Official Report of the Grand Committee on the Companies (Audit, Investigations and Community Enterprise) Bill [H.L.]

HL Deb 17 March 2004 vol 659 cc75-138GC

(Second Day)

Wednesday, 17 March 2004.

The Committee met at half past three of the clock.

[The Deputy Chairman of Committees (Lord Lyell) in the Chair.]

Clause 8 [Auditors' rights to information]:

Lord Hodgson of Astley Abbotts moved Amendment No. 31: Page 10, line 11, after "explanations" insert "(in written form where so requested)

The noble Lord said: We move now to Chapter 2, which takes us from the structure of the accounting profession, and Mr Masson's brilliant charts, to accounts and reports. Amendment No. 31 relates to auditors' rights to information and concerns the manner in which statements are to be taken by auditors. It states that an auditor may require information or explanations in written form by inserting the words in the amendment after the word "explanations".

Under current law, as I understand it, auditors have the right to demand explanations in writing but it is not clear whether that is the case in the Bill. That is why we have tabled the amendment. The value of the provision is self-evident. If director A makes a comment to the auditor which the auditor considers important, the auditor should be empowered to require that the statement be put in writing. I beg to move.

The Parliamentary Under-Secretary of State, Department of Trade and Industry (Lord Sainsbury of Turville)

Clause 8 contains important provisions on the right of auditors to obtain information. These derive mostly from existing law but with the significant change that those required to provide information and explanations to the auditor include employees for the first time. That change reflects clear recommendations from both the Company Law Review Group and the Co-ordinating Group on Audit and Accounting.

Auditors should be able to ask for information and expect truthful answers from as many as possible of those likely to have information necessary for the successful performance of the audit. The amendment would specifically enable the auditors to require information and explanations to be given in writing. We do not think that this is necessary. The auditor's right under this clause, as under the existing provision, is to such information and explanations as he thinks necessary for the performance of his duty as an auditor.

As far as we are aware, there has been no difficulty because auditors cannot specifically require explanations in writing. if an auditor is dissatisfied with oral information—perhaps because the subject matter is highly complicated—it will be possible for him to say that he has not had the necessary information for the performance of his duties and to ask for the information in writing.

The noble Lord may see this change as linked to his further proposal, which we shall reach at Amendment No. 44, to restrict the offence of providing a misleading, false or deceptive statement or explanation to an auditor only where it is written. If the amendment is seen as a way of addressing the gap opened up by his Amendment No. 44, I do not think that that is a good enough reason for this amendment. Giving the auditor the right to require a person to provide the information or explanation in writing does not change our view about the desirability of that amendment, to which we will come later.

So, in simple terms, we do not think that this is necessary. The auditor would be able to get a written statement if he so wished.

Lord Hodgson of Astley Abbotts

I can reassure the Minister that Amendment No. 44 stands alone. This amendment is not linked to it in any way.

Our advice is that existing law provides for an explanation to be given in writing. The Minister may say that that does not matter but, of course, his officials have argued strenuously that changes elsewhere in the Bill which drop provisions—this happened in regard to vouchers yesterday—indicate that Parliament's will might be altering. If it stated "written" before but does not state "written" now—which is probably a matter of fact that his officials can confirm—why does not this provision indicate that Parliament's will is changing on this matter? If "written" is to be dropped, surely the courts will interpret that accordingly. Does the Minister wish to comment on that?

Lord Sainsbury of Turville

Yes, I do. I do not think that anything I said should imply that we are changing here. There is not a requirement for information to be written now and we are not proposing a change to that. The noble Lord seems to suggest that a barnacle should be added to the ship, rather than taking one away.

Lord Hodgson of Astley Abbotts

I am grateful to the Minister for that explanation. If the provision is not in existing law—our legal briefings suggested that it was and that therefore there would be a reduction or a weakness—and as I do not know the detail, I shall obviously take further advice. In the mean time, I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Lord Hodgson of Astley Abbotts moved Amendment No. 32: Page 10, leave out line 14 and insert— (a) any officer of the company or those employees of the company engaged in the preparation of the company's accounts:

The noble Lord said: We arc still on the same clause. We now come to consider the position of employees for the first time, to which the Minister referred in his reply to Amendment No. 31. Amendment No. 32, which is grouped with Amendment No. 76, would limit the people who must provide information to the auditors not just to officers or employees of the company, but also to those who are engaged in the preparation of the company's accounts. Therefore, the amendment would confine the auditors' source of information to those who are engaged in preparing the company's accounts.

By this and the next group of amendments, we wish to probe the Government's thinking on the position of employees. Although it seems unjust to put every employee in the firing line, we recognise the force of the argument that it is more reasonable to permit the auditor's inquiries to include those involved in preparing the company's accounts, because the verification of the accounts is the auditor's key role. The law should give the auditor access to information relevant to his task. If the auditor asks to look over all information stemming from every possible source within the company, however unrelated it might be to the company's accounts, there may be a risk that the focus of the audit becomes blurred—as, indeed, does the role of the auditor. Some might argue that if the scope of the auditor's duty is to become as extensive as that, is he not in danger of becoming an investigator rather than an auditor?

As we understand it, it should be noted that those included in the range of the auditor's rights to information under the provisions of this clause would include anyone who was formerly an employee or officer of the company at any such time—that is in new Section 389A(2)(e). The upshot is that the duty of cooperation goes far beyond those responsible for the company at the time of the audit. Rather, the duty would be imposed so widely, with co-operation demanded of not only "any employee" but also of any past employee. That is indeed a wide definition.

Bringing all employees within that provision with its criminal sanction not only has drawbacks that may be undesirable to companies, employees and even to auditors, but creates what is essentially a duplication. As we shall debate under later clauses, the directors are under a duty to ensure that the auditors are made aware of all relevant information—at new Section 234ZA, page 12, line 11. Therefore, the scope of this clause should be limited to those engaged in the preparation of company's accounts. I beg to move.

The Deputy Chairman of Committees (Lord Lyell)

I advise the Committee that if Amendment No. 32 is agreed to, I shall not be able to call Amendment No. 33.

Lord Sharman

I think that the narrowing of those people who would be obliged to provide information to auditors would be very dangerous. An audit is concerned with the verification of accounts. but in so doing it has to take a judgment over many matters and many items that appear in those accounts. In doing that, it will need information from many people who arc not directly, or even indirectly, involved in the preparation of those accounts.

I can think, for example, of an organisation such as an oil and gas company and those responsible for the booking of its reserves, which might have a fairly significant impact on the depreciation charges. None of those people would be directly, or even indirectly, involved in the preparation of the accounts, but they would have a very significant impact on the judgments that could be arrived at in so doing. I am afraid that I cannot support the amendment. I think that it is too narrow.

Lord Hodgson of Astley Abbotts

In the circumstances of oil and gas reserves that the noble Lord has just described, could he envisage that this would be undertaken by a person who was not an officer of the company?

Lord Sharman

Yes, I can. There may well be a situation where the individual responsible for booking the reserves of an oil and gas company may not be a director or an officer.

Lord Sainsbury of Turville

The amendments would weaken what the Government propose. I shall speak first to Amendment No. 32, which would amend Clause 8. This would restrict the ability of the auditors to require information and explanations to only those employees engaged in the preparation of the company's accounts. Our purpose is to enable the company auditors to carry out their duties more effectively and thus to increase the reliability of and confidence in company accounts. The noble Lord's amendment would restrict the scope to those employees involved in the preparation of accounts. In our view, that would weaken the provision significantly.

It is a little difficult to know who would be covered by the phrase, engaged in the preparation of the … accounts". Even if some fairly wide definition could be found, there may well still be others holding relevant and valuable information who should be under an obligation to answer an auditor's questions.

In practice, the auditors talk to and ask questions of a wide range of employees and this is likely to go well beyond those who could in some sense be said to be involved in the preparation of the company's accounts; to cite a simple example, those who are responsible for the company's stocks. The auditor should be able to require information and explanations from all those employees who he feels may be able to provide such information as he thinks necessary for the performance of his duties as auditor.

The idea that the auditor needs information only from those involved in the preparation of accounts seems to be based on a very outdated view of what an audit is about. For example, it is essential, not least to enable the auditors to assess the risks to the entity, for the auditor to obtain a good knowledge of the business of the entity. An excellent way of obtaining that knowledge may well be by questioning those in a wide range of functions, such as computer personnel, internal auditors and senior operating personnel. All are good examples of such people.

I turn now to Amendment No. 76 to Clause 12. This clause provides the Financial Reporting Review Panel, the body which reviews the annual accounts of public and large private companies, with a statutory power to obtain relevant information from the company, and from any officer, employee or auditor of that company. This raises similar issues to those we have already discussed in relation to Clause 8.

To date, the FRRP has relied on voluntary co-operation to get the information it requires, and this has worked. Rarely in practice has the panel encountered difficulties in obtaining what it needs to carry out an investigation. However, with the panel moving on to a more proactive footing and increasing the number of accounts it reviews, there is clearly an increased likelihood, if only in pure number terms, of a company failing to co-operate. We have therefore sought to provide powers for the FRRP in Clause 12 which are wide enough to enable it to have access to all the information and documentation it needs to undertake its work—no more and no less than that.

