently sensible discussions and consultations on the wider issues affecting charities have been concluded. This is yet another example of Government incompetence, their abuse of the House of Commons and their failure to live up to their high aspiration for joined-up government.
Fourthly, the Bill, which was introduced in November 2003 and imposes more liabilities on directors, completely pre-empts and makes a mockery of the Government consultation exercise on auditor and director liability concluded in March this year and on which they have only this morning rushed out a statement. Thorough consultation before the drafting and publication of the Bill would have been far more appropriate and would have led, one hopes, to a more tightly and better-drafted Bill that was less in need of correction and amendment.
As the Bill is an amalgam of leftovers and add-ons, it is very difficult to appreciate the full impact that it will have. That is particularly true of the measures designed to strengthen corporate governance and audit practice, some of which the Minister mentioned. The Bill is only the tip of the iceberg—the tip that requires legislation—but there is a great deal going on elsewhere that does not require or has not required legislation.
Paragraph 3 of the original explanatory notes states:These legislative changes…are intended to complement a package of non-legislative measures designed to strengthen corporate governance and audit practice".647 The non-legislative measures are very important. They include changes to the combined code on corporate governance in July 2003 following a review by Sir Derek Higgs of the role and effectiveness of non-executive directors, Sir Robert Smith's guidance on audit committees in January 2003 and the Financial Reporting Council taking over the functions of the former Accountancy Foundation.
No one can be in any doubt about how very complicated these issues are, and especially about how the Bill relates to the wider package of reforms and changes. We need to ensure that the parameters of these legislative provisions are appropriate, given that wider framework. A great deal remains to be done. Not only do we continue to await wholesale reform of company law, but the Government still have not tackled issues such as auditor liability. I hope to say something about that at the end of my remarks that may even be helpful to Ministers.
In the rush to push the Bill through Parliament, the Government have produced a measure that is deeply flawed and often poorly drafted. I am particularly alarmed that so many provisions rely on secondary legislation and additional and often undetermined regulations. There are no fewer than 81 references to further or existing regulations. Even in the smaller second part of the Bill, which tackles the CICs, further regulation is required under—at the very least—clauses 27, 28, 29, 31, 32, 33, 34, 44 and 55. We are all grateful to the House of Lords, and especially to Lord Hodgson and Lord Glentoran for their thorough scrutiny of the Bill, which led to much-needed amendments and clarifications. Here, at last, we can say something more positive.
On reading the list of amendments accepted on Report in the other place, I was relieved to see that the Government have made several concessions, which go some way to improving the legislation. About half the Government amendments were a response to points made by the Opposition during consideration of the Bill. In particular, we are pleased to see the original clause 9 replaced entirely, in response to Lord Hodgson's argument that the original wording—relating to the statement of disclosure to auditors—placed an onerous and unacceptable burden on directors.
We remain concerned, however, that the introduction of a new clause 9 does not go far enough. Although directors are now provided with some defence, there is not sufficient distinction between the role and responsibilities of executive and non-executive directors. Under company law, all directors are considered equally responsible for the company and therefore equally liable; new clause 9 does not undermine that. However, in reality a non-executive director does not play the same role as an executive director, nor is he as well informed about the operations of the company. He must rely on his co-directors, yet the Bill fails to recognise that.
Any person who is thinking of taking on such a role will ask themselves, "If I am going to take on this non-executive role, what are the risks involved and possible costs?" If we want to encourage good-quality people to take on those positions, we must ensure that the risk 648 involved does not outweigh any potential reward. As the Bill stands, the role of a non-executive director will become increasingly undesirable.
Picking on directors or auditors may excite the juices of some Labour Members, but there are very serious issues at stake. The potential personal liability of a director of a public company is out of all proportion to any rewards he or she may receive. That simply means that good people will not come forward to serve on major public boards. We are moving towards a situation where experienced independent non-executive directors will not be willing or available to come forward just when we are all agreed that company boards should have more independent non-executives on them to promote good corporate governance.
As Lord Hodgson said in the other place, we are nearing the point when the only qualification for being a non-executive director is to know nothing about it. I shall come to auditors later, but our argument about capping potential liability of directors remains compelling, as the Government have begun to accept in their response to the consultation document today.
We have also made some progress in other areas. We are glad that the Government have accepted the Opposition argument that co-operation between the FRC and the accounting profession is vital, and that clause 2 has been amended to ensure that co-operation is not misconstrued as compromising the independence of arrangements under the FRC structure. The original clause ran the risk of preventing senior members of the accounting profession from sitting on the council or its board of directors, providing much needed experience and advice. We can all agree that co-operation is essential for the smooth running of the new system.
I will not tire the House with a full list of the changes that have been secured, but it will be a relief to those thinking of setting up a CIC to learn that clause 23 of the original Bill—now clause 24—has been amended, replacing the original and vague wording with a clearer and more precise concept of the CIC and the issues surrounding charitable status. They will also find a number of amendments accepted to clause 28, which places a cap on distributions and interest, creating an asset lock relating to restrictions on distributions; distribution limits, which are now to be set according to "descriptions" of CICs, based on sector or geographical area rather than each CIC; and the removal of specific powers from the Secretary of State relating to the manner in which the regulator is to review the limits on distributions. Furthermore, greater transparency will be achieved as a result of the Government's support for an amendment to clause 32, which will require that information on directors' remuneration must be included in the annual report of any CIC.
That is not a complete list, but I hope that it might show that the Government continue to have an open mind about other necessary amendments, on which basis I advise my right hon. and hon. Friends not to oppose this Bill on Second Reading today. I can tell the Government, however, that our position on Third Reading will depend on whether the spirit of cooperation evident on Report in the other place survives the Bill's translation to Committee and Report in this place.
649 I turn now to our concerns about the Bill, and it might help the Minister to consider them before they are discussed in Committee. We remain particularly concerned about six aspects.
First, on the independent monitoring of major audits, the Bill's scope is too broad. The aim of part 1 is to reinforce faith in the auditing and investigatory regime and to protect the UK economy from the impact of a crisis similar to that experienced in the United States. The Government would have us believe that that can be achieved only by introducing the independent monitoring of audits of all listed companies—excluding the alternative investment market—and other major companies. However—this point has been made many times in the Lords, albeit with little effect on the Government—the same protection could be achieved by limiting the compass of the term "major audit" to the constituents of the FTSE 350 index, which, after all, cover 96.5 per cent. of the whole market capitalisation.
In that way, we may avoid excessive regulation and supervision where it is not warranted, and instead focus attention and resources on the areas where an audit failure is likely to have the most significant adverse effect and impact on the economy. That is not a choice between monitoring and not monitoring, but a choice between an independent body monitoring audits of major companies and the regulatory bodies continuing to regulate the audits of other companies. As the law stands, accountancy firms have a statutory obligation to carry out company audits in accordance with the rules set down by the recognised supervisory body, and that body has a duty to monitor it. That situation will continue.
The imposition of statutory regulation under the FRC to complement the already existing self-regulation through the recognised supervisory bodies runs the risk of creating a complicated, multi-layered regulatory system. A more cautious and limited approach would be better and would achieve very similar results.
Secondly, on the levy, there is a considerable danger that part 1 will overburden businesses, leaving them with little hope of redress. In particular, the ability of the Secretary of State, under clause 17, to increase the levy payable, without limit, to cover the costs of the FRC could see listed companies' contributions rise inexorably. The Government have already predicted a 400 per cent. increase from £400 to at least £1,600 by 2006.
A safeguard is necessary in the event that the current funding arrangements, which are purely voluntary, break down. The voluntary arrangements have seen the running costs of the Financial Reporting Councilbroadly shared by Government, business, and the professional accountancy bodies",but there is no guarantee that the Government will continue to pay one third of the FRC's costs. They may choose, particularly in a cash-strapped year, to pass the costs on to those that pay the levy, and there will be little that anyone can do to prevent it.
We are particularly concerned that the levy may become an onerous burden for the smaller listed companies. Irrespective of their size in terms of turnover, all listed companies, simply because they are listed, will face the exact same bill as decided by the Secretary of State. The impact, however, will not be the 650 same. Selecting those that will pay the levy by relying on a criterion of being listed is incredibly crude. Lord Evans of Temple Guiting assured us in the other place that it is not the Government'sintention to use the levy power to change this balance of funding"—[Official Report, House of Lords, 22 March 2004; Vol. 659, c. GC242.]He can only speak for now, however; his word is not a safeguard against the future.
Thirdly, a wider group of people could face serious criminal penalties for failing to provide necessary information—
§ Mr. Cousins
To return to the hon. Gentleman's previous point, is the implication of his remark that he would want a cap on expenditure on regulation, and that he would want to build that into the Bill? That would be a very significant step.
§ Mr. Mitchell
Indeed. However, I assure the hon. Gentleman that that is not my intention. I want to see the Government committed to paying their fair share, along with the business community. They cannot in one year decide that they are not going to pay it, and leave the cost entirely to the business community as a result.
My third point relates to the wider group of people who could face serious criminal penalties for failing to provide necessary criminal information. There is concern that the correct balance has not been struck between strengthening the auditing regime—empowering auditors and investigators—and adequately protecting those against whom the powers may be exercised. For example, the original clause 9 required directors to state that not only have they given to the auditors any relevant information, but that each and every other director of the company has also given to the auditor the information that he or she should have. Directors were not only asked to take responsibility for the actions of their colleagues but were required to state that there was no information that had not been disclosed to the company's auditors—an extraordinary requirement.
The problem has been dealt with by the introduction of new clause 9, following several amendments sponsored by Lord Hodgson, but officers and employees of the company remain relatively at risk under clause 8. Clause 8 empowers an auditor to require a very wide range of people—under sanction of serious criminal penalties—to provide him with information, includingany officer or employee of the companyor "a subsidiary". An auditor may require information from any and every employee of the company, irrespective of their role or position.
There is a considerable risk that employees who have not had their duties explained to them in as much detail as directors might unwittingly fail to provide information, or sufficient information, and face considerable penalties and/or fines. It is possible to imagine a scenario in which a junior employee, perhaps on the accounts team, might have access to, or handle, relevant information, and yet he or she may not fully comprehend what is required of them by the auditor or the nature of the information to which they have access. There is a distinction between having information and 651 having knowledge. I have in my study an encyclopaedia, but that does not mean that I have encyclopaedic knowledge.
§ Mr. Austin Mitchell
Is not the real problem not the hypothetical one to which the hon. Gentleman refers, but that someone who does give information—such as a tea lady reporting a conversation that she has heard in the canteen between directors, which indicates that something irresponsible is going on—is effectively a whistleblower, blowing a whistle to the audit firm, and will be dismissed? That kind of person needs protection.
§ Mr. Andrew Mitchell
I look forward to discussing those measures with the hon. Gentleman in Committee. He is dealing with exactly the same problem as me: the role and position of a junior employee not being protected in the same way as that of a director.
Similarly, an employee may handle aspects of company accounts without realising their import.
The Bill fails to provide adequate grounds of defence. The defence allowed to an employee of the company is thatit was not reasonably practicable for him to provide the required information or explanations.That is insufficient.
I therefore hope that the hon. Gentleman agrees with me that the Government have agreed to give an improved level of protection for directors but not for those further down the scale. It will therefore fall to the Conservative party, as so often before in Committee, to protect and enhance the position of ordinary people, unionised or not, whom Labour has forgotten.
Fourthly, I turn to the issue of excessive investigatory powers. Provisions contained in the Bill, particular clause 21, place only the barest of limits on investigatory powers, and may well give rise to an abuse of power. Clause 21 empowers inspectors and investigators to enter and remain on premises, considerably extending their existing powers. Previously, they had no power of entry without a search warrant.
I am not against giving inspectors and investigators power of entry, but I am firmly against allowing them entry when they only think it will materially assist their work. The House has rightly resisted the giving of powers to investigatory officials to go on fishing trips for information, and it should certainly do so again in this case. The inspector or investigator must reasonably believe that entering and remaining on the premises will materially assist him. That is particularly vital because there is no limit to the time for which he may remain on the premises. Is he to be allowed to sit in someone's house for any length of time, just because that person carries on a business from his home? The Government must offer clear legislative protection against abuse, rather than seeking to rely on administrative law and retrospective challenge.
My fifth point relates to compliance with the European convention on human rights. Despite Lord Sainsbury's statement, under section 19(1)(a) of the Human Rights Act 1998, that the provisions of the Bill are compatible with the convention rights, the 652 Government appear reluctant to enforce ECHR article 6, which concerns the right to a fair trial. We fear that the Government will not prescribe in legislation how disciplinary hearings relating to public interest cases are to be conducted. We are informed by Lord Sainsbury that the representation of all defendants is too detailed a matter to include in the Bill, and isbest left to the arrangements".—[Official Report, House of Lords, Grand Committee: 16 March 2004; Vol. 659, c. 33.]Although we accept the Government's argument that if there were no access to representation the person or body exercising the recognition function would not agree that the particular disciplinary arrangements were "appropriate", there seems no good reason not to "set in stone" the rights of the defendant.
It must be made clear that the hearings are to comply with the rights of the defendant in accordance with the ECHR—specifically article 6—and the standards expected in a fair trial. As all parties are agreed that representation is necessary, and the Minister has stated that the Bill is compliant with the ECHR, there is no good reason why that should not be confirmed in primary legislation.
Let me say something about CICs, which the Minister mentioned. While we support the concept of the CIC, I feel that the introduction of yet another legal form for those wishing to set up a not-for-profit body or a social enterprise is unnecessary, and is contributing to the growing confusion of the wider public and those wishing to set up such enterprises. As I mentioned earlier, it seems very strange that CICs are to be introduced ahead of the Charities Bill, which promises wholesale reform of charity law, when that Bill is only now receiving pre-legislative scrutiny. It would surely have been sensible to keep the proposals on CICs until we could see how they would fit into the new regime following the long-promised overhaul of charity law. There may even be other models that would be preferable.
In creating ad hoc new legal forms and tacking them on to any Bill, we risk confusing and discouraging both the wider public and people wishing to set up a not-for-profit body or a social enterprise. I doubt that there is a benefit in setting up an additional special legal form for non-charitable public interest organisations. In particular, I cannot see that CICs offer any real advantage over industrial provident societies, established in 1965 and reformed partially in 2000 and 2003.
The "distinguishing" characteristics of a CIC, outlined in paragraph 161 of the original explanatory notes, are very similar to those of industrial provident societies, established by the Industrial and Provident Societies Act 1965. In particular, the justification for CICs has focused on the provision of an asset lock, but sufficient protection already exists for industrial provident societies. The Financial Services Authority will not register a community benefit society unless it has an asset lock-in, prohibiting the distribution of assets to any person or body other than another society with an equivalent rule or a charity, in its constitution.
The problem that a society might convert to a company and some time later reverse the asset lock-in rule in its company constitution was tackled by the Cooperatives and Community Benefit Societies Act 2003.
653 The Act contained an enabling provision allowing the Treasury, through secondary legislation, to make provisions to permit IPSs whose business is conducted for the benefit of the community to commit their assets permanently for that purpose—in other words, an asset lock-in—subject to appropriate safeguards and supplementary provisions, thus giving community benefit societies the option of protecting their assets in perpetuity for a public purpose. All that is set out in the regulatory impact assessment.
Rather than introducing yet another additional form, the Government should provide the much-delayed and much-needed secondary legislation. There are problems with the industrial provident societies, but it would be far better to amend IPS legislation so that one form is flexible enough to cope with differing circumstances than to create a plethora of new forms.
Let me now deal with an issue that has attracted a great deal of public comment—auditors' liability. This is a glaring omission from the Bill. Large audit firms are in all respects, bar one, like any other commercial business. Every other business—I can think of no exception—can either limit its liability by way of contract with its customers, or obtain insurance to cover any residual risk that cannot be limited by contract. Auditors can do neither. They are unable to limit their liability by contract, because of the terms of section 310 of the Companies Act 1985; but they are also not able to obtain insurance in the commercial market to protect them from catastrophe. There is simply no capacity in the market. In other words, we have the bizarre situation that professional men and women are being asked to take on a risk that the insurance market, with all its resources, deems to be unacceptable.
§ Mr. Cousins
Does the hon. Gentleman accept two things? First, does he accept that limited liability partnerships have been introduced to protect people involved with audit firms? Secondly, does he accept that the motivation behind the exclusion clause in the 1985 Act was the fact that those who remove financial hazards create moral hazards?
§ Mr. Mitchell
The hon. Gentleman is right about the creation of a new form of company, but wrong in thinking that it works in these circumstances. If he will bear with me, I hope I will be able to carry him with me.
There are only four auditors left who can audit our largest companies. It is therefore important not only to make sure in so far as we can that those four remain, but, if possible, to encourage new entrants to make the necessary investments to take on the audits of larger companies.
The Government recognise that the problem is a real threat to the stability of the audit profession, and indeed to the UK corporate sector. Today, they have finally responded, very negatively, to the consultation on auditors. It is widely believed that DTI Ministers understand and accept that the liability must be capped, but are being restrained from taking the necessary action by their colleagues in the Treasury. In Committee the Conservatives will table a range of amendments for the Government to choose from, so that the Government can discharge their responsibilities to the UK corporate sector.
§ Mr. Austin Mitchell
I do not want to restrain the hon. Gentleman's headlong rush into this folly, but does he accept that most actions against auditors are pursued by the insolvency arm of the big four, which is anxious to recoup fees and other money from the auditors of another arm? Where will this end? If we cap the liability of auditors, why cannot motor manufacturers or insurance companies, or any other section of society, say, "We want our liability capped?" Why should we give so much to a group that is making enormous profits from selling other services that often produce the problem?
§ Mr. Andrew Mitchell
The hon. Gentleman did not listen to what I said earlier, which explained precisely that point. I can think of no other group of men and women who cannot go to the market to receive insurance to cover those risks, apart from the big four audit companies. The reality of section 310 of the 1985 Act is this: if, God forfend, there is another collapse and one of the auditors goes down, there will then be only three. There will certainly be no new entrants to the market. There will be a systemic failure in the governance of our major companies, with all that that means for the corporate sector, for savers, for pensioners and for others who depend on it.
One of our amendments—I have made it clear to the House that we will submit various amendments—in the best tradition of the deregulatory agenda championed by the Conservative party, would amend or scrap section 310 of the 1985 Act. That would allow markets to reach a conclusion and would be a deregulatory and permissive measure, subject to negotiation between willing parties. There would almost certainly be a role for the CBI and the Financial Reporting Council in bringing together all the relevant parties, and there would also be full transparency in respect of any contractual arrangements.
There are of course other ways of limiting auditors' liabilities, but the important point is that they should no longer be unlimited. Leaving the matter to a later date, as the Government's response today envisages, increases the very real risk of one of the large firm's failing, and of consequent damage to confidence in the UK capital markets. That, in turn, would cause huge damage to savers.
We have a lot to examine in our two days in Committee and on Report. The Bill has already benefited from some improvement in the Lords, but we remain very concerned about the Government's failure to introduce the long-promised company law review, and about the way in which CICs have been tacked on to the Bill. Those issues are small parts of what should be two major and separate Bills, and we greatly regret the Government's failure to tackle the important issue of auditor liability.
We are committed to ensuring that the UK is the best place in the world to do business, which means achieving the correct regulatory balance. The continuing delay in the overhaul of company law will certainly not improve the UK's competitive position. As in so many other areas, this Government have lost an important opportunity and failed to measure up to the challenges before us.
§ Mr. John Battle (Leeds, West) (Lab)
I generally welcome the Bill and I note in passing the Opposition's willingness to see it progress to consideration in Committee, despite their having serious reservations about it. The first part deals with the organisation and regulation of auditors of companies, and the second and substantial part, which consists of clauses 24 to 61, is concerned with setting up a new form of company, known as a community interest company. CICs will build on Britain's experience of social enterprises, which provide new kinds of mutual companies that offer support, goods or services to particular groups in our communities. I welcome and look forward to the setting up of these CICs.
The Bill could provide a new instrument to help in the economic development of communities. In talking about community development, we often miss out the crucial word "economic". Such development is central, and vital in ensuring that our communities have a future. We can talk for ever about social work in the best of all senses, but without genuine micro-economic development our communities will have no future. So I welcome the introduction of another such instrument, and in that regard I do not take quite such a dim view as the Opposition.
I hope that CICs will not be overlooked, not least because in the other place, gladly, most Members seemed to be satisfied with the detailed provisions relating to them. I would not like this issue to die through lack of interest in the House or in Committee, or for the real potential of CICs not to be recognised outside this place. The Social Enterprise Coalition welcomes the introduction of CICs, as does the new West Yorkshire Social Enterprise School. In her introductory remarks, the Minister talked about the difficulties associated with forming companies before Gladstone's Act. I should point out that, even now, it is difficult to set up companies. It can take up to a year for even a well-developed proposal to be turned into a business proposition that gains acceptance. However, CICs would cut through that difficulty, and well-developed proposals could get through in days. Encouraging people to set up more businesses more quickly is to be warmly welcomed.
The CIC will be used primarily by non-profit enterprises that provide benefits to the community. Such enterprises will have to define what those benefits are. Traditionally, social enterprises provide community services such as child care, housing, services for the elderly, leisure services and community transport. As we know, existing social enterprises, like traditional private businesses, are usually companies limited by guarantee and share ownership. However, the new vehicle of the CIC will enable those working specifically for the benefit of the community to do so within the relative freedom of a non-charitable organisation; they will not be limited by the restrictions of charity law. Those of us who have been involved in charity law know how constricting such restrictions can occasionally prove. At the same time, a clear assurance of non-profit distribution status will be offered.
I should point out to the Minister that we need to spell out to people—be it in Committee or at a later stage—what non-profit distribution status will actually mean, so that they can be encouraged to join in. In order to set 656 up a CIC, a proposed company will have to satisfy a new community interest test. It will have to show that it will pursue purposes beneficial to the community and will not serve a restricted group of interests, so the key test will be the provision of services to the community. That could prove incredibly innovative. New kinds of services and blends of services and goods could be provided. The primary interest will not be the promoting of a trendy name for a company and the floating of a new brand in order to see how it goes; nor will it simply be a question of keeping a good idea for a business ticking over, or of providing employment for those who work for the company. The focus will be not just on jobs for paid employees, but on how the business will benefit the community.