In most cases, the FRRP will be interested in getting documents or information from those employees who are or were involved in the preparation of the accounts, but that need not always be the case. As I mentioned in the context of Clause 8, there are difficulties of definition. What does it mean to be engaged in the "preparation of the accounts"? There may well be other employees holding some information which would be relevant to the FRRP investigation, and in exceptional or complex cases the FRRP may want to talk to a wide range of employees, not just those involved with the accounts. Again, the example of company stock is an obvious one. Clerical assistants and personal secretaries may also hold valuable information. Is the personal assistant to the finance director a person who is, involved in the preparation of the company's accounts"?. That is a debatable point.

This amendment would introduce an unnecessary degree of uncertainty. It is clearer and better to have a general obligation on employees to comply with requests from the FRRP. But I must emphasise that this is not an unfettered power. Whoever the employee is, under subsection (2) the FRRP can only require the provision of information that it may reasonably need for the purposes of the functions it has been authorised to perform.

While I cannot accept these amendments, I am grateful to the noble Lord for giving me the opportunity to outline the Government's intention in these matters. I hope that I have reassured the noble Lord that while our version of these provisions is slightly wider than would be the case if this group of amendments was accepted, what we are introducing is proportionate and, in the case of the FRRP, properly safeguarded.

Lord Hodgson of Astley Abbotts

We did not expect the amendments to be appreciated with open arms, but we wanted a chance to discuss them and the wider issues that come in the next two groups of amendments. I understand the difficulties of definition, and see the recommendations made by various review bodies. I also understand the points made by the noble Lord, Lord Sharman, although he was a little abrupt on the question of whether an officer should have passed his opinion on a major issue involving a company. However, I am perfectly happy to beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

3.45 p.m.

Lord Hodgson of Astley Abbotts moved Amendment No. 33: Page 10, line 14, leave out "or employee

The noble Lord said: Amendments Nos. 33, 36 and 77 have been grouped together, and I shall speak to them all. They cover a wider aspect of the arguments that we discussed on the previous group, and propose a more radical solution. We hoped to table them so that we could discuss them before the previous group, but were told by the Table Office that, unfortunately, we had to deal with the other group first due to the way in which we tabled them.

The amendments remove every employee from the auditors' potential line of inquiry. There are two parallel and, at times, overlapping issues on which we wish to probe the Government's thinking. The first is the position of employees of a UK-incorporated company or its UK-incorporated subsidiary, whether they are working in the UK or overseas. The second regards UK companies that have subsidiaries incorporated overseas and the position of their employees, which is dealt with in the next group of amendments. However, Amendments Nos. 33, 36 and 77 deal with the first issue; namely, the extension of auditors' rights to information to include employees of UK-incorporated companies and their UK-incorporated subsidiaries.

The first two amendments withdraw auditors' rights to information extending to all employees. Amendment No. 33 leaves out the employee of the company from the list of those from whom the auditors have rights to information. Amendment No. 36 leaves out the employee of any such subsidiary undertaking from the same list. Amendment No. 77 concerns Clause 12. which is on the power of the authorised person to require documents, information and an explanation. That amendment leaves employees of a company out of the scope of the auditors' rights to information.

Currently, the Companies Act 1985 entitles the auditor or an authorised person to ask for information or documents from officers of a company. such as directors, company secretaries or managers—that is, people who have direct knowledge and/or responsibility for the company's affairs. The Explanatory Notes state at paragraph 42: Clause 8 reflects a recommendation in the Company Law Review".

The recommendation was that, employees should be brought within the scope of the current duty and its criminal sanction".

We have had a very useful briefing from Mr George Bompas QC, a leading commercial Silk. He tells us that the recommendation appears to have been directed at employees of companies subject to audit in accordance with the Companies Act, not at employees of subsidiary companies—whether or not GB-incorporated—and to have been aimed at imposing on that class of person a direct duty to provide an explanation where the auditors think it necessary for their audit. In other words, the recommendation of the company law review would have been sufficiently dealt with by including, in existing Section 389A(1), "and employees" after "officers", and, in existing Section 389A(2), "or employee" after "officer".

In fact, the new draft of Section 389A goes further. It extends the range of persons from whom the auditors have the power to require information and explanations. Those newly included under it are: employees of the company; persons holding the company's books, accounts or vouchers; officers, auditors and employees of the company's GB-incorporated subsidiaries; and persons holding the books, accounts and vouchers of any such subsidiaries.

Our amendment focuses on the first of those categories: the employees of the company or its subsidiaries. We examined that extension in the light of the extensions proposed in Section 389B in Clause 8 on page 11, which states that any person giving misleading evidence to an auditor is guilty of a fine, imprisonment, or both. It could be argued that it is quite a leap to include "any employee" within that liability, and going beyond what the company law review suggested.

"Any employee" is a broad category, which may usefully need further defining. At what level does "any employee" stop? Does the clause, for example. extend to the postman and the photocopy attendant? How will they be made aware of the serious nature of the inquiries being made of them and of the consequences which may follow from an answer that may be given capriciously or without due reflection? What is their position if they were to give false information after persuasive instructions from a superior? There is an issue of "equality of arms"—equal knowledge, equal sophistication and equal awareness. It could be too easy for very junior employees to become unwittingly caught up in a maelstrom in no way of their own making. We wish the Government to explain more clearly the parameters of the definition of "any employee" and how the new provision will work.

Furthermore, the main interest of the auditor is to extract relevant material—be it explanations, statements or documents from the company in question. For that to be achieved with maximum effect, total co-operation is needed from the relevant persons. If the relevant persons are junior employees who are aware that they now fall within a liability that could result in imprisonment, will that cause them to be more or less forthcoming with material?

The law should unquestionably come down heavily upon a director or an officer who submits misleading, false or deceptive information. A director has obvious obligations to a company as well as a full understanding of the consequences of misleading an auditor. The same cannot be said of every other employee, particularly those of minor ranking. "Employees" should therefore be omitted from this field of responsibility. I beg to move.

Lord Sharman

First, I apologise to the noble Lord for my abruptness. If he felt that I was abrupt, it is only a reflection of how deeply held are my views.

The issue that we come up against here is one that we touched on yesterday—the conflict between the legal and the accountancy professions. We have enough problems with auditing at the moment; auditing is under pressure, has been criticised widely and, in many cases, access to information has been restricted. If one considers auditing failures, one will find time and again that they happened because of restricted access or because access has been in some way curbed.

I contrast that with the Government's attitude and the general international development towards encouraging whistleblowing. If one is going to encourage whistleblowing, one must have a process that responds to that. Part of that process means that the individual employee has to feel responsible for blowing the whistle when something is going wrong. I find it very difficult to see how one removes the responsibility from the individual employee to provide the information that the auditor wants and at the same time say that he must blow the whistle if he sees something going wrong. There is a conflict here, which we need to be careful in resolving.

I always start from the basis that an auditor must have unrestricted access. To restrict access means effectively that one is saying that one is not going to let him do his job properly. We must be very careful about pulling back those parameters.

Lord Sainsbury of Turville

In some senses, these amendments cover old ground. I will not repeat the arguments about why employees should be covered. I see no need to set limits on the questioning of employees. Obviously, the auditors will have queries only for those who may have relevant information. Although, in practice, that may involve asking the postman for information, that may be the best way of finding out what is happening in the company. I do not think that we need worry too much about where the line is drawn.

The noble Lord raised one new and very important question—the argument that Clause 8 imposes too great a burden on employees. He argues that the Bill's requirements place an unreasonable burden on the employee. Of course, we recognise the need to strike the right balance between the rights of the auditors and the burdens placed on employees. We think that the clause achieves just that.

I emphasise that there are important protections for the employee. The employee does not commit an offence simply by giving information that turns out to be false or by failing to give that information. The information must be false in a material particular. The employee must have known that the statement was false or have been reckless as to whether it was false. The employee is protected against self-incrimination, and the employee is able to show by way of defence that it was not reasonably practicable to provide the information.

There is another issue. The employee may still be in an impossible position when, for example, a manager makes it clear that he does not expect employees to co-operate with the auditor. There may be circumstances in which it proves difficult for the employee. However, those are likely to be cases where the management has something important to hide from the auditor. Placing an obligation on the employee, as this clause does, overrides any duties of confidentiality that the employee might otherwise owe to the company.

Employment law has, of course, long allowed employees, subject to qualifying service, to complain to an employment tribunal if they believe that they have been dismissed unfairly. A dismissal where the employee is simply fulfilling his legal obligation under this clause would almost certainly be an unfair one.

Finally, how will employees be aware of their obligation? We will, of course, expect companies to make their employees aware of the obligation. It is also for the auditors to make the position clear to employees when requiring information from them. I hope that I have demonstrated to the noble Lord why employees should be covered. As for this group of amendments, we think that the employee would have proper protection if he provided information to the auditors.

Lord Wedderburn of Charlton

I entirely appreciate my noble friend's case that the auditor must be entitled to the kind of information that he is describing. However, he said that if an employee was in some way disadvantaged—I think he said "dismissed"—then he would "almost certainly" find that he is justified in any other proceedings. Does my noble friend think it would perhaps be sensible to consider striking out the "almost" and making other provision in the Bill?