CICs could prove a very innovative generator of micro-businesses. I accept that they will not wipe out the residue of unemployment, but they could spark some new ideas and ways of providing goods and services in our neighbourhood communities. They will be wider in scope, but simpler and clearer, than the traditional charitable test of public benefit.
Some immediate benefits arise from CICs. When a proposal is put together, it will be easier for other investors, supporters and public bodies to back it. In other words, it will be easier to attract funds in the first place. At the moment, there is some haziness so far as charities considering their trading options are concerned. It should also be easier to engage individual people, who will be able to become economic participants in companies in their neighbourhoods. They will be able to buy shares in a community enterprise, which is to be welcomed. Such companies will be able to act like proper companies—pay their directors, change the nature of their activities—but they will also have to meet the reporting and accounting requirements associated with being a company. That is also to be welcomed.
In the other place, the Minister emphasised thatCICs should resemble other companies as far as possible in terms of the way in which company law applies to them.".—[Official Report, House of Lords, 25 March 2004; Vol. 659, c. GC354.]So they will still be under company law, but we need to spell out not just the legal details of how to set up a CIC; we also need to give general advice on the benefits of a CIC to a neighbourhood. For example, what would be the gain in terms of regenerating our urban neighbourhoods in particular? What are the benefits associated with blending together workers and volunteers to provide goods and services locally? The new corporate vehicle that the CIC could become should make it simpler and easier to set up a local business whose profits and assets are used for the benefit of a given neighbourhood and community. That is why the special feature of the CIC's statutory lock—as we now refer to it in technical terms—on profits and assets is important. It sends a clear signal to ordinary people who might want to buy a share that their investment is safe. They are investing in their neighbourhood not to walk away as millionaires at the end of it, but to contribute to building up the community. That is where the lock on profits and financial assets as well as the cap on dividends is such a positive attribute of the CIC.
657 Basically, CICs will ordinarily be prohibited from distributing any of their profits to their members and I understand that, when the CIC is wound up, its residual assets will not be distributed to its members, but will remain in the community. If I understand it rightly, the assets will be passed on either to other CICs or to other charities in the neighbourhood, so the assets will remain in the locality. That is rather different from other co-operative ventures—the provident societies and other kinds of mutuals—to which the hon. Member for Sutton Coldfield (Mr. Mitchell) referred. Locking the assets into the community provides a different feature—an insistence that the assets are reinvested locally, even if the company goes under.
There was a debate in the other place about the implications of charity law and charities, but we do not need to get bogged down by it. We need clarity and to be able to give good advice about what non-profit distribution status actually entails. Already some charities providing services that budget from month to month or hand to mouth are looking into the trading possibilities. They need to be clear about what the new option actually means. I know that there are further proposals to reform charity law, but we do not need to wait for them. I believe that we can get this vehicle up and running in the meantime.
A letter from the charity commissioners supporting the Government's approach was quoted in the other place and is worth repeating. The letter said:It is not always clear-cut when a particular form of object is charitable or not. That is, perhaps, particularly so in the area of social enterprise where many CICs are likely to operate, and where ideas as to what should, and should not, be regarded as charitable are evolving. Our understanding is that there is a demand for a form of company where the promoters can be certain that, notwithstanding the public interest element, the company will not fall within the framework of charity regulation.It is the freedom there that is important, without getting bogged down in the constraints of charity law. That is what we should focus on and emphasise at this point. I particularly underline the word "evolving" in that letter. I have dealt with charity law for many years, so I know that it has been evolving and I hope that it will continue to evolve, as will the nature of businesses, social enterprises and community businesses. It is right and proper to move forward and not hold back in the vain hope that we can fix all the law so that businesses will fall into line to suit the needs of the people in the future. It will not happen that way round.
We therefore need rather more clarity about the status of a community interest company. It is not a charity, so a donation to a CIC will not attract tax relief, to give a practical example, whereas a donation to a charitable trust of which a CIC is a trustee will be eligible for relief. Those issues are important for people who deal with charitable status and they must have clarity at an early stage, so that they know whether to move into CICs or even whether to take an interest in them rather than be frightened off by them. If we do not provide more clarity about the relationship between CICs and the difference between them and charities, it might put people off.
Transferring existing companies into CICs or setting up CICs for charities requires particular clarity in respect of the financial benefits. We must be able to spell out what it means when a CIC is established for a 658 charitable purpose without being a charity, as it states in the Bill, so that ordinary people who want to set up businesses are not frightened off by feeling that they are going into a morass of charity law or an enmeshing argument between business law and charity law. I want people to be enthusiastic, to see the benefits simple and clear and to move forward to have a go. We need the new legal entity to be as simple and as uncomplicated as possible so that it is clearly understood not only by people in communities that might get engaged in these companies, but—dare I add—by banks and other businesses that will deal with them and will also want to know that the rules of the game are clear. Let us remember that it is a new option for organisations seeking a flexible form that will not be restricted by traditional charitable status, so it should be of benefit to communities.
As said in the other place, we should not see the new CICs—I am already falling into the acronym for community interest companies—as a brand for all social or co-operative ventures or mutuals. It is another form within that family, which we should experiment with and support. The difference in the Bill between the non-profit distribution service and charitable status benefits needs spelling out rather more clearly.
I have already said that there was a debate in the other place about the difference between a community interest company and a charity, particularly the benefits or otherwise of charitable status. That relates to tax reliefs, mandatory reliefs and all the rest of it. The noble Lord Sainsbury spelled out that clause 23 is in the Bill to ensure a clear distinction between the new type of company and charities, but I have to say, in all honesty, that I do not fully understand the distinction. I doubt whether it has the practical clarity that he claimed for it. However, I understand and accept the intention to regard the CIC as a new instrument rather than simply a revision of charity law that will arrive later with the forthcoming Charities Bill. CICs should be regarded as an alternative or a new model that we should experiment with. They will be able to trade and behave in enterprising ways as other businesses do.
My main point is that while it is right to focus on the regulation and the legal framework of the CIC, that should not overshadow encouraging people to set them up. I am in favour of making use of this new instrument and encouraging more people to set up new businesses—not the opposite. I do not want people to be warned or frightened off. There is almost a tendency to discuss getting the disposal of a CIC's assets right before convincing anyone that they should try to set one up. I welcome the establishment of a regulator and the forthcoming detailed regulations, but at this stage we should be advertising the benefits to convince people to have a go.
My constituency of Leeds, West is a sort of pizza slice coming out from the city centre towards Bradford and the ring road. It is on the south-west of the city and, amazingly, if we examine the structure of cities in Britain, we find that small businesses often cluster in the south-west corners. The heavy industry tends to be, for some reason, on the eastern side of cities. In my neighbourhoods of Armley, Kirkstall, Wortley, Farnley, Burley and Bramley, there are more than 400 small businesses, most of which employ fewer than 10 people. I was surprised to discover how many small 659 businesses and family firms—some going back more than 100 years—have been based there. One or two have moved out nationally, but there could be an entrepreneurial gene in the water in west Leeds, which we should encourage and build on. We want more businesses to come forward.
At the same time as small businesses are developing, the needs of the people are increasing, particularly in respect of care for the elderly, the sick and the young. We have good voluntary bodies working locally—whether it be Bramley elderly action, Armley helping hands, the Burley 2000 or the Farnley elderly group—but I see no reason at all why new mutual forms of business cannot be engaged in all that, particularly in view of the community focus. The introduction of Sure Start projects in Bramley and Burley is welcome, and a healthy living project supplements the work of the new primary care trust, but much more remains to be done, especially in the provision of caring services. Help is needed with shopping and gardening, and with the provision of nurseries and play services. I see no reason why that cannot be part of the structure of businesses formed through CICs.
The decline of local family shops has led to units in community shopping parades being boarded up, but people still need fresh food, healthy eating options and even farmers markets. Where there is little in the way of entertainment for local people, the provision of cinemas, theatres and music venues could be part of the new initiative.
§ Mr. Battle
My hon. Friend suggests that jazz clubs could be provided, and I know that he is a great jazz fan. I see no reason why entertainment and leisure provision should not be part of the new companies' remit. A micro-economy is developed through the local provision of services and goods. New forms of social enterprise can meet local needs, and new community economic development can serve as the focus for the work of community development and rebuilding. In turn, that will lead to local people being trained in new skills. People will therefore remain in the community because they enjoy living there, as a result of having the access to the same services and goods as are available elsewhere.
A recent report from the London Business School entitled "Social Entrepreneurship Monitor UK 2004" found that 7 per cent. of the UK population was engaged in some form of community work or social entrepreneurial activity. That is a start, but the figure is still far too low if we want to think about regenerating urban neighbourhoods. In the past, social enterprises that use business tools and techniques have resulted in co-operatives and housing associations being set up. Café Direct and The Big Issue are examples of that, but most social enterprise has been focused around London, as the LBS study found. I suggest that it needs to be spread around the country.
We need more of it in west Yorkshire and in my neighbourhood. We must encourage people to have a go, and we will not do that if we do not sell the ideas 660 behind CICs. If people take on this new interest, the development of micro-businesses could be assisted. What is more, they could open up some innovative space and provide to their communities new goods and services that have not previously been thought of. That entrepreneurial imagination would be most welcome.
There remains a need for quality jobs and training and for businesses to provide goods and services. That is certainly true in my constituency, but the provision must happen within a fully sustainable economy so that we can move into the future with some stability.
I am enthusiastic about CICs and believe that they will have a role to play in the community economic development of the future. However, I urge the Minister to ensure that we get the solid legal framework right in our discussions in this Chamber and in Standing Committee. I hope that she and the Government will take a more proactive role in encouraging and supporting the development and growth of CICs, as soon as the Bill becomes law.
§ Brian Cotter (Weston-super-Mare) (LD)
Thomas Edison, the famous inventor, once said that opportunity is missed by most people because it is dressed in overalls and looks like work. When it comes to the question of reforming company law, I would certainly not accuse the Government of being workshy. An enormous amount of consultation has already been completed in this area, yet various proposals are still waiting to be enacted.
Thus, for whatever reason, this Bill represents a major missed opportunity to carry out the extensive reform and simplification of the law that is so desperately needed. That point that was made eloquently by my noble Friend Lord Sharman in the other place when he criticised the Government for nibbling away at the edges of company law reform. My noble Friend mentioned the Enterprise Act 2002, which dealt with questions of bankruptcy and insolvency, but now we have this Bill, which devotes 17 clauses to the reform of regulation, five to improving company investigations, and 37 to establishing community interest companies.
But what about other matters that have yet to be addressed? We still await draft regulations to require companies to produce an annual operating and financial review. This continued piecemeal approach to company law is causing immense frustration. Last month, Eric Anstee, the chief executive of the Institute of Chartered Accountants told the Financial Times that, without action on both auditor and director liability, the initiative by the Department of Trade and Industry on the OFR was "doomed to failure."
I now turn to this morning's statement announcing the Government's approach to director and auditor liability. I shall come to auditors later, but I give one cheer to the announcement that companies will be allowed to indemnify directors in terms of legal costs. That is a step forward, but will the Minister explain why the Government rejected the proposal from the Institute of Directors to cap director liability?
The prospect for company directors is therefore bleak and, for the near future, it is evident that they will have no choice but to continue wading through successive 661 layers of company law many of which have become unfathomable as a result of continual change and amendment.
§ Mr. Austin Mitchell
Does the hon. Gentleman agree that, if we are to cap the obligations of company directors, chief executives and the like, we should also cap their salaries? Their salaries can be raised to quite obscene levels, and the people involved use their positions to control and decide them.
§ Brian Cotter
The hon. Gentleman raises a matter that is of great concern. The way salaries have been raised is absolutely appalling, but I do not think that problem falls within ambit of this Bill.
A written ministerial statement made by the Secretary of State on 26 May 2004 announced new proposals to try and deal with this problem, promising the introduction ofnew types of legislative power enabling company law in future to be amended by a special form of secondary legislation".That would make it easier to keep company law updated over time. The Secretary of State assures us that these new powers will beintroduced as part of the major new Companies Bill…as soon as Parliamentary time allows."—[Official Report, 26 May 2004; Vol. 421, c. 78W.]Yet here we are in the meantime scrutinising another companies Bill. On behalf of all the company directors who are currently frustrated by the plethora of company law regulations, the first thing I ask the Minister is how much longer they will have to wait for the major reform and simplification that is promised.
Although the Bill is a missed opportunity, it still has merits that the Liberal Democrats wish to support—as do those who sit on the Conservative Benches. The first part of the Bill aims to improve public confidence in companies and financial markets by strengthening the system of regulating auditors, tightening up the enforcement of accounting and reporting requirements, and strengthening the company investigations regime.
That is very welcome in light of the recent Enron and Parmalat cases, and others, and I know that my noble friend Lord Sharman was able to offer his expertise to strengthen the Bill further, in respect of the provisions relating to auditing and investigations. Indeed, he has applied his expertise so rigorously that we are relatively content with this part of the Bill.
We are all aware, as a result of what has been written in the pages of the Financial Times, of the arguments that have been raging between the Treasury and the DTI about whether a cap should be introduced to limit auditor liability. We found out today who won that particular argument.
The Liberal Democrat party is concerned to ensure that the free market should be allowed to operate in this area. We currently have a unique situation in which statutory intervention will not allow an auditor and a company freely to negotiate the liability to be borne by either party. We know that auditors, lawyers and the business community have questioned the Office of Fair Trading's conclusion that a cap on liability would be competitively neutral and that they have claimed that the OFT's report is flawed.
662 At face value, those claims carry some weight. In Germany, where a cap is in existence, 67 of the top 300 quoted companies are audited outside the big four auditing firms, and the story is similar in countries such as Greece and Austria. In the UK, in contrast, all the FTSE 100 companies, and 248 of the FTSE 250 companies, are audited by the big four firms. Are the Government satisfied that these competition points were adequately addressed by the OFT? If agreement is reached, will the Secretary of State consider a legislative timetable in relation to auditors' liability so that we can look forward to legislation early next year?
Does the Minister further accept that confidence is dented if the OFT gets so wrong the availability of personal indemnity insurance for auditors? In the statement issued earlier, the Secretary of State said that the Government would look closely at the option of proportionate liability by contract. We welcome that. It would ensure that auditors paid for their mistakes in an equitable way, which would, I think, carry the support of businesses and the auditing profession. I ask the Minister to clarify two points. First, what is the timetable for looking at proportionate liability by contract? Secondly, will the right hon. Lady make a commitment the effect that if agreement is reached between auditors, investors and business, the Government will quickly legislate to allow proportionate liability by contract?
§ Mr. Cousins
In his apparent support for the idea of a contractual limiting of auditor liability between the auditor and the company, does the hon. Gentleman conceive of possible collusive relationships that might be built up?
§ Brian Cotter
Yes. That is why we need a lot more consultation to arrive at the solutions we need. We certainly need a way forward.
The second part of the Bill introduces the community interest company, which is a new type of company whose profits and assets will be used for the public good. The Minister quite rightly applauded that sector, and I pay tribute to the right hon. Member for Leeds, West (Mr. Battle) who promoted CICs through his very constructive speech. For many years, we as a party were leaders in the co-operative field, and we therefore support community interest companies very much. When we reach Committee stage, I hope to deal with the important issues that the right hon. Gentleman raised. I shall certainly look at the Bill with renewed interest to ensure that it contains every encouragement for community interest companies to be effective and to provide a route for economic progress in many parts of the country. I have met a number of people involved in community interests of one sort or another—the right hon. Gentleman mentioned cinemas, but there are many others. I welcome the Government's saying that they will progress that part of the Bill.
We have historically welcomed such things. Indeed, we argued that the Government's long-promised companies Bill should be used to create a public benefit organisation structure, which is very much in sympathy with the aim of the community interest companies that are now being proposed. However, we still have some concerns about the nature of the new companies. In the other place, Lord Phillips of Sudbury was able to use his 663 expertise in the legal and charitable sectors to argue that the Bill should not prevent charities from choosing to become community interest companies, which is what seems to be being proposed. As he said,the law of charity has been distinguished by being a function of purpose and not a form or format."—[Official Report, House of Lords, 7 July 2003; Vol. 663, c. 848.]That principle has given charities maximum choice in allowing them to determine whichever form best allows them to carry out their work. The Bill represents the first step away from that flexibility. Although opinion is somewhat divided on the issue, we feel that there is an important point to which we shall return in Committee.
Corporate governance is an area in which the general public increasingly look to companies to demonstrate high standards. Indeed, we would hope for high standards when it comes to remuneration and just returns as shareholders and stakeholders. My friends in the other place, Lord Sharman and Lord Razzall, attempted to mitigate the slow progress towards reporting details of social and environmental performance by tabling an amendment requiring the Secretary of State to publish standards in order to guide companies further in that respect. That may be an issue to which we will wish to return, as it is an important one. I have been involved in small business all my life, and when I came back to big business after many years of non-involvement, I was quite concerned about the lack of transparency.
There is another issue of corporate governance relating to larger companies dealing with smaller suppliers. In particular, there is the issue of late payment of debt, an ongoing bugbear for British small firms, which according to some estimates are owed up to £20 billion by larger companies in payment for services and goods provided. The Federation of Small Business estimates that one in four business failures are as a result of cash-flow problems caused by the late payment of commercial debt. I very much supported the Bill on late payment brought in by the Government, and the FSB and the Forum of Private Business were instrumental in helping me and others to do our best to ensure that it was placed on the statute book. Clearly, there is a major problem, and despite the introduction of legislation allowing businesses to claim statutory interest on any overdue invoice, the situation has not improved as much as we had hoped. Further action is needed to tackle the culture of late payment.
At least five pieces of independent research confirming that have been published since January. A Bank of Scotland survey this month found that almost half of small businesses had been forced to take legal action against late or non-paying ones. The FSB payment performance tables in April showed no improvement in the amount of time it takes plcs to settle their commercial bills. The latest survey, published in July by Experion, suggested that the amount of time it takes companies to settle their bills has risen to its highest level since 1998, which is very worrying. Unless the Government encourage and actively help the largest companies to lead by example, we will never achieve the culture change that is needed to eliminate the late payment that continues to plague Britain's small businesses.
664 Sadly, the Government are failing to lead by example, as my hon. Friend the Member for Twickenham (Dr. Cable) illustrated when he revealed this week that the Treasury is one of the worst culprits when it comes to late payment of bills. The Forum of Private Business has been particularly assiduous in pressing the Department for Environment, Food and Rural Affairs to release the money that it still owes many foot and mouth contractors for work carried out during the crisis some three and a half years ago. It is hardly surprising that many large businesses still fail to pay small suppliers on time.
Trying to identify in advance whether a large company is likely to pay on time is near impossible for small businesses. Under the Companies Act 1985, UK plcs are required to publish details of their payment performances in their annual accounts. Yet when the FSB was conducting research for its payment performance league tables, it was unable to find that information for 57 of the FTSE 100 companies. Following an investigation at my request, Companies House confirmed that all the companies had published the details, but the problem is that there are no standard requirements for reporting payment performance. The job of finding the information is rather like hunting for the proverbial needle in the haystack. Following my inquiries, Companies House admitted that it had takena considerable amount of time to examine each set of accountsto check whether the companies had made the required disclosure. Clearly, there is a problem there. If Companies House cannot easily identify the information, how on earth is a small business person who lacks the necessary resources supposed to identify it?
I hope that the Government will take the issue seriously. Liberal Democrats, the Government and others are committed to the measure, but there are clearly problems with the way in which it works. If a business cannot access a company's payment performance record, how can it make an informed decision about whether to enter into a contract to supply that company? Given that the law was introduced to help small firms, we must ensure that it does so effectively.
Having addressed that point, let me say that I hope we can make progress on the Bill in Committee to ensure that small business and others have transparent information available based on strict and clear guidelines on what firms should include in their records. As Companies House has difficulty in listing the information, perhaps we can do something to clarify that situation. I look forward to addressing that issue and others in Committee.
§ 7.2 pm
§ Mr. Austin Mitchell (Great Grimsby) (Lab)
I am surprised that the spokespeople for the two Opposition parties are so overwhelmingly favourable to the big four. It is an interesting revelation. They are both sycophantically grovelling at the feet of the big four, but it is no use: we have been so kind to the big four that they are probably about to affiliate to the Labour party, so there is no hope of attracting their support.
The hon. Member for Sutton Coldfield (Mr. Mitchell) gave us the views of unregenerate accountants, greedy and irresponsible chief executives and indolent non- 665 executives—three small minorities in the business community—and erected them into an ideology for the Conservative party. Indeed, the longer he spoke, the more favourable I became to the Bill, which I did not favour in the first place. Having given that panegyric on the big four and that astonishing rant against a mild an innocuous Bill, he has given me the opportunity to welcome it. The measure is long overdue and has the potential for being improved in Committee. I know that there are doubts about the Whips' enthusiasm for putting critics on Committees, but I hope to contribute to those debates to produce an effective system of regulation of the business community. That is the strongest praise I will give the Bill, so I put it at the head of my speech.
I want to deal primarily with part 1. It follows a long period of delay and obfuscation by the Department of Trade and Industry, which over the years has acted as the protector, friend and, alarmingly, sometimes the spokesperson for the big four. The DTI stands in awe of them. It must be frustrating for civil servants to have to put the views of the big four when they get much lower salaries than the partners of the big four, but that is the reality: hear no evil, see no evil, speak no evil.