Lord Sainsbury of Turville

That is an extremely important point, which is quite properly covered in the normal way. If a person were dismissed, that would be a matter for an employment tribunal. I do not think that anything is added to his protection simply by saying that he is protected in that way.

Lord Hodgson of Astley Abbotts

I am grateful to the Minister, particularly for listing the protections available to employees, especially junior employees, on this equality of arms issue. I accept the basic premise about the need for the auditors to be able to obtain information that is as unfettered as possible. I have no wish to find myself as the nut in the cracker of the accounting and legal professions. However, I hope the Committee will forgive me if I consult again and, if I have fresh ammunition, bring back the amendments. I heg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

[Amendment No. 34 not moved.]

4 p.m.

Lord Hodgson of Astley Abbotts moved Amendment No. 35: Page 10, line 17, leave out from "company" to end of line 18 and insert "including subsidiaries outside the United Kingdom

The noble Lord said: We come to the second barrel, so to speak. This is a group of six amendments that deal with the other half of the issue; that is, employees outside the United Kingdom. Here, a distinction is being drawn between UK-incorporated subsidiaries and subsidiaries incorporated outside the UK. At Second Reading, we raised and recognised the difficult questions involving extra-territorial jurisdiction. These amendments are designed to probe and question and to encourage the Government to illuminate their thinking on this point.

Amendment No. 35 alters the auditors' rights to information from being limited to "any subsidiary undertaking, which is a body corporate incorporated in Great Britain" to "any subsidiary undertaking, including subsidiaries outside the United Kingdom". Amendments Nos. 38, 39 and 41 are consequential. They seek to remove subsections (3), (4) and (5) of new Section 389A, which explain the distinctions between the treatment of subsidiary undertakings incorporated inside Great Britain and those incorporated outside.

Amendments Nos. 75 and 78 concern Clause 12 and the issue that we considered in the earlier groups. They face the other way and seek to include the company's subsidiaries within the power of the authorised person to require documents, information and explanations. Nevertheless, they raise the same issues of extraterritoriality, so we have grouped them.

Under the Bill, the officers and employees of a subsidiary incorporated outside Great Britain are not under any duty to respond to requests for information or explanations and, as I understand it. cannot be made criminally liable.

Subsections (3), (4) and (5) of new Section 389A explain that, imposing instead upon the parent company the duty of obtaining from the subsidiary, its officers, auditors, employees, and persons holding the subsidiary's books, accounts or vouchers, or any former officers, information or explanations reasonably required by the parent company's auditors. That different regime applies even though the subsidiary incorporated outside Great Britain may be carrying on business inside the United Kingdom and, indeed, may have a greater UK presence than a GB-incorporated subsidiary of the same parent which is carrying on all its business outside the United Kingdom. In other words, an overseas subsidiary may be doing business in the UK greater than that of the parent company itself.

The thinking behind those provisions seems to be that it would be wrong to impose duties and criminal sanctions on foreigners. However, the proposal for separate regimes applicable in the case of GB-incorporated companies on the one hand and non-GB incorporated companies on the other must be seen to be crude and unsatisfactory. That is particularly true when bearing in mind that employees and persons holding documents of a company may have no idea whether the company that employs them is a GB or a non-GB incorporated company, and that their own duty and liability will depend not on the place where they are based or where the company carries on its business, but on the accident of the place of incorporation of the company that employs them.

The Government claim that the Bill is part of their strategy to help restore investor confidence in companies following recent corporate failures. Others have less kindly called it a knee-jerk reaction. But however described, the Bill is largely the product of recent mishaps in America with WorldCom and Enron. The only comparable financial debacle in the UK is the events concerning Barings Bank. Problems and fraud within Barings Securities Singapore as an offshore subsidiary of Barings brought down the parent. Yet under the Bill, there will be no direct authority to go into the affairs of the Singapore company. Is that a sensible and coherent approach?

The intention of the amendments taken as a whole is to put overseas subsidiaries on a level playing field with UK subsidiaries. The noble Lord, Lord Sharman, said that accountants need unrestricted and unfettered access. So be it. We do not underestimate the difficulties of this approach, but if restoring investor confidence is really what the Government are seeking to achieve, that would be best achieved by including subsidiaries incorporated outside the United Kingdom within the jurisdiction covered in Clause 8, providing for a single regime applicable wherever the subsidiary is incorporated.

If the Government feel that that is too extreme for foreign jurisdictions and wish to keep the distinction. the rational solution would be to use Amendment No. 36 and remove subsidiaries' employees from these provisions. I beg to move.

Lord Sainsbury of Turville

I am grateful to have this opportunity to discuss the issues raised by the noble Lord's amendments, which relate to the issue of group auditors and overseas subsidiaries. I should like to begin by addressing the amendments to Clause 8—that is, Amendments Nos. 35, 38, 39 and 41. Perhaps I can explain why we cannot support these amendments and then comment on some of the wider concerns raised at Second Reading about the auditors' right to information from an overseas subsidiary.

The noble Lord, Lord Hodgson. mentioned at Second Reading the example of Barings Bank, where a failed overseas subsidiary brought down the whole company; and, of course, the role of overseas subsidiaries seems to be a significant element in the Parmalat case. I do not think our response can be described as "knee-jerk". We gave careful deliberations to the whole issue before bringing forward these carefully judged changes.

Amendment No. 35, the substantive amendment, would place obligations on overseas subsidiaries, their directors, employees and some others. It would introduce an extra-territorial element into the legal rights conferred on auditors. In all likelihood the only connection such people have to Great Britain is that they are directors of, or are employed by, a company which happens to have a GB company as its holding company. I accept the noble Lord's point that there may be cases where such companies have significant operations in the UK. We do not intend to impose direct obligations and penalties on such persons.

Of course it seems desirable to place such direct obligations on those who have the relevant information, but we do not think this is reasonable or likely to be effective. In practice, it would be very difficult to enforce the obligations that could arise as a result of the amendment. It is not a practical way of ensuring that auditors of an international group headed by a GB parent get all the information they need. In any event, to claim jurisdiction on that basis risks undermining our position in resisting claims by foreign states to exercise jurisdiction in the UK.

Nevertheless, we share the concerns expressed that what happens in an overseas subsidiary is all too often the cause of serious problems or worse for an international group. Barings Bank and Parmalat are high profile examples of that. There is a role for the law in facilitating the auditor's access to information on overseas subsidiaries. Thus, both the existing law and the Bill place a specific requirement on a GB parent, when asked by the auditor, to take all reasonable steps to obtain the required information from the subsidiary. We think that is the best approach and we think it is effective.

There is a criminal sanction against the parent provided for in new Section 389B; and, very importantly, the auditor, under Section 237(3), must state if he has not received all the information and explanations necessary for the purpose of his audit. Any indication by the auditor that he may make such a statement unless he gets adequate information about the subsidiary is likely to focus the minds of the directors of the parent company very sharply indeed.

Let me now turn to the similar amendments which the noble Lord proposes to Clause 12. I briefly remind the Committee that Clause 12 provides the Financial Reporting Review Panel, the body which reviews the annual accounts of public and large private companies, with a statutory power to obtain relevant information from the company and from any officer, employee or auditor of the company.

The points raised by the noble Lord about subsidiary companies are interesting and I shall do my best to address them. In order to do so, I need first to distinguish between domestic subsidiaries and foreign subsidiaries. In respect of the former, we do not believe that the clause needs to make any special provision. We are trying to keep the powers of the FRRP as straightforward as possible. It seems to us that all that is required is the power to require the documents, information and explanations from the company whose accounts are being looked at. That may include relevant information about subsidiaries where this is pertinent to the group's accounts, because group accounts are, of course, the accounts of the parent company.

If the FRRP concluded that as a result of its investigations into the parent company it should also carry out a review of the accounts of a subsidiary company, it could open an investigation into the accounts of that company and then, of course, use the Clause 12 powers in relation to that company as well. It would have to satisfy the criterion set out in Clause 12(1)— that there is, or may he, a question whether the annual accounts of a company comply with the requirements of this Act". The case of overseas subsidiaries is somewhat different, and what I have just said about the amendments to Clause 8 applies here as well. It is neither straightforward nor generally desirable to empower a UK regulator or auditor to require overseas companies to produce documents. I do not think that it is worth going into all the arguments again other than to emphasise the point that this would introduce an undesirable extra-territorial element. We do not think that that approach would be reasonable or desirable or, above all, effective. So it is not a practical way of ensuring that the FRRP obtains the information it requires to undertake its work. On those grounds, it will be clear why we should like to keep the clause as it stands.

Lord Hodgson of Astley Abbotts

As I said, I understand the issue of extra-territoriality, which is clearly sensitive. Our difficulty with the present proposal may be made clear with a practical example. A UK company has a French subsidiary incorporated in France and shares an office with the French sales subsidiary of a UK-incorporated company. Two people could be sitting next to each other at their desks because they happen to operate out of the same office. However, one person would be criminally liable for information given while the other would have absolutely no obligation. That is where we encounter the hard point of the issue, and whether it is a sufficiently hard point to deal with the question of extra-territoriality—one that is complex and has major inward implications for the United Kingdom requires further reflection.