The measure goes back a long way. In 1992, my hon. Friend the Member for Newcastle upon Tyne, Central (Mr. Cousins) and I, along with our advisor, Professor Prem Sikka, persuaded the then Opposition spokesperson on trade and industry, Mo Mowlam, to include in the manifesto a provision for the independent regulation of accountancy, like the Securities and Exchange Commission. In 1997, independent regulation of accountancy appeared in Labour's business manifesto and stayed there all those years, which is quite an achievement given the transformation that took place. However, when we sent our ritual delegations to the DTI to ask when we were getting the independent regulation, we were told, "Oh no. Sorry. There's no time for the independent regulation that we promised in the business manifesto. What we're going to do is create a foundation based on the Swinson report", which was a means of avoiding independent regulation. The Department would have put that foundation on top of the 23 other bodies responsible for regulating accountancy and auditing—a cherry on top of the pie. Lovely.
We were told there was no time for legislation and that the foundation would do the job, but the Bill effectively kills off the foundation, which in reality was stillborn. It achieved nothing and was a waste of seven years. The big four, however, decided that that was not enough. They wanted limited liability partnerships, which they set about achieving by buying legislation in Jersey. They drew up legislation, which Jersey passed. That clearly concentrated the mind of the Government. Indeed, the senior partner of Ernst and Young said:
It was the work that Ernst & Young and Price Waterhouse undertook with the Jersey government"—
they actually took over the job of the Jersey Government—
that concentrated the mind of UK ministers on the structure of professional partnerships… The idea that two of the biggest accountancy firms plus, conceivably, legal, architectural and engineering and other partnerships, might take flight and register offshore looked like a real threat…I have no doubt whatsoever that ourselves and Price Waterhouse drove it onto the government's agenda because of the Jersey idea".
666 By threatening to go to Jersey and getting limited liability partnerships past their Government, the big four forced the hand of our Government who, having told us that there was no time to legislate for independent regulation, immediately rushed through limited liability partnerships.
The big four now want us to move a stage further. We are told that they want us to cap their liability. It appears from the report that I received that the Minister told the Institute of Chartered Accountants conference in July that the DTI would cap their liability. We are confused about what will happen and I want to encourage the Minister not to go ahead with that disastrous idea or anything like it. It is not simply that the European Union Commissioner, the American Government, the Office of Fair Trading and the institutional investors—all minor, unimportant people—are against it, but that it is daft. We could have a dual system, as the Americans do. They have a day-tripper auditor—an external auditor—plus the Federal Reserve audit of all financial institutions, which could be handled by the Financial Services Authority here.
We are told that there is an issue of competition. In that case, why were all the mergers of the big accountancy houses allowed? If competition is now so restricted that we have to revive it and encourage it by capping liability, why did we allow the mergers in the first place? It seems a little illogical. We could introduce competition by using other sources of audit. Why should not the Inland Revenue, Customs and Excise or the National Audit Office do audits? Why should not financial service groups such as Virgin or Marks and Spencer's financial services do audits? Either widen the competition or, having encouraged the concentration, break up the big four so that we get real competition.
Most of the claims against auditors come from the insolvency arms of other big accountancy houses. The problem is self-perpetuating. The inflated figures that have been bandied around to create shock and horror take no account of the fact that the principle of contributory negligence was introduced in 1993. Deloitte used that in the Barings case to get a fine of £150 million reduced to £1.5 million on the basis that its negligence was only contributory.
We also have to think of the knock-on effect on other sectors and industries. It is all very well for the Opposition to say that other firms can get insurance cover against their failures, but they might not want to because it becomes expensive. So why not cap their liabilities, as has been suggested for accountants? If we do it for one sector, we shall have to do it for others. It is ludicrous to argue that we would not because the companies can get insurance cover, because there is no guarantee that that will be maintained.
§ Mr. Andrew Mitchell
With the greatest respect, the hon. Gentleman is talking absolute nonsense. People might not like the cost of getting insurance, but insurance is available for them in the market, if they choose to take it. Can he name any other group in society that is in the position of the auditors, which simply cannot get insurance but are expected to take on the liability?
§ Mr. Austin Mitchell
Speaking from a higher level of nonsense than the hon. Gentleman, let me say that there is no need for it, because the claims are enormously exaggerated and hypothetical. In addition, the firms have not tried to get insurance cover, so we do not know whether they could get it; in any case, insurance cover could be arranged. There is no need to cap liability. Why should one sector, comprising the incompetent auditor, the failed auditor, and the auditor who has cut corners, be protected from the consequences of its failure? If the auditors' liability is capped and the public have no right to sue, why should the public not demand compensation from the Government who applied capping? Capping will lead to all sorts of legal complications, of which the hon. Gentleman took no account.
Perhaps we should give up on the proposal. I am sorry to say that, because my right hon. Friend the Minister for Industry and the Regions, who spoke well today, has received us courteously and always listens to our arguments. However, I remember that when F. E. Smith claimed that something that he had said in the House of Commons had shocked the world, moved the Hottentots and frightened the Eskimos, the concluding line of Chesterton's poetic response was was, "Chuck it, Smith!" The same applies to limited liability, capping and the rest of my right hon. Friend's proposals for the big four.
The Bill is the product of a review conducted by interested parties dominated by business and accountancy interests, and spatchcocked into it is our response to Enron, Global Crossing, Tyco International, Parmalat and all the other scandals. We have had our own share of scandals, including the Versailles accident group, Wickes, Slug and Lettuce—I am not sure which of them failed—Wiggins and Shell, as well as the endowment mortgage scandal, personal pension failures and Equitable Life. It is time that something was done to prevent further problems, but the pressure for action arose from the scandals in the USA. It is interesting to compare what happened in this country with what happened in America when both were faced with similar scandals and similar potential for business fraud.
In the United States, the independent regulator had the strength and the independence to take powerful action—"perps walked," as they say in the USA. In this country, if they walked, they walked off to Switzerland or to the south of France with their retirement benefits. In the USA, fines ran into billions of dollars; here, they were pathetic in relation to the income of the accountancy houses. Even a company the size of Shell received only a small fine. In contrast, in the United States Andersens was closed down within five months, after the authorities launched criminal actions against it in respect of the frauds that had been carried out. In addition, 250 chief executives were prosecuted, at least 25 of whom were convicted and imprisoned, such is the strength of the sanctions available in the USA.
All big four accountancy houses are now being pursued for various infringements by federal or state authorities—a study of auditing practices at PricewaterhouseCoopers revealed 8,000 violations of rules and ethics by that one firm in a single month, such is the scale of invigilation in the United States. Ten banks were charged in connection with fraudulent research, and 350 companies were forced to restate their 668 accounts. Ernst and Young was banned from new audit business for a year, the judge in that case saying that the company had shown no regard for the rules, for professional ethics or for morality.
That is the treatment meted out by independent regulators in the United States to the big four accountancy houses—multinationals operating in this country as well. What happened in this country? Our first reaction resembledgoing around the country stirring up apathy,as Lord Whitelaw put it. It was to say that what happened in the US could not happen here—there was no problem. The British Government even lobbied for exemption for British multinationals from the Sarbanes-Oxley legislation. I had the pleasure of meeting Senator Sarbanes last year and I introduced myself as a British MP. He leapt back, saying "No!" When I asked him why, he said, "You are the latest in a long line of Brits and British companies who have come to me to ask for exemption from Sarbanes-Oxley. Well, you're not going to get it!" He is a good man who got through good legislation—earlier, my hon. Friends and I agreed that in this country, Senator Sarbanes would have been a member of the old Labour party. It is incredible that the British lobbied for exemption on the grounds that our accountants were better regulated, our standards higher and our accountants more honourable.
The proposals in the Bill are weak. The Financial Reporting Council will now dance to a different tune and will be an independent regulator—one of 23 remaining regulators, not including the DTI. That will simply add to the confusion. No ombudsman is provided for appeals at the end of the process. Let us consider what the effect of the Bill would be on the type of scandal experienced in Britain and the United States.
Four problems are common to all the big corporations that have been affected by scandals and, in some cases, collapsed because of them. First, corporate power is concentrated in too few hands—the classic example is the case of Robert Maxwell, where corporate power was focused entirely on him. The Bill contains no proposal to prevent such concentration of power in the hands of a few overweening individuals, who are able to serve their own greedy purposes, set their own salaries and rewards, and milk the companies like Lord Black milked Hollinger. The Bill contains no proposal for two-tier boards, which are an effective form of protection against concentration of power that enables one individual who is paid according to the company's profitability to hike profits by using creative accountancy in collusion with the accountants, thus enabling that individual to pay himself more and milk the company uncontrolled.
The second common characteristic of such companies is that they have ineffective audit committees. Traditionally, such committees often comprise non-executive directors who are the directors' golf club pals, or the chief executive's mates. They hold too many non-executive directorships and do not bother themselves with getting to grips with the affairs of any one company, because they are waiting for the Rolls to collect them and take them to another board meeting at another company that has a different set of problems. They do not have time to focus on the issues. The Bill makes no provision for representation on audit 669 committees of stakeholders—people who invest their lives in the companies—or for election of the audit committee.
The third characteristic common to the companies in question is that they all had extremely complex structures, which resulted in extremely opaque accounts. No one knew what was going on. No outside assessor was able to deal firmly with the accounts or to obtain a clear picture of what was going—on usually because so many transactions were channelled through tax havens and companies in other jurisdictions that no one could trace the money. Most FTSE 250 companies use tax havens and channel money through overseas companies to obscure their accounts. It has become a classic technique for News International because as most of its profits pass through companies in other jurisdictions, it does not pay tax here to any extent and its accounts cannot be effectively audited. Virgin does the same thing, but it restructures every couple of years, so no one can work out a clear trail of where the money has gone, the companies through which it has passed, who has done what and who has responsibility for it. Nothing in the Bill will stop that practice because it cannot be traced.
We cannot control transfer pricing, transfers of capital or companies' activities if we do not know what is going on and, indeed, we cannot stop off-balance-sheet accounting. Private finance initiative projects in this country are financed by that practice, but the Americans have just banned it. Cable and Wireless indulges in hollow swaps with other telecommunications companies and treats debts as investments, which is the basis of the finance of British Nuclear Fuels Ltd., in which the Government are the only major shareholder. Capitalising interest is the basis of the finance of British Energy. All the practices that brought down American companies are available here. They are authorised by accountants and used by companies whose accounts are opaque and kept that way.
The fourth common factor of such corporations is the longevity of their relationships with auditors. It is all very well for the Minister to tell us about rotating partners, but Maxwell's relationship with Coopers and Lybrand was so long standing that the partners must have rotated several times. However, that did not change Coopers' deference to Maxwell because it wanted to keep its other business.
We must tackle the key problem that auditors are deferential because they make more than 70 per cent. of their money from selling other services to audit clients, but the Bill does nothing about that. Auditors are deferential because they want to sell more business. Ernst and Young has established a $4 million contract in the United States for cleaning lavatories. Accountancy firms will sell any services to audit clients to make a buck, but that creates a collusive and damaging relationship in which auditors authorise practices that they should not and treat things that are dodgy as safe without drawing public attention to the fact.
The most telling quote about the problem comes from the senior audit partner of Coopers who was responsible for the Maxwell audit. He told his audit team:
The first requirement is to continue to be at the beck and call of RM"—
670 I give hon. Members three guesses at who RM is—
his sons and staff, appear when wanted and provide whatever is required".
The senior audit partner told his team that it was its job to jump when Maxwell wanted it to jump and to do whatever Maxwell wanted. Dependent relationships produce such practice and the situation has not changed—rotating partners will not change it. It might be changed only if new auditors are brought in and the sale of other services to audit clients is banned—that is the key problem. The Government have not done that. Although they are holding a consultation on what should and should not be sold, only a total ban will work.
A classic example of why the rotation of individual auditors in a company will not work comes from Andersen. Carl Bass, one of its auditors, began to have doubts about Enron's accounting practices in 1999. He voiced them to Andersen, but the firm did not say, "More power to you! Keep at it and we'll stop this." It simply moved him on to another account, thus getting rid of the man and the inconvenience.
The sale of other services makes for complacent auditing, so the practice should be stopped. The Bill does not address such matters, so although it could be improved, it represents a lost opportunity. I could have understood that happening if the Bill had been introduced in 1997 because we were learning the job then, but we have now had seven years' experience of such practices and we have not done enough about them. The Financial Reporting Council will not be able to do much either. I tabled a question about the council and found that since 1991, it has required only 14 companies to restate their accounts, although some 350 companies were required to do that over six months in the United States. Only two such cases occurred in 2002, and two in 2003. The council is statute based, which I want, but it is insufficiently independent because it is made up of representatives of the big four and other corporate interests that dominate the scene and work with them and because it has no ombudsman. We could devise a more effective way of dealing with the problem—I hope that the amendments that I will move in Committee will do that—than such comparatively weak and inadequate measures.
I am not impugning the integrity of auditors. We need audit because it represents the police force of capitalism. We need accurate reports and information for markets, shareholders and stakeholders. We must have good audit and if that costs more, the charge must be paid. No market can work without the accurate and honest information that is provided by independent auditors who are not brought into a collusive relationship with the companies that they audit.
I look forward to a co-operative relationship with Ministers who will serve on the Committee on the amendments that I have in mind to improve and strengthen the Bill, which I welcome. I hope that my critical remarks about the DTI's relationship with the big four will not affect my impetuous enthusiasm to work with it for a better Bill.
§ Mr. Mark Hoban (Fareham) (Con)
I rise with some trepidation because I am probably the only person in the Chamber who has worked for one of the big four firms 671 that the hon. Member for Great Grimsby (Mr. Mitchell) called into disrepute. I am a non-practising chartered accountant, and I want to focus my speech on auditors' liability.
The Minister was right to stand firm against the siren voices of her colleagues, especially the hon. Member for Great Grimsby, who called for more detailed regulations and rules on aspects of audit firms' operations, because a rules-driven approach has been shown not to work in certain jurisdictions. The principles that underlie UK accounting standards, rather than the rules-driven approach that underpinned US practice, explain why we have managed to avoid the great corporate collapses experienced in the States over recent years. It is important to stand behind the principle-driven approach on regulation and accounting.
Having said that, it is a great shame that the Bill has not been used to limit auditors' liability by setting up rules for proportionate liability or capping the liabilities faced by audit firms—different approaches to tackling liability that, I suspect, would have different consequences for the market for audit services. It is especially disappointing that this morning's written ministerial statement used the cover of the Office of Fair Trading report as a reason not to proceed with limiting liability through the Bill. The report has come in for a fair bit of criticism from not only the accountancy profession but independent commentators, due to its relative merits, the time scale in which it was completed and its lack of a thorough investigation of the market. I hope that the Government will support and encourage the consultation process to which the Minister referred in her speech and the Secretary of State referred in the written statement so that the issue will not continue to fester for years to come.
Limitation of liability is a problem for auditors for two reasons. First, the legal position is that an auditor held responsible with other parties for the loss suffered by a company, no matter how minimal its role in that loss, is liable as a consequence of joint and several liability to pick up the whole loss. People often sue audit firms because they believe that they have deep pockets. The hon. Member for Great Grimsby highlighted the fact that insolvency practitioners pursue firms of auditors to recover losses suffered by creditors and shareholders. It is right and proper for them to do so, as they have a duty to maximise the amounts that they secure for creditors. Sometimes, however, auditors are seen as an easy target, compared with directors, who may not have the resources of accountancy firms.
Secondly, limitation of liability is a pressing issue because of the financial risk to which my hon. Friend the Member for Sutton Coldfield (Mr. Mitchell) referred. Large firms of auditors may be unable to secure sufficient insurance cover for the financial risks that they face as a consequence of claims. If cover is not in place firms are exposed to the danger of a catastrophic loss, leading to the collapse of the business. That also acts as a barrier to other audit firms that may wish to enter the market for large audit clients—a point to which I shall return. As well lacking access to insurance cover an audit firm, by virtue of being a people business and a partnership, may lack ready access to capital. A big four 672 firm may have a £1 billion turnover in fees, but its net assets are a quarter of that sum. A successful claim against such a company could lead to its collapse.
We need to think carefully about the consequences of not implementing limitation of liability. Audit firms will continue to tighten their client acceptance and retention procedures, which determine whether or not they take on or retain a client. When I worked for an audit firm, there was a distinct tightening of risk management. Audit firms are focusing much more on risk in a range of different areas, especially client acceptance and retention. In recent years, their procedures for doing so have become more rigorous, and as the risks faced by auditors increase as a result of the growing size and complexity of their client companies, they will adopt an even more rigorous approach to client acceptance. Auditors will look more carefully at high-risk factors and companies, and decide whether or not they want to be exposed to the risk that such companies bring. They may start to show the independence that the hon. Member for Great Grimsby wanted them to show by turning such clients away. That process could start if limitation of liability is not implemented.
§ Mr. Austin Mitchell
Does the hon. Gentleman think that that careful scrutiny of clients is more common than the widespread practice of low-balling—putting in a low bid to get the audit contract? We have heard several examples of things that firms have done to get their foot in the door and get the contract, so that they can sell other services. However, they have to reduce the quality of the audit, perhaps by using unsupervised and untrained staff, and cut corners so that the audit meets the cost given in their bid.
§ Mr. Hoban
The hon. Gentleman's intervention demonstrates the weakness of his case, as he tends to overstate the extent of low-balling and collusion. In her written statement today, the Secretary of State referred to the reputation of audit firms, which they know they risk if they produce poor quality audits. The value that they place on their reputation stops them cutting corners and risking the quality of their audit work. In overstating his case, the hon. Gentleman does himself an injustice, as earlier he made a powerful argument about problems that need to be tackled.
There is a risk that some clients will be turned away and will not find an auditor to audit their accounts. At the weekend, one newspaper referred to the prospect of companies in the financial services sector being unable to find an auditor, which would create a serious risk for capital markets and shareholders. Auditors must engage in a debate about the financial risks that they are prepared to accept when taking on clients and the extent of their financial exposure. Reluctance to limit auditors' liability could also restrict the work that they do. In the past few years, as I saw when I was in the profession, more and more information has been included in company accounts. In addition to financial data, there are reports on corporate governance, internal controls and, as was said earlier, operating financial reviews. Much of that information is non-financial and is not audited. Auditors are required only to give a true and fair opinion of financial statements, so a large part of the accounts that shareholders receive includes information that the auditor has not looked at. I looked at a copy of 673 an audit report earlier today, and the auditors clearly differentiate between their work to test the accuracy and integrity of financial accounts and their work on non-financial data. They do not pass comment on the quality of a company's systems, on which the directors themselves report. They do not say whether those controls are adequate or inadequate—they simply say that a board has published a statement, and do not comment on the effectiveness of corporate governance or risk and control procedures.
I should have thought, however, that many investors would like the auditors to comment on those internal controls and corporate governance procedures. The risk to which audit firms would be exposed if they made such a report restricts to the minimum the scope of the comfort that they can give. If we want better-quality information to be given to shareholders, and if it is to be validated and verified by accountancy firms, we must look at their liability, and decide whether we want to restrict it to enable auditors to undertake more services of genuine value to investors and shareholders. The hon. Member for Weston-super-Mare (Brian Cotter) referred to the comments of the chief executive of the Institute of Chartered Accountants, Eric Anstee, who said:
A fair liability regime encourages more transparent corporate reporting and enables auditors to exercise professional judgment on matters that go beyond the statutory audit requirements.
That is a valid point—if the Government want auditors to comment on the operating financial review and non-financial data and accounts, they must look at the liability faced by auditors in producing such work and consider whether they should restrict it to enable them to provide much greater assurances.
Another consequence of a failure to tackle limitation of liability in the Bill is a restriction of the number of firms willing or able to audit large companies. I became an accountant in the mid 1980s, when I joined a big eight firm. Those firms have now been reduced to the big four, which, as has been said, dominate the market for large audits, auditing every single FTSE 100 company and 97 per cent. of FTSE 250 companies. A catastrophic claim against one of the big four could restrict those firms to the big three. It could be argued that that creates an opportunity for someone to enter the market and pick up audit work, but under current conditions that is not possible, as Steve Edmonds of Grant Thornton pointed out:
The OFT's report has not addressed the consequences of the marketplace if another Big Four firm were forced to seek protection from enormous professional indemnity claims. Were the Big Four reduced to a 'big three', it is highly unlikely that Grant Thornton or another mid-tier firm would seek to take the place of the former Big Four member in such a risk segment of the audit market.
Eric Anstee said of middle-tier firms:
These firms wrote to the DTI at the time of the original consultation indicating they wished to audit larger public companies but were reluctant to do so either because they could not get insurance or because the potential exposure was too great.
There we have it. If we are looking to support the existing structure of the market or to support competition between audit firms, we need to reconsider the limitation of liability for audit firms. If we wish to move away from the big four and encourage middle-tier 674 firms to audit larger clients, we need to limit liability for their sake, to reduce their exposure. Comments have already been made about the much greater dilution of power in some of the overseas markets where there is already limitation of liability. In Germany and Austria a larger number of companies are audited outside the big four because those smaller firms feel confident, given the existence of the cap on liability.
The principal argument against the limitation of liability is the concept of moral hazard—that if we start to restrict the liability of auditors, they will reduce the standard of their work and, in the words of the hon. Member for Great Grimsby, cut corners. I am not sure that that would happen. I have done work that was subject to unlimited and limited liability, and I do not believe that my standard of professionalism dropped between different types of assignment. One tackles all assignments with the same degree of care and the same sense of the importance of one's work for the firm's reputation.
The Government have made a mistake by trying to kick the issue of limiting auditors' liability into the long grass. By setting up an open-ended consultation process and by not tackling the issue in the Bill, they are creating the potential for a further concentration of the audit market down to the big three, and a situation where audit firms will turn away clients whom they consider to be too great a risk for them to bear. That will lead to a restriction in the type of work that audit firms will consider. I hope that the Government will take advantage of a short Committee stage to think again and take some positive action to tackle the issue of auditors' liability.