Having heard the Minister's thoughts and comments, and bearing in mind the wish of the noble Lord, Lord Sharman, to have unfettered access—-I know that he is keen on that—I shall withdraw the amendment, reflect on it and perhaps come back to the matter.

Amendment, by leave, withdrawn.

[Amendments Nos. 36 to 41 not moved.]

Lord Hodgson of Astley Abbotts moved Amendment No. 42: Page 10, line 40, leave out "concerned" and insert "as defined in subsection (4)

The noble Lord said: I am glad that I have the noble Lord, Lord Sharman, on my side this time. Amendment No. 42 still relates to Clause 8, subsection (5)—which, I shall point out before another noble Lord rises to do so, is a subsection that under a previous amendment we sought to leave out. But never mind that. We hope that this amendment will provide a nice alternative for the Government.

Subsection (5) provides that when an auditor requires information from an overseas subsidiary, the parent company must obtain the information from the person concerned. However, in line 40 the subsection does not specify that the "person concerned" is a person attached to the undertaking as described in paragraphs (4)(a) to (d). For the purposes of clarity, we believe that the term "persons concerned" in subsection (5) should refer explicitly to the previous paragraph. I beg to move.

Lord Sharman

I am delighted to agree entirely with the noble Lord, Lord Hodgson, on this.

Lord Sainsbury of Turville

The noble Lord suggests that the drafting would be clearer if the reference to the "person concerned" in subsection (5) explicitly referred back to the person as defined in subsection (4). I hope that I shall not be accused of unfair prejudice towards accountants if I say that I have some sympathy with the points made by both noble Lords on this.

I do not think that the phrase could be interpreted as referring to any person other than one of those listed in subsection (4), from whom the auditor has required the parent company to obtain information. Nevertheless, the basic thrust of this amendment is right in that it seeks to spell out to whom the phrase "person concerned" refers. However, I cannot accept the amendment as it stands, not least because it refers to persons being "defined in subsection (4)", when in fact these persons are listed rather than defined. Accordingly, we will bring forward at the next stage an amendment expressly to spell out to whom the term "person concerned" is intended to refer.

Lord Hodgson of Astley Abbotts

That is generous of the Minister. After a day and a half of honest endeavour, to have had an amendment more or less accepted I regard as a home run. We are very grateful, and I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

4.15 p.m.

Lord Sharman moved Amendment No. 43: Page 11, leave out lines 1 to 4.

The noble Lord said: Amendment No. 43 deals with an issue that we have touched on of late, which I might describe broadly as yet further fettering of the auditors' access. Proposed new Section 389A(7)—an exception for legally privileged information—would, if enacted, result in a scaling back of the auditors' current rights to information. Current practice is that such information is available to auditors. It is quite important in the auditors' forming an opinion, certainly on disclosure of contingent liabilities, where there are major cases of litigation.

If the auditors were denied access to such information, it is questionable whether they would be able to form an opinion on whether the accounts gave a true and fair view. As a result, they would have to qualify their approval. Moreover, I cannot see how disclosure of such information to the auditor would prejudice the matter to which the information related. The auditor needs the information to form a true and fair view. He does not need to publicise it to any other party. If the information relates to litigation between the auditor and the entity, the auditor would of course not be able to act anyway, so he would have resigned.

We note that, quite rightly, there is no equivalent exception in Clause 9, which deals with the directors' disclosures. The information in regard to such matters would have to be volunteered in some way. Therefore, the exception in Clause 8 is an ineffective anomaly and needs to be removed. I beg to move.

Lord Razzall

I support my noble friend, and should say that Hansard should record that, for the first time, a Member of the Liberal Democrat opposition has managed to seize a Dispatch Box. Characteristically, my noble friend understated the problem. When an audit occurs, the normal format in relation to any form of litigation—potential claims or actual litigation going on—is that the auditors will write to the company, asking for an opinion from the firm of solicitors advising it about the litigation. They will ask whether there is a potential claim and what the potential magnitude is.

As a former practising solicitor, I assure Members of the Committee that, when that letter arrives from the company or the auditors, it is a serious matter for the firm of solicitors. If they write an opinion that indicates that the claim is scurrilous or on the other hand potentially worth £125 billion, there is serious potential liability for that firm of lawyers if the statement is wrong. If the clause were implemented in its current form, as surely as night follows day, any firm of solicitors worth its salt, when asked for that opinion by either the company or the auditors, would simply say, "I'm terribly sorry; that is a matter of legal professional privilege and, under Section 8(7) of the new companies Act I do not have to provide it".

We will actually have endless company reports where the auditors say, "We have to qualify the accounts because we cannot form a true and fair view". The reason that they will not be able to do so is that the firm involved—Linklaters, Freshfields, Slaughter and May or whoever—will have written a letter quoting the clause and saying, "I'm terribly sorry; we can't give an opinion". It will relieve endless firms of solicitors and insurers of professional firms from their potential concerns on the issue. Therefore, I would have thought that the clause, which is apparently small, would have a devastating impact on the production of companies' accounts.

Lord Hodgson of Astley Abbotts

I do not wish to be seen again as the voice of the legal profession, but we have some concerns about the proposal to remove subsection (7) because of the fundamental nature of legal professional privilege and its removal being undesirable except in exceptional circumstances. As we have said in previous debates, we are in favour of facilitating the auditor's right to information, and the immunity of professional privilege embodies a substantial legal right that should not be easily overridden. However, we are not sure that the case made here justifies that approach.

The noble Lord, Lord Razzall, referred to the impact on companies' accounts but, if I were a director of a company and the result was that my accounts would be qualified, I would go to my solicitors and say, "I would like this sorted out because I do not want to find myself with a qualification on my accounts". That is far more dangerous than anything else.

As a director of a company, I would want the auditors to sign on to a true and fair view. Their great power is to refuse to sign unless they get the information to enable them to do so. In those circumstances, what is proposed here tackles and weakens a fundamental civil and legal right. On the arguments we have heard so far, I am not convinced that we should give it our support.

Lord Sainsbury of Turville

When a lawyer and an accountant join forces, one should look very carefully at what is being proposed. In this case. I think that the lawyer rather than the accountant is probably on the stronger ground.

The aim of Clause 8 is to increase the ability of auditors to carry out their duties effectively, thus increasing the reliability of, and confidence in, a company's accounts. It achieves this by strengthening the existing rights of company auditors to obtain information and explanations by entitling the auditor to require information and explanations from a wider group of people and by introducing a criminal offence for the failure to provide such information.

The Committee should note that I said "strengthening the existing rights of company auditors". It is not our intention that Clause 8 should change the position in respect of legal professional privilege. Subsection (7) therefore makes it explicit that an auditor cannot require a person to give information which is subject to legal professional privilege.

We believe that it is desirable to make this explicit because the Bill creates a new criminal offence in new Section 389B(2), inserted by Clause 8, where a person fails to comply with a requirement to provide information or explanations. There is an issue as to whether disclosure to the auditors of such information would involve an infringement of legal professional privilege, given the particular nature of the relationship between the company and the auditor.

However, the auditor's duties may involve the disclosure to the public of the information he obtains if it calls into question the truth or fairness of the accounts. Although the arguments are finely balanced, we believe that this would mean that a disclosure to an auditor of information subject to legal professional privilege might lead to disclosure to the public and thus involve an infringement of that privilege.

Thus, as the law stands, we think it unlikely that auditors currently have the power to require officers of a company to produce information in respect of which legal professional privilege could be claimed. The Bill puts that beyond doubt in the context of the new criminal offence. I also agree with the noble Lord, Lord Hodgson, that the problem raised by the noble Lord, Lord Razzall, is in practice not a serious issue because of the way in which companies would behave. Where an auditor believes that he is not receiving the required information for the purpose of his duties as an auditor, on the basis that such information was subject to legal professional privilege, he would consider whether to qualify his report on the accounts. We believe that, faced with this possibility, the directors would choose whether to waive their right to legal professional privilege and disclose the information to the auditor, or to protect the privileged information and risk the adverse consequences of qualified accounts. We believe it is clear what decision they are likely to take. On that basis, we oppose the amendments.

Lord Wedderburn of Charlton

This privilege is a very important right, but it is not a divine right. What is at stake here, if I have understood the matter at all, is what the auditor has a right to know. It is the very important issue of producing proper accounts. My noble friend mentioned Parmalat and other dreadful matters, of which very little is said here. But that is becoming increasingly important to a wider and wider sector of the community, and to the public interest. Is it really necessary to include a clause that simply makes a pronouncement of legal professional privilege a complete barrier, no matter what the course of action in the litigation or the parties involved, and no matter what else is involved?

Would it not be possible to produce a more limited clause giving legal professional privilege in some areas its right as an answer but not as absolute as in the Bill? I do not know, I must admit, what is the position of the professional bodies on the matter, but I should be very surprised if all lawyers demanded this absolute subsection, which really seems to go very far.

Lord Razzall

Following on from that, I should like to give a practical example. If I may dare to be so bold, the Minister, whose brief was probably written before he heard what my noble friend Lord Sharman or I had to say on the topic, has not actually answered the question.

Let us take the example of Enron. Suppose that we had an Enron situation in the United Kingdom: and the Crown Prosecution Service, if it was still called that, chose to launch prosecutions against the Enron-equivalent directors before the audited accounts had been produced. The clause would mean that anyone involved in producing the audit or in what had happened would be able to say to the auditors. "I am terribly sorry, but I am not gong to disclose the information you have asked for because I am protected by Clause 8(7)". That would be because, a claim to legal professional privilege", would apply in relation to all those matters, because a prosecution had been launched. That cannot be right.

It cannot be the intention of the legislation to enable people to shelter behind legal professional privilege in failing to give information to the auditors. Incidentally, auditors under their own professional rules would be under an obligation not to disclose. They can disclose the conclusion that they draw—that this forms a true and fair view and that in their belief there must be a contingent liability note that Enron owes 125 billion dollars to whomever. But there is no obligation on the auditors to disclose to the public any information that they have. In those circumstances, the company and its professional advisers could simply shelter behind the clause and fail to give the auditors the information. That cannot be right.

Lord Sainsbury of Turville

Of course, my answer was drafted very carefully before I heard the words of the noble Lord, but I thought that the anticipation was very good and answered exactly his point. As I hope that I made clear, in practice, any company faced with an auditor threatening to qualify the accounts because he could not get hold of the information would, without any question, unless there was something appalling to hide, ask for the legal privilege to be waived. Therefore, in the specific matter of auditors considering accounts, I cannot see that that would in any way impede people getting the information.

4.30 p.m.

Lord Razzall

Were that the case, what would be the need for the clause, if every company would simply waive it?

Lord Sainsbury of Turville

This is a new criminal charge, so the situation should be clear.

Lord Sharman

It is important to understand the nature of the qualification that would result. There would be a withdrawal of opinion, which would not mean that the accounts do not present or that they present subject to certain matters; it would mean, "We cannot form an opinion", which does not take us anywhere.

Lord Wedderburn of Charlton

With the greatest respect, I did not find my noble friend's reply totally convincing. One is always suspicious of the argument that a legal provision that appears to be absolute will not work like that in practice, because the next thing you come up with is that the case regarded by the authority as exceptional is where it does work like that. As I understood him, my noble friend accepted the argument on Enron. Having done a certain amount of reading on Enron, I was not entirely sure that the noble Lord, Lord Razzall, could not be criticised in his argument. Broadly speaking, however, my noble friend appears to accept that, in an Enron situation, the clause would be the answer and the end of the matter.

Lord Sainsbury of Turville

If Enron had come forward and said, "Our accounts are being qualified by the auditor because he cannot get hold of this legal information", even in the state of market opinion that we have sometimes had, I can see no circumstances in which a company could deal with that. The noble Lord, Lord Sharman, who probably has much greater expertise in the area, seems to believe that companies can tell the Stock Exchange, "Our accounts are qualified because we cannot get hold of this legal advice", and that people will say that that is a minor technicality. I fear that I do not believe that that is how the world works.

Clearly noble Lords have strong views on the issue. In particular, there is the question of whether, in subsequent investigations as opposed to the initial stages, there is an issue about auditors' rights of information. We certainly do not intend to scale back on the auditors' rights of information. On that basis, I should very much like to take another look at the amendment.

Lord Sharman

When the Minister looks at the amendment, will he consider the proposition that a qualification that results from an inability to obtain information is normally an expression of what is known as a "no opinion", meaning "We are unable to form an opinion". In circumstances where the information withheld is so catastrophic or important to the formation of that view, there may be a board of directors that would regard that as a better solution than providing the information and the consequent opinion that would flow therefrom.

Lord Sainsbury of Turville

That obviously raises questions about the noble Lord's clients. We will take the matter away and look at it.

Lord Sharman

Having listened to the Minister's response, I thank all noble Lords for their contributions. I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Lord Hodgson of Astley Abbotts moved Amendment No. 44: Page 11, line 7, leave out "statement (oral or written)" and insert "written statement

The noble Lord said: We are still winding our way through Clause 8, on auditors' rights to information. This amendment relates to new Clause 389B, on the offences relating to the provision of information to auditors. Punishment for those offences includes imprisonment, so it is a serious matter.

The Bill gives auditors the option to take statements in written or oral form. Our amendments seek to limit the auditor to taking written statements because of the risk of errors and misunderstanding that could arise from relying on oral statements alone. Let us consider the practicalities of the provision. For example, as a director of a company, I may be interviewed by the auditor and he or she may make notes of my remarks, which may well be written up, if at all, in a hotel room or office hours or days later. What I think I said and what the auditor thought I said could be very different, not for reasons of malice but because of the jumbled process of normal human communication. This amendment is designed to avoid those complications by forcing auditors to prepare written statements, where relevant, and to obtain a sign-off.

I am aware that the unamended formulation of words is to be found in Section 389A(2) of the Companies Act 1989, but there are some important points to be made. First, on effectiveness, according to legal advice, only one case about the use of oral evidence has been brought since the provisions of the Act came into force. That hardly argues that it is a hugely effective and important provision. Some might argue that, if the provisions cause so few problems, it could be left in. The Minister will know that I am not of that persuasion and believe that, where provisions have not been regularly used over a long period. they should be removed.

The second point relates to extent. As we have already discussed, Section 389A(2) currently extends liability only to officers of the company, but it is now to be extended to any employee. Accordingly, if potentially incriminating statements are to be taken from a much broader and varying range of company employees, including very junior ones, there is reason to argue that the process of statement-taking requires extra diligence.

Finally, there is the issue of proportionality. There is no doubt that we live in an increasingly litigious age, and that the pressure, weight and responsibility on the director of a company increases all the time. In principle, we do not and cannot object to that. but for a non-executive director to find himself or herself in hugely time-consuming, extensive and reputation-damaging litigation that may continue for years because of an oral statement that he or she made is, to say the least, a disincentive to serving on a board.

In summary, the statement given by an officer or employee under the provisions could possibly lead to their imprisonment. We do not believe that notes taken by an auditor from an employee's oral statement have the thoroughness and accuracy that is necessary. Oral statements can often be misleading, and emphasis placed on the wrong word can change the entire meaning of a sentence. Any notes of the speeches that we make in Committee this afternoon will probably differ in little ways. and mistakes may even be made. I dare say that the near-faultless and untiring Hansard writers very occasionally make a mistake, and they rightly consider themselves one of the most practised, professional oral note-takers in the country.

Considering the liability involved, the breadth of those who will now be liable, and the increasing resort to litigation that is part of our society, it seems right that auditors should rely only on written statements. To those who say that the issue is irrelevant because the provision will never be able to be used in a court of law, I reply: why bother to include it? I beg to move.

Lord Borrie

I am not entirely surprised that over all those years there has been only one case of a misleading oral statement. After all, it is much more difficult to prove that an oral statement has been made, because many meetings between auditors and the directors and employees of companies may be on a one-to-one basis, so there may not be much evidence. Inevitably, there is a difficulty of proving that a misleading oral statement has been made. But that should not lead us to delete the word "oral" and confine the possibility of an offence to written statements. After all, there must be some occasions when very seriously misleading oral statements are made. If—naturally, it is a very big "if"—-that can be established by adequate evidence, why should not that offence be considered proved?

The noble Lord has made perfectly reasonable points about the maximum punishment, but that is in the hands of the court, and will no doubt depend on the seriousness of the matter and what is justified.

Lord Wedderburn of Charlton

Surely my noble friend is right. Would not the effect of the amendment—to put it somewhat softly perhaps; but with no hostile intent to the noble Lord who moved it—be that, instead of saying, "Thou shalt not make deceptive statements knowingly or recklessly", it would say, "Thou shalt not make such statements if they are reduced to writing". It is a quite extraordinary provision to put on the statute book.

Lord Sainsbury of Turville

Clause 8 contains important provisions on the rights of auditors to obtain information. These derive mostly from the existing law, but with the significant change that those required to provide information and explanations to the auditor include employees for the first time. That change reflects clear recommendations from both the Company Law Review Group and the Co-ordinating Group on Audit and Accounting. Auditors should be able to ask for information, and expect truthful answers, from as many as possible of those likely to have information necessary for the successful performance of the audit. I very much agree with the noble Lord, Lord Wedderburn, that this amendment effectively says, "You can make inaccurate statements as long as you do not put them in writing".

The noble Lord's amendment would make the task that we have set ourselves more difficult. Of course, there may be greater difficulty in proving that oral information is false or misleading than is the case where information is written. But that is not a good reason for excluding oral information from the scope of the offence. To do so would simply send a signal that it is all right to give a misleading oral statement to the auditors. It is important to uphold, not weaken, the principle that those giving information to an auditor have an obligation to do so honestly.

I think that accepting the noble Lord's amendment would mean that we are taking a step backwards from the current law in this area and would weaken the Bill. Let us remember that the point of the Bill is to increase the effectiveness of auditing, even if it is not used a great deal. I think it sends entirely the right signal—that we are very concerned to increase the effectiveness of auditing.