§ Mr. Jim Cousins (Newcastle upon Tyne, Central) (Lab)
I intend to be extremely brief, so I shall do nothing other than comment on the part of the Bill that refers to the creation of community interest companies, except to say that I thoroughly support the remarks of my right hon. Friend the Member for Leeds, West (Mr. Battle) in his excellent exposition of the case for such companies and the service that might be provided by them. I shall not dwell too long on aspects of the Bill that I wholeheartedly support, such as the creation of new rights for auditors to demand papers and to demand replies of the companies and services that they audit. That is extremely sensible.
My hon. Friend the Member for Great Grimsby (Mr. Mitchell) draws to the attention of the House the problem of the new grandees of our economic life—the big four accountancy firms. The Bill does not address that issue. It is one thing for a Parliament to decide that it does not wish to address some matter. It is another thing for a Parliament to give the impression that it is happy and satisfied with the matter. Of course, Parliament and Government have important relationships with the big four accountancy firms. More than £100 million in the past three years was commissioned in contracts by Government Departments. That does not include the cost of the beginnings of the implementation of the identity card scheme by the Home Office, which has been placed by one of the big four accountancy firms, nor does it include the Department of Health, for the remarkable 675 reason that the Department of Health cannot tell us the extent of its contracts with the big four accountancy firms, which is not good news.
For that reason, I share with my hon. Friend the Member for Great Grimsby great concern about the connection between audit and non-audit services. We should recognise that the value of non-audit services now far exceeds the value of audit services. That offers the possibility that audit services become a loss leader to attract non-audit business. It is true, as my right hon. Friend the Minister set out, that it is open to the Auditing Practices Board to lay down guidance and rules about limitations on audit and non-audit services, but that would mean Parliament farming out its duties to another body. I regret the fact that the Minister did not offer any guidance to the Auditing Practices Board on how it should seek to exercise its powers in that respect.
The House should recognise that it is no longer its own master with regard to these issues. The Sarbanes-Oxley Act—the new regulatory legislation in the United States—will apply to a great many British companies if they list and are quoted on American stock exchanges. Parliament cannot simply pass such matters over to some other body. It would be entirely wrong for Parliament to leave these issues to be determined by the US Congress. When we see in the American legislation that, for example, audit firms are banned from outsourcing internal audit functions, it is hard to say that that is not right. When we see that the American legislation bans audit firms from supplying investment broking services to the companies that they are auditing, it is hard to say that that is wrong, or that we would not want to consider that for our own legislation.
The Minister said that tax advice was not part of the limitations of the American legislation, and that audit firms can carry out tax advice as part of their non-audit services to the same firms. That is true, of course, but she did not tell us that that was one of the most hotly contested issues in Congress, and that many in Congress bitterly regretted the fact that there would be no ban on tax advice being given by firms that were supplying audit services to the same companies.
The Minister also did not tell us that those in Congress who wanted passionately to see that limitation introduced were successful in requiring that audit firms that offered tax advice should have the specific approval of the audit committee for the tax advice that they were giving, issue by issue, contract by contract. These issues are being raised in the US Congress and put into American legislation, and they will apply to UK companies, yet Parliament expresses no view about them. What an incentive, what an encouragement to all the proactive prosecutors in the United States to take their revenge on our companies for our failure as a Parliament to address the same and similar issues.
What a pity, too, that we have offered no guidance to the financial reporting review panel on what duties it should regard itself as having. The Bill increases the panel's powers and allows the Inland Revenue to talk to it. That is good, but we have not provided any guidance on what duties we see the panel carrying out or how it should report to Parliament or the outside world. We have left the impression that those activities are simply 676 the property of a small collection of key stakeholders and that they are not a matter of public interest and public debate. That omission is important, and British companies will pay a heavy price for it at the hands of prosecutors in other jurisdictions.
On a cap on audit liability, the Companies Act 1985, which has already been referred to, specifically provided that no cap on auditor liability should be introduced. That was not an oversight, because Parliament considered the matter in 1985 and decided that it did not want to go down that route. Why did the 1985 Act provide that no cap on auditor liability should be introduced? It was because Parliament sought to strike a balance between financial and moral hazard—by increasing financial hazard, moral hazard is reduced, which provides the need for regulation.
If Opposition Members who want to remove the cap on auditor liability go down that path, they will change the debate, and the issue of Parliament itself providing statutory regulation for the resulting moral hazard issues will be on table. I invite them to consider that the shift is not one way—if they shift the debate in that way, they will shift it in other ways, too.
§ Mr. Austin Mitchell
The same point applies to limited liability partnerships. If the liability of one particular partner is reduced, the tendency for all partners to invigilate each other in order to protect the whole firm's reputation diminishes, which weakens corporate strength in the big accountancy houses.
§ Mr. Cousins
When Parliament conceded limited liability partnership legislation and provided the framework, it was a great shame that it did not also address the inevitable issues concerning regulation. That was a failure, but in politics it is pointless to dwell on battles lost, because one is likely to lose current battles. I simply say that we should not compound that mistake.
I welcome this morning's statement by the Department of Trade and Industry. When I asked my right hon. Friend the Minister whether the closure of the issue of a cap on auditor liability applies to this Bill, however, I did not get a clear answer. I wonder whether the Government will return to that issue during the passage of the Bill, and I therefore need to make the point that such a return would be unacceptable to many Labour Members.
I do not regard allowing a system of contractual limitation of liability agreed between companies and their auditors, which was outlined and suggested in this morning's statement, as a comfortable or satisfactory way in which to proceed, because it opens the way for collusive relationships between auditors and those whom they audit, the prevention of which is a company audit's entire purpose.
I am extremely concerned about those issues. I will not dwell on them now, but I remind the House that if it fails to grasp them, it will not kick them into touch, but it will leave British companies wide open to legislation in other jurisdictions, such as the United States of America. On the strength of tonight's debate, the land of the brave and the home of the free is more courageous than this House on the regulation of enterprise and auditors.
§ Mr. Andrew Mitchell
With the leave of the House, Mr. Deputy Speaker.
Given the nature of the subject, the debate has been interesting. With regard to my contributions, I hope that the Minister feels that there is no party political division on much that we have discussed. We both paid tribute to the good work that has been done in the other place on reforming the Bill and I pay tribute to the way in which the Government have listened to the Opposition and framed a number of their amendments around our concerns.
Broad strategic agreement exists on both sides of the House about where we want to go. I say to the hon. Members for Great Grimsby (Mr. Mitchell) and for Newcastle upon Tyne, Central (Mr. Cousins) that I agree with their desire to ensure that the law punishes wickedness and holds to account people who do not behave as they should.
I shall make a couple of points about this morning's statement and I hope that the Minister will comment on them in her winding-up speech. On directors' liability, we must consider her remarks carefully, but, on the face of it, the measure looks rational and hopeful, in so far as it goes. I am sure that we will return to that point in Committee when the Minister tables her amendments, which she kindly says that she will make available to the Opposition parties.
Will the Minister explain why her Department has decided that capping for auditors is wrong, but that capping of directors' liabilities to protect them from third-party claims is right? Does she intend that companies that make such arrangements with their directors should get their shareholders to approve them?
Why have the goalposts been moved on auditor liability? In the consultation document, the Government refer to their determination to ensure that a "competitive market is maintained". In today's statement, they say that they want to see "significantly enhanced competition". How does the Minister think that enhanced competition and new entrants into the market can be achieved while maintaining unlimited and uncapped liability?
The Minister has kindly said that she will ensure that Opposition parties receive an analysis of the responses to the consultation process. However, the vast majority of respondents said that action was urgently needed, and most respondents, including the Association of British Insurers and Hermes, favoured some form of proportionality. How can hon. Members form a proper view without seeing an analysis of the views that were received? What possible justification can there be for further delay? More than three years ago, the company law review recommended that serious action should be taken, and the Minister's Department must take the necessary action.
The right hon. Member for Leeds, West (Mr. Battle) spoke with his usual passion and commitment—his credentials are very strong too—about the charity sector. Conservative Members agree with his point about the need to support such community enterprises. Our reservation, with which I think he will agree, is that the structure that he described is confusing.
The right hon. Gentleman rightly pointed out that the failure to introduce secondary legislation to deal with the lock-in in the industrial provident society legislation 678 is extremely important. This Bill introduces the community interest company and the draft Charities Bill introduces the community interest organisation. I venture to suggest to the House that the CIO will be successful, but I suspect that the CIC will be much more challenged in meeting the objectives that the right hon. Gentleman set out for it and that Conservative Members fear that it may well not meet. I share his enthusiasms; I hope that he shares my reservations on the nature of the format.
The hon. Member for Weston-super-Mare (Brian Cotter) largely agrees with Conservative Members on the nature of the Bill. He wants its remit to be extended significantly, not least to deal with the vexed subject of late payment. I have no doubt that we can explore that in Committee.
The hon. Member for Great Grimsby, whose accusations against international capitalism are far too hot for me to handle, inveighed against indolent non-executives, overpaid chief executives, fat cats, friends of the big four, and—rightly—Robert Maxwell, a former member of his party. The hon. Gentleman described the audit partner's relationship with that company, which he and I can agree was an absolute scandal.
In relation to clause 8, the hon. Gentleman said that he is anxious to protect those people who were forgotten by the Government in the Lords. I look forward to tabling what might come to he known as the Mitchell amendment in Committee to deal precisely with the point that we both raised in that respect.
From the vantage point of expertise, my hon. Friend the Member for Fareham (Mr. Hoban) made a wise speech in which he stressed that in every other business sphere, a business man or woman can limit their liability either by contract with their customers or by obtaining insurance. He flagged up the real danger that a major company might not be able to secure an auditor. We want a fair liability regime, and that is what we should be working towards.
The hon. Member for Newcastle upon Tyne, Central talked about the danger of collusive relationships in the sphere of auditor activity. He is right: that is precisely why the legislation—not that passed in 1985, but much earlier in the last century—sought to deal with the issue of collusive relationships between companies and their auditors. I wish to propose in Committee a relationship that deals with the serious issues that I discussed in my opening speech—one that does not fall into the moral hazard that was suggested by the hon. Members for Great Grimsby and for Newcastle upon Tyne, Central, but that tackles it in the interests of a competitive market where many of the abuses about which the hon. Member for Great Grimsby is so concerned would be dealt with.
Conservative Members are not prescriptive, but we strongly believe that the Government must measure up to their responsibilities to the corporate sector and come up with a proposal for handling the problem. We will try to table the widest possible range of amendments to deal with that. We do not have the resources that the Minister has, with her fine body of civil servants, and if our drafting is defective we will of course defer to her, but we hope to carry her on this point. Something needs to be done, and we will come up with some ideas that we hope will find favour.
679 We are concerned about three aspects of the Bill. The first relates to its diminutive status. The Government have missed the opportunity to address the excellent work done by the 15 members of the company law review, which has been on the Minister's desk since the middle of 2001. We are disappointed that the DTI has not taken this opportunity to bring forward that much-needed legislation.
Secondly, we are worried by the Government's failure to understand the effect of this level of regulation in terms of stifling initiative and entrepreneurialism. It used to be high tax that killed off enterprise in this country; now, the spirit of enterprise is being strangled by red tape, regulation and bureaucracy. The Government must have a care to ensure that they do not allow that to persist.