We considered the position of employees very carefully in relation to the criminal offence, precisely because they may be less aware—than the directors, for example—of the possible consequences of what they say. We think that the clause gets the balance right between protecting the individual and meeting its purpose. In particular, as I said, to be guilty of an offence, a person must "knowingly or recklessly" provide information which is, misleading, false or deceptive in a material particular". Secondly, it is open to a person charged with an offence to show by way of a defence that it was not reasonably practicable for him to provide the required information. Thirdly, the information given cannot be used against him in criminal proceedings for any other offence.

In those circumstances, I think it right and proper to say that all statements by employees, oral or written, should come within the scope of the law. On that basis, we oppose the amendments.

Lord Hodgson of Astley Abbotts

I understand the points made by the noble Lords, Lord Borrie and Lord Wedderburn. I suppose that my practical answer to their point is that if I am making a reckless oral statement to the auditor and the auditor believes that I am doing so, the auditor could say, "Will you now please put that in writing?" In our earlier debate on Amendment No. 31, we suggested that the auditor should have powers to require that matters be put in writing.

Our concern, and the reason why we tabled this probing amendment, is that there will be an increasing amount of litigation—not necessarily because corporate behaviour is less good, but because people are much more aware of their legal rights and how to exercise them. One of the characteristics of those rights is that they take a long time to reach fruition. Directors can spend a long time with a sword of Damocles hanging over their heads. It is a disincentive for good quality people to sit on boards. We therefore wished to probe the Government's thinking on oral statements, which, in the vernacular, can be "flaky". We thought it might be worthwhile to discuss the possibility of placing on such statements the constraints that we have suggested. However, I understand where the Government are coming from. In the circumstances, I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 8 agreed to.

Clause 9 [Statement in directors' report as to information disclosed to auditors]:

4.45 p.m.

Lord Hodgson of Astley Abbotts moved Amendment No. 45: Page 11, leave out line 27 and insert— Before the report is approved under section 234A each director shall ensure that the auditors are aware of the information required of him by section 234ZA(1).

The noble Lord said: With some relief, I leave Clause 8 and move on to the next clause. This concerns the additional statement in the directors' report about information disclosed to auditors. The amendments in this group—Amendments Nos. 45, 48, 53, 56, 58 and 62—all relate to Clause 9.

The clause introduces a new statement under Section 234ZA, which is to be added to existing Section 234. In regard to this clause, I acknowledge the help we have had from Mr George Bompas QC in drafting this group of amendments.

The additional statement requires that at the time of the approval of the report, there is no information of a particular description that has not been disclosed to the company's auditors under Section 234ZA(1). The description of the information in proposed subsection 234ZA(2) is information that any director knows, or which it would be reasonable for him to obtain by making inquiries, and which he knows, or ought to know, to be relevant for the purposes of the auditors' determination of whether companies' accounts have been properly prepared in accordance with the 1985 Act and, finally, information which he knows, or ought to know, the auditors do not know.

Where the statement is made and is untrue, every director of the company will be guilty of an offence and liable to imprisonment, a fine or both, subject to the director himself failing to take all reasonable steps to prevent the approval of the statement when he either knew the statement was false or was reckless as to its falsity under Section 234(7).

According to paragraph 48 of the Explanatory Notes accompanying the Bill, Clause 9 is designed to, make it less likely that a director will hold back information from the auditors"— and is— similar to one of the objectives of the recommendation in the Company Law Review".

That relevant recommendation is that directors should be under a duty, to volunteer information where the normal standards of directors' care and skill require them to recognise that such information is needed".

However, the criminal sanctions should be applied only to breaches of the extension of the duty where the director knows that the information is material to the audit.

The difficulty with the proposal is that it places on directors, under sanction of serious criminal penalties, a duty of onerous and obscure extent. This is despite the fact that the directors are already under a duty which ought to be sufficient to meet the recommended objective. The warranty which, in effect, each director is required to give by the inclusion of the proposed new statement in the directors' report, is not only that he has himself given to the auditors any relevant information fitting the descriptions in paragraphs (a) and (b) of Section 234ZA(2), but also that each and every other director of the company has also given to the auditor the information he or she should have. In other words, not only are directors bound to search out what they know, or should know, is relevant to the audit, and make sure that the auditors know about it, they are also bound to search out and make sure that each and every other of their fellow directors has done the same thing.

Let us reflect on what this means in reality. For example, a non-executive director on, say, a 15-person board is taking responsibility for every other director, including members of the executive team, for failing to disclose to the auditors relevant information, and is doing so on pain of potential imprisonment. That surely fails the test of balance. Of course each individual director can, and must, take responsibility for his or her actions, but to take responsibility for the actions of all his or her board colleagues is not reasonable. So the amendments limit each director's liability to responsibility for his own actions.

Amendment No. 45 amends subsection (2A) by making sure that before, the report is approved under section 234A each director shall ensure that the auditors are aware of the information required of him by section 234ZA(1)".

That ensures that the director accepts and undertakes a direct responsibility before the report is approved. That has the consequential effect of deleting subsection (1) of new Section 234ZA as per Amendment No. 53, because it is no longer necessary.

Amendment No. 48 then replaces subsection (7) of Section 234, and states: Where a directors' report is approved under section 234A but the auditors are unaware of information which, as regards any director, is information required by section 234ZA( I ), and the director failed to take all reasonable steps to prevent the report from being approved, the director is guilty of an offence and liable to imprisonment or a fine, or both".

That withdraws the reference to subsection (2B) and withdraws further whether the director knew that the statement was false or reckless, which is not necessary as it is covered by existing statute. It can be seen that the wording from the Bill to the effect that, the director failed to take all reasonable steps", remains in our amendment. While we approve of the duty being placed on the director, it would be helpful if the Minister would explain the Government's thinking on the definition of "reasonable steps" in the light of this new legislation and, indeed, of modern legal practice.

Amendments Nos. 53, 56 and 58 amend subsections (1) and (2) of new Section 234ZA, which is entitled: Information to have been disclosed to auditors before directors' report approved".

The amendments replace subsection (2) so that it reads: Information is required of a director of a company as mentioned in section 234(2A) if", the, director … is aware of the information or it would be reasonable for a director … to obtain the information by making enquiries".

Paragraphs (b) and (c) continue unamended. With subsection (1) of new Section 234ZA removed by Amendment No. 53, Amendment No. 62 renumbers the subsections so that subsection (2) becomes subsection (1).

The punishment for a negligent director who contravenes Section 234ZA will remain the same, but the amendments make it implicit that the director has a clear personal responsibility to ensure that the auditors have the required information. At the same time, they relieve directors of any joint liability. The wording in the Bill, especially in new subsection (7) in Section 234, fails to make that clear. Hence the necessity for the amendments. I beg to move.

Lord Wedderburn of Charlton

Because of the nature of our procedures, I could not ask the noble Lord while he was still semi-recumbent a question about his rather complicated argument, which I may have failed to follow. If so, I apologise.

As I understood it, he was arguing that Clause 9 as it stands makes the director responsible in virtually every case when one of his fellow directors is at fault. Does he base his opposition on the fact that in such cases the director cannot have taken all reasonable steps, or is there something else in Clause 9 that I have missed, which is the ground for his argument? I should have thought that, if he is resting on the proposition that the director must take all reasonable steps, there would be cases when a director would not be responsible for the fault of his fellow directors, and the responsibility in the clause is indeed personal. I may have misunderstood the noble Lord, and I thought it better to clear up that very simple point at this stage.

Lord Hodgson of Astley Abbotts

Perhaps I may answer that question—I have not become recumbent. As we understand the proposal for the new statement, the drafting requires that a director, in approving the statement, must ensure that all his fellow directors have complied with it. It is joint, several liability, not a single liability.

On later amendments, we will discuss the issue of what information is required. It is very wide-ranging and includes a number of statements, in particular about what the auditors know or ought to know. It is difficult enough for a director to know in respect of himself, but it is even more difficult for him to know exactly how well other members of the board—for example, a chief executive who is working in the company day to day—have complied with the requirement. If, however, the Minister says that we misinterpreted the clause, and that there is only a single responsibility, not joint responsibility for the activities or disclosures of the directors, clearly some of my argument falls away. But we are advised that, as currently drafted, the provision creates a joint responsibility, not a single one.

Lord Evans of Temple Guiting

Clause 9 introduces an important new requirement that the directors' report must include a statement that information required to be disclosed to the company's auditors by the directors has been so disclosed. Given its importance, I wish to spend a few moments answering the questions raised.

The amendments would remove the requirement for such a statement, replacing it with a requirement on each director to ensure that the auditors are aware of the required information. We have listened carefully to what has been said. I understand the concern that we should not impose disproportionate or unreasonable requirements on directors, particularly non-executive directors. I want to explain why I do not think that that is the case, and why we should not change the Bill as suggested in the amendments.

First, I should explain why requiring the directors' report to include a statement is the best way of achieving our objective of strengthening the auditors' position. The statement provides the spur and focus for each director to think hard about whether he or she is aware of any information that it is important for the auditors to know; it encourages directors to discuss this prior to approving their report. The statement is an outward sign that they have done that. The alternative approach in the amendments is much less satisfactory; it would simply place a general requirement on each director.

Secondly, although we do not want one director to take responsibility for the failings of others, we think it right that a director should have regard to his or her fellow directors when considering his or her position with regard to disclosure. Let me explain—this is perhaps the key—why we do not believe that the clause imposes an unreasonable requirement on a company director. I want to be clear, however, that we do not intend to let off the hook a director who is tempted to mislead; a director who knows that another director is concealing critical information but turns a blind eye; or indeed a director who simply could not care whether his fellow directors were concealing information.

The best way in which I can explain why the provisions are balanced and fair is simply to outline what a director would need to do to fall foul of the requirements. The statement of disclosure of information that is required to be in the directors' report applies only to information that meets all the following three criteria. First, the director must be aware of the information, or it must be reasonable for hint to obtain the information by making enquiries. There is a separate amendment to explore what is meant by "reasonable" in this context, so I suggest that we do not consider it now.

Secondly, the director either must know or ought to know that the information is relevant for the auditor's determination of his report under Section 235; that it is relevant to the auditor reaching a view that the accounts meet the requirements of the Act. In particular, it must fulfil the requirement that the accounts give a true and fair view. Again, there is a separate amendment on what we mean by "ought to know". I suggestion we leave the discussion on that until later.

Thirdly, the director must know or ought to know that the auditors are not aware of the information. If information exists which comes within the above criteria and which is not disclosed to the auditors, the statement in the directors' report will be false. However, a director does not commit an offence simply by virtue of the statement in the directors' report being false. He or she must know that it is false—for example, because of knowledge that other directors are withholding information—or must be reckless as to whether it was false—for example, because a director does not care whether or not it is false. This is already, deliberately, a stiff test for the prosecution to show is the case.

In addition, the director must have failed to take all reasonable steps to prevent the directors' report being approved. Again, there is a separate amendment to explore that specific provision. The clause does not mean that every director is guilty of an offence simply because one of the directors has concealed key information. Nor does it mean that all directors are treated the same regardless of their function; quite the opposite. What it is reasonable to expect, for example, the finance director to inquire into is likely to be different to what it is reasonable to expect a non-executive director to inquire into. As the clause explicitly makes clear in new Section 234ZA(3), what a director ought to know relates both to the knowledge, skill and experience that can be reasonably expected of someone carrying out their functions and to their actual knowledge, skill and experience.

The noble Lord asked what is meant by Section 234 new subsection (7)(b) where a director takes or fails to take, reasonable steps to prevent the [directors] report from being approved". The purpose of new subsection (7)(b) is to protect the director who does his best to prevent the approval of a directors' report containing a statement concerning disclosure to auditors that he knows to be false. It would be for the prosecution to show that the director had failed to take reasonable steps. What is reasonable will depend on the circumstances.

In conclusion, the requirements imposed on directors by the clause are proportional, balanced and practicable. The honest, reasonably diligent director has nothing to fear. The amendments are undesirable both in that they would remove the need for the explicit statement in the directors' report and because they would limit the requirements on directors. That is not necessary, for the reasons I have given. The effect is likely to be a Bill with less effective provisions. For that reason, I invite the noble Lord to withdraw the amendment.

5 p.m.

Lord MacGregor of Pulham Market

I am not sure that this is the appropriate time for me to intervene in this matter; it may be better on later amendments. As a non-accountant, I hesitate to embark in a debate on these matters, but I have been a non-executive director of a number of companies for some time. I have some concerns about the overall impact of the clause. We shall turn to the references to "reasonable" and "ought to know" later, but they are highly relevant.

I noted that the Minister referred to the fact that a reasonably diligent director has nothing to fear. I like to feel that I am a reasonably diligent director and I certainly have no intention of letting directors off the hook. I should like to explain from where my worries about how this is put together come. I start from the view that I am finding it increasingly difficult to recruit extremely good people to be non-executive directors, particularly for companies that are in regulated industries.

The risk/reward ratio has undoubtedly altered over recent years. The amount of work involved has increased considerably. Therefore, the amount of time that a director has to take, particularly if he is on the audit committee, is now quite substantial and, undoubtedly, has put a lot of people off wishing to do it. My concern is that these issues are exacerbated by parts of this clause. I am not yet reassured by the Minister that I am wrong. I hope that he will be able to do so.

My main concern is that the phrase "ought to know"—"reasonable" is another issue—seems to apply as equally to the non-executive directors as to the finance director. As a non-executive director with an inevitably limited amount of time to spend on the company's affairs—and I spend a great deal of time on audit committees already—am I expected to delve even further to establish what I ought to know? I am certainly concerned that everything I know should be revealed to the auditors, but I do not know how I will actually know what I "ought to know". I am certainly not in the same position as a finance director, on whom I rely very considerably in these matters.

Even if the non-executive director has the knowledge, skill and experience, I doubt whether he will have the time or scope to delve into all the details in an audit report—they are now voluminous—to ensure that he has not missed something which he ought not to have missed. I am therefore concerned about the introduction of "ought to know". Inevitably, a non-executive director relies very considerably on the executive directors and, in large companies, cannot get round the whole company.

"Reasonable" is another issue. I am not clear what would be "reasonable". It is clear that, as the Minister says, one would be dependent on the courts in any particular case. However, with the introduction of "ought to know", I have a fear that many people will feel that they do not want to embark on this risk, because they do not want to find themselves spending a long time in a court establishing the "reasonable" position that they have.

I am also not clear what Clause 234ZA(3) actually means. It refers to, the knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by the director in relation to the company", and to, the knowledge, skill and experience that the director has". In terms of the Smith report, we are now seeking to recruit finance directors and accountants—the former senior partners of accountancy firms—to join and chair the audit committee. Is there not a risk that, in this context, it depends what "knowledge, skills and experience" means? Does it mean that a much lesser test will be applied to those who do not have that knowledge and are not accountants, than to the non-executive director who has accountancy skills?

I can see that we are trying to recruit people from a much wider range for non-executive directors, but is that the implication? It would mean that it would be more difficult to recruit non-executive directors who are accountants and finance directors and whom one wants to get on to the audit committee. So I have a number of concerns about this. I hope that I am wrong in my interpretation, but my fear is that it will become more difficult to persuade people to take on these tasks if this clause is phrased in exactly the way it is now.

Baroness Noakes

Perhaps I may echo the points just made by my noble friend Lord MacGregor. The clause is particularly worrying because of the way in which the actions or non-actions of other directors are brought within the scope. We will come on to discuss what one ought to know and what is reasonable. In a sense, however, we cannot conclude the discussion on this group of amendments until we have had discussions on the other amendments.

One point is very clear to me. Overall, this clause is bringing in the benefit of hindsight in a context in which the specific duties are not well understood or codified. The concept of different standards for different functions of directors is a very novel one. We are not only going into the territory of liability attaching to the individual director, with all the difficulties expressed by my noble friend; we are effectively picking up the liability for all other directors. That is what many of those I have spoken to are particularly worried about.

The benefit of hindsight is a wonderful thing. The people I have been speaking to recently have been appalled, for example, at the way in which non-executive directors at Equitable have been castigated for what they did. I do not want to discuss the substance of that, but it is very clear that the benefit of hindsight has been used extensively there. The concern is that the benefit of hindsight would be used, not only to damn one's own activities but also to damn one in relation to everybody else's activities.

The whole clause, and the individual points that we shall be debating over the next few groups, raise very significant issues. I believe that the provisions will significantly impair the pool of those willing to undertake roles in relation to non-executives, and particularly in relation to the audit committee, to which I understood that the Government were firmly committed.

Lord Wedderburn of Charlton

Before my noble friend the Minister answers the long list of questions—and without trespassing on the amendments that are to come, which is very difficult in the present discussion—does he recognise that the introduction of the objective standard of care, skill and diligence is one of the most important provisions in the Bill? Of course, every time a duty of skill and care or indeed any other duty is introduced by legislation, people want to know—I was about to say, what non-lawyers want to know, but sometimes lawyers engage in it—precisely what facts will give rise to liability. Of course, no one can answer that.

What a person ought to know depends on the facts. My noble friend is not being asked questions of law, which is what legislation is about. He is being asked questions of fact. What a non-executive director or a finance director should know is defined as far as the law can possibly do it. In Section 234ZA(3), he must have the, knowledge, skill and experience that may reasonably be expected of a person carrying out the … functions". If he has special knowledge, skill and experience, he will of course by judged by them.

No doctor would expect any further definition of his legal standard of skill and care. He would know that when he went before the General Medical Council, or some such body, the question of facts—of whether he had operated at a reasonable standard of medical care—would be judged. But no statute can answer that. I hope that my noble friend will not be led into trying to define the types of fact that could give rise to liability, which would be quite impossible for a statute to do, and is something that a statute should not be expected to do.

The substitution of a positive objective standard of care for directors is of course one of the most important recommendations in the Company Law Review reports. The 19th century subjective approach, to which we shall come in later amendments, is now being overtaken. Those who are used to having their standards of skill and care judged by what they happen to know and think in a subjective way will of course complain about that—unless, perhaps, they reflect that it is time that British business had standards of skill and care in the boardroom that the reasonable man on the Clapham omnibus and the reasonable doctor would expect to have applied to him. They might understand that there is now going to be a reasonable man in the Clapham taxi cab.