Thirdly, on the community interest company, we are worried that the Bill as it stands will not meet the aspirations expressed by the right hon. Member for Leeds, West. We hope that we can improve the situation by probing and questioning the nature of the CIC with the Minister in Committee.
As the Minister knows, we are concerned about directors' liability, although we will look carefully at what she said today. We are concerned about auditor liability and about the difference between directors and non-executive directors, with all the risks and dangers for our system of corporate governance that result. We are worried about the levy and seek assurances from the Government on that. We are worried about the extent of the independent monitoring of major audits and fear that it may be excessive. We want to protect the rights of the individual, about which this House has always been concerned, in relation to excessive investigatory powers. We want to reassure the citizen that the powers that we give to officials and enforcement authorities are really necessary.
Conservative Members do not wish to divide the House tonight. We hope that the spirit of co-operation shown by Government Front Benchers on Report in the Lords will persist in Committee and on Report here. On that note, I rest our case.
§ 8.5 pm
§ Jacqui Smith
With the leave of the House, Madam Deputy Speaker.
We have had a useful debate that was probably more interesting than some people thought that it was going to be, although it ranged a little wider than the Bill. I am pleased that the House has had the opportunity to devote some attention to the subject of company law. Companies are an essential feature of our lives and it is crucial that we do not leave this area solely as the preserve of specialist lawyers—or even accountants, notwithstanding the very good speech by the hon. Member for Fareham (Mr. Hoban).
I want to respond to some of the issues that hon. Members raised, but we will return to some of the more detailed points in Committee. Several Members asked about the progress that we are making on the company law review. As I said in my introduction, we are the Government who undertook that review, which spelled out the comprehensive nature of the reform that is 680 necessary. Let me be clear that we are working on and will make proposals that will enhance shareholder engagement, foster a long-term investment culture, help to ensure better regulation, enshrine the principles of "think small first", make it easier to set up and run a company, and ensure that the law remains flexible for the future.
As the hon. Member for Weston-super-Mare (Brian Cotter) said, we have already started our consultation on the new powers to reform and restate company law. Taking forward that detailed work is no small task, but we will ensure that we get it right by drawing on expertise in business and elsewhere to help us. We will legislate as soon as parliamentary time allows and publish a draft Bill beforehand to allow for further full consultation.
Several hon. Members referred to the operating and financial review, which represents an important opportunity to develop the information that is available to shareholders and the market and to enhance financial statements to allow much broader discussion and analysis of the business. We consulted widely on that. The consultation closed on 6 August, and we received more than 130 responses. We will soon introduce regulations to ensure that we make progress on that important aspect.
Interestingly, almost all hon. Members commented on audit liability. The voices of the hon. Members for Sutton Coldfield (Mr. Mitchell), for Fareham and for Weston-super-Mare, on one side of the House, and of my hon. Friends the Members for Great Grimsby (Mr. Mitchell) and for Newcastle upon Tyne, Central (Mr. Cousins) on the other, identified the difficult challenges involved in taking that matter forward.
I am somewhat averse to calling the hon. Member for Sutton Coldfield a Johnny-come-lately to this issue, but not so averse that I will not. It was this Government who undertook the review that led to the changes that brought in limited liability partnerships, and this Government who undertook the consultation to which we have received several detailed responses. Although some respondents will have asked for confidentiality, I will ensure that those responses that we can make available are placed in the Library. Subsequently and rightly, we asked the Office of Fair Trading to consider the competitive impact of proposals for a cap on auditor liability. Let me reiterate our objectives for progress on that: to ensure access to high quality audit provision for our businesses; to ensure that we continue to drive up the quality of the audit; and to ensure competition in the audit market. I believe that I am—dare I say it—the voice of reason in the discussion. We shall keep the objectives at the centre of our consideration.
As my right hon. Friend the Secretary of State made clear in the statement, we will not ignore the advice of the independent OFT, which has made clear its view that the proposals for a cap on auditor liability as proposed in the consultation may be competitively neutral. However, we shall consider seriously ideas for limiting liability proportionately by contract. As I said earlier, the challenge is for us all, including auditors, investors and business, to come together to ascertain whether that would work, whether it would be desirable and whether it would deliver the objectives that I outlined.
681 The hon. Member for Sutton Coldfield mentioned directors' liability. Our objective is to maintain the necessary pool of expertise to direct our businesses. He asked some specific questions. He asked why we were changing that law but not the law on auditor liability. As I said earlier, changes should be considered on their merits. There is stronger and clearer consensus that the need for reform is more urgent in respect of director liability and greater agreement exists on the proposed reforms, which are not a cap on directors' liability but provide the ability for businesses to indemnify some of the costs that might confront directors when facing action.
On shareholder approval, the proposals will provide shareholders with information. They will not require prior shareholder approval specifically because we do not propose a cap on liability in the way in which the hon. Gentleman expected.
The hon. Gentleman criticised us both for not taking action quickly enough and for bringing forward action on community interest companies in advance of the Charities Bill and the proposals for a charitable incorporated organisation. As my right hon. Friend the Member for Leeds, West (Mr. Battle) ably pointed out, the introduction of the community interest company is an important part of the Government's programme for support for social enterprise and will complement the other available options. Work is well advanced on it and many community and social enterprises will benefit from its introduction. It is therefore right to take that forward.
Charitable incorporated organisations come from a different direction, although both they and community interest companies were recommended by the strategy unit and both were supported in consultation. As my right hon. Friend said, although charitable incorporated organisations provide some of the restrictions, they come from the charity sector and are therefore subject to some of the restrictions of charity law, whereas community interest companies come from the enterprise end, take the form of a company and therefore do not have some of the restrictions but bring with them other responsibilities. There is a distinction between the two and it is therefore logical to bring forward community interest companies in a way that will help to promote social enterprise and create many of the benefits that my right hon. Friend rightly identified.
The benefits include communities' ability to develop not only socially but economically, therefore facilitating the establishment of the asset lock and ensuring that entrepreneurs do not need to reinvent the wheel when determining an asset lock. The hon. Member for Sutton Coldfield appeared to suggest that they should have to do that on each occasion. We believe that the measure will help us to help entrepreneurs and to develop the social enterprise sector.
I agree with my right hon. Friend the Member for Leeds, West that we need clarity about non-profit distribution and to encourage and support growth. I hope that we can discuss in Committee, and when we consider the Department's action to promote social enterprise, how we can ensure that we not only put in place the legal framework but that CICs deliver the benefits for our communities and our economy that he ably spelt out.
682 The hon. Member for Weston-super-Mare mentioned, among other things, late payment. It is a serious issue, albeit outside the Bill's remit. Of course, the Government are aware of the problems that late payment causes small firms in particular. That is why, as he pointed out, we legislated on that basis. We shall study his remarks carefully and are always open to suggestions to help smaller businesses and encourage enterprise.
My hon. Friend the Member for Great Grimsby continued his crusade, possibly against auditors and accountants, although he claimed to recognise the important role that auditors play. I look forward slightly to the time when the comments of one A. Mitchell are confused with the comments of the other A. Mitchell.
My hon. Friend made several important points. I agreed with some and disagreed with others. He mentioned competition among the big four auditors. I have already mentioned competition in the context of auditor liability. The OFT reviewed the competitive position of the big four in 2002. It concluded that the market for audit and accountancy is highly concentrated and announced its intention to keep that under review. In addition, the European Commission has announced that it intends to progress such work. We do not disagree about the importance of competition in the market for audit, but we possibly disagree about how we get there.
I disagree with my hon. Friend's comments about the nature of the regulatory structure. The Bill makes the regulatory structure more independent and coherent. The new financial reporting council will be a more effective regulator with the four clear responsibilities that I set out.
My hon. Friend the Member for Newcastle upon Tyne, Central was worried about whether we had abrogated our responsibility to the Auditing Practices Board on how to frame standards. The co-ordinating group on accounting and audit, which was not dominated by professional interests but made up of Government regulatory bodies and independent experts, gave much attention to precisely the sort of standards that my hon. Friend mentioned. The Auditing Practices Board has made constant reference to that report. There has also been the report by Sir Robert Smith on audit committees and the European Commission recommendations have been borne in mind. There has been considerable input, including considerable independent and lay input, into the progress that needs to be made in developing audit standards.
My hon. Friend the Member for Great Grimsby mentioned the enforcement of financial reporting requirements and suggested that we had not strengthened them sufficiently. The Bill strengthens the role of the financial reporting and review panel in three important ways. Clause 14 allows it to consider interim as well as annual accounts. Clause 12 grants the panel the power to require information so that it no longer relies on voluntary co-operation and opens an information gateway to enable the Inland Revenue to notify the panel in the course of its normal business when it becomes aware of instances of mis-accounting.
683 On top of that—this does not need the Bill; it is already happening—the panel is taking a more proactive approach to the scrutiny of accounts. That is important in turning the spotlight on to accounts to ensure that they maintain the high standards that we expect.
A general theme outlined by some of my hon. Friends is that this package of measures does not go far enough to improve audit independence and quality. I repeat my contention that the UK system of core principles and safeguards has already proved itself to be more effective than an American-style set of rules and prohibitions. We are putting in place a whole range of measures to address auditor independence. As a result of that, the co-ordinating group report deals with the problems from various angles—those of the auditor, the company and the oversight body. That is why there will be tougher ethical standards on independence and objectivity and they will be binding on the profession. That is why the standards setter, the Auditing Practices Board, will be independent of the professional accountancy bodies. That is why the new standards will require audit partners to be rotated more frequently and will introduce a two-year cooling-off period before an auditor can be employed by a client.
Firms themselves will ensure that there is a much stronger role for the company's audit committee. Clause 7 builds on that by increasing the transparency of the non-audit services provided to permit the market itself to decide when the company audit relationship may be inappropriate. When the legislative and non-legislative measures are taken together with the independent body that is being set up through the FRC, they will provide a UK approach as well as a strong and independent approach to ensuring the quality of audit that we all want.
Whether as Governments, businesses, investors or individuals, we all have a role and a responsibility in taking forward the strengthening of the environment within which businesses operate in the UK. I strongly believe that the UK continues to offer an attractive environment for companies to operate in. It is an environment in which our regulation does not overly burden businesses and in which change is driven forward by consultation and mutually agreed solutions. This enables investors and markets to prosper, enterprise to thrive, communities to develop and jobs to be created in the knowledge that a secure supporting structure is in place that is flexible enough to respond to the concerns as they arise.
That approach is taken forward in this carefully targeted Bill. It responds to important issues that have been raised in the context of company law. It contains the legal changes identified as priorities in the light of Enron and similar scandals, and it contains measures to promote the creation and development of social enterprises that can bring significant benefits to local communities and more widely.
On Third Reading in another place, one of the Opposition spokesmen said that
we now have a Bill that is workable and will be of great benefit".—[Official Report, House of Lords, 14 July 2004; Vol. 663, c. 1297.]
684 I cannot put it better myself. I commend the Bill to the House.
Question put and agreed to.
Bill accordingly read a Second time, and committed to a Standing Committee, pursuant to Standing Order No. 63 (Committal of Bills).