5.15 p.m.

Baroness Noakes

Perhaps I may develop that argument with the noble Lord. He talks about reasonable care—for example, the reasonable care and skill of a doctor. Does the noble Lord think that it is reasonable that, say, a doctor in a team of surgeons should be held in some way responsible for the standards of care adopted by other members of the team? In effect, that is what this clause attempts to do.

Lord Wedderburn of Charlton

With great respect, the noble Baroness is going back to our previous discussion. I disagreed with the noble Lord, Lord Hodgson, that this clause, as a whole, imposes a kind of "pudding" of liability on the entire directorate for any fault in any single director. I do not think that is what the clause means at all. I very much hope that my noble friend will repeat that that is not what it says. That is a total misunderstanding of the clause. That is what we discussed just now.

Now, we are discussing the point raised by the noble Lord about the actual standard of what the director will be liable for in terms of a duty of skill and care under subsection (3) of new Section 234ZA. In that respect, I again hope that my noble friend will not be led into defining every possible situation of fact that could possibly give rise to liability. The definition is clear.

Lord Evans of Temple Guiting

I am very grateful to my noble friend Lord Wedderburn for making those points. We agree with him. This has been an interesting but difficult discussion which has looked ahead to a number of proposed amendments. We shall return to "ought to know" and such issues later.

I turn now to the problem of the non-executive director. Having spent most of my working life as director of a company, I am very interested—as are other noble Lords—in the implications of this clause. I talked to a number of people in the accountancy world and to various head-hunters. The general view is that this Bill is trying to improve the standards of audit in the UK. In doing so, the standard of the non-executive needs to be improved. Although there are some extraordinarily able non-executive directors, as we know, the position of non-executive director has been the sort of job that one could get on retirement. It was a rather comfortable job for a few hours a week, with a small amount of money. I can see heads being shaken, but I can point to a number of companies where that is the case.

Baroness Noakes

I am grateful to the noble Lord for taking the intervention. The noble Lord is repeating stereotypical views from another era. I do not know which head-hunters he has been talking to recently, but I could take him to the leading head-hunters of today who, frankly, would find that deeply insulting in relation to the work that they carry out in placing individuals on boards. It is also deeply insulting to the vast majority of non-executive directors in British business.

Lord Evans of Temple Guiting

I think that I am being misunderstood. I talked about the traditional non-executive director, for a number of whom the stereotype is correct. I spoke to two senior, well-established head-hunters who are delighted that the standard of non-executive directors to be appointed will be raised by the Bill.

In the company I chaired for many years, the non-executive director was, and is the managing partner in a large firm of accountants. I asked him, "Will this result in a change in your attitude to being a non-executive director in this company?". He said, "Yes, it will and I am delighted that it will. I will now have to take an even greater interest in the company's activities". He saw it as a positive rather than a negative. Therefore, I am not as worried as the noble Lord, Lord MacGregor, about the problem of recruiting non-executive directors. It is right and important to impose on them a level of professionalism, which most of them have already.

Lord MacGregor of Pulham Market

I do not recognise the kind of non-executive director to which the Minister refers in terms of the new non-executive directors coming forward. The world has changed very considerably in the past 10 years—well before the Higgs report, which is making it change even more. Certainly I find that, in nomination committees now, most boards are seeking to appoint people not because of who they know, or anything like that, but because of the skills and experience they can bring to bear. My one concern is to make sure that we get the balance right and that we do not go too far and discourage those kind of people from continuing to perform the role.

Lord Evans of Temple Guiting

I accept that point. However, I return to a point I made earlier: that the two senior head-hunters to whom I have spoken about this issue do not think that this clause will be a disincentive to people who wish to be non-executive directors.

We shall come on to many of the issues raised but perhaps I may make two important points arising out of the discussion. In spite of what I have said, the Government are aware of the concerns in relation to the recruitment of able non-executive directors. We have recently consulted on directors' liability and are considering the responses carefully. The consultation directly addressed the position of the non-executive director.

In addition, a point was made about one director picking up the liabilities of other directors. This will not be the case.

Lord Wedderburn of Charlton

Before my noble friend sits down, will he not join me in a general rejoicing at the description given by noble Lords of very great experience in these matters? They have described non-executive directors who will not have much difficulty in complying with the standards the Government are rightly setting down.

Lord Evans of Temple Guiting

I thank my noble friend Lord Wedderburn for his support. What he says is the absolute logic. If professional standards are improved by the Bill, what problem is there?

Lord Hodgson of Astley Abbotts

We have had an interesting debate on this group of amendments. I am extremely grateful to my noble friends Lord MacGregor and Lady Noakes. They provided a breath of fresh air in the real world as opposed to the theoretical world. I take issue with my noble friend Lord MacGregor on only one matter. He said that we could end up spending a long time in court. For most non-executive directors or directors, the issue is not so much the long time in court but the long time spent preparing to go to court. The court process is quite easy, but you can wait two or three years while preparing to go to court. That is a time of agonising suspense and it can damage your reputation. Your professional career cannot develop in any way because of the matter hanging over you.

The noble Lord, Lord Wedderburn, encouraged the Government on the issue of depending on the facts. I understand his point. But the noble Lord should know that the reality out there is that people say, "If I am going to take on this non-executive role, what are the risks and what are my chances?". They are entitled to ask for some assessment of those issues if they are going to take on the task. Trying to define it may not be attractive but, if we are to encourage good quality people to come forward, they will want to know the "risk for reward" ratio—-not so much in terms of money but in terms of reputation—that goes with a task such as this.

I am grateful to the Minister for trying to cover some of the points. I entirely accept his point about directors who behave capriciously and knowingly allow matters to go through when they know that their fellow directors have not acted responsibly. Capricious behaviour is unacceptable—I take that as a very fair point—but I was not absolutely clear about the degree of responsibility that one director will take for another. George Bompas, a legal expert, states that it is very considerable. The Bill as presently drafted will mean that it is a joint and several liability. If someone on the board withholds something without telling you about it, you will be in dire straits. That is his view.

I should like to read what the Minister said, take into account the other points made in the debate and consult further. I shall then, quite likely, come back and readdress the issue. This is a serious and important matter and we share the Government's desire to have the highest quality people serving as non-executive directors. We have had a good preliminary canter over the ground.

Lord Wedderburn of Charlton

I do not wish to delay matters, but I wonder whether the noble Lord can help us. This is a very important point in the discussion more generally. The legal advice that he obtained is that there is a general joint or collective liability somewhere in the clause. Can he tell me on which part of the clause his legal advice is based?

Lord Hodgson of Astley Abbotts

As I understand it, it is in lines 38 and 39. The failure to take "reasonable steps" imposes a severe duty on the directors as a body to ensure that all directors have complied. "Reasonable steps'' will include steps to ensure that one's fellow directors have done it. Although a large board may be composed of 15 or 20 people, "reasonable steps" would require that to happen.

As I said, I do not wish to cross swords with the noble Lord on the finer points of law. I am in danger of repeating what I have been told; however, that is what I have been told.

Lord Evans of Temple Guiting

Before we move on, it may be helpful to the Committee if I say a word about joint and several liability so that it is in the record for the noble Lord, Lord Hodgson to read, along with everything else.

The offence in new Section 234(7) applies to every director to whom paragraphs (a) and (b) in that subsection apply. Accordingly, just because one director commits an offence under new Section 234(7), it does not necessarily mean that the offence is committed by all of the directors.

Lord Hodgson of Astley Abbotts

I am very grateful to the Minister for reading that into the record. It will indeed illuminate our thinking. I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Baroness Turner of Camden moved Amendment No. 46: Page 11, line 27, leave out "statement" and insert "statements

The noble Baroness said

In moving Amendment No. 46, I shall speak also to Amendments Nos. 47, 49, 50, 51, 54 and 65, which stand in my name and that of my noble friend Lord Wedderburn. We are seeking to amend Clause 9 of the Bill. As we know, this clause seeks to establish the obligation of directors to disclose information of which they should be aware. A statement is to be provided in line with the requirements of the clause. We seek to lake these requirements further, particularly in our new clause set out in Amendment No. 65.

Subsection (3) of our new clause specifies that a statement must be made stating whether all of the meetings of the remuneration or other committees concerned with directors' remuneration were attended by social partner representatives. We further define what is meant by "social partner representatives". It means representatives of the employees of the company appointed or elected in accordance with regulations made by the Secretary of State and having the rights and capacities set out in the regulations.

Why are we making these proposals? In recent years there has been much talk of "fat cats". One of my noble friends—sadly no longer with us—Lord Dormand of Easington, used regularly to table Questions to HMG, drawing attention to the astonishing increases in pay and benefits of senior executives in companies—payouts which took place even when the company itself was not doing very well and workers were facing redundancies. He was usually told by the Minister that this was not a matter for legislative intervention. However, it is increasingly a matter of concern, not only in this country but also in the United States. American lawyers have begun to call it "rent extraction" by the top managerial elite. In Britain the process began in the 1980s, but the big take-off in directors' rewards took place in the 1990s. Between 1994 and 2000, the median annual salary and bonus for the highest paid British directors increased by 107 per cent, while the median increase for employees in the same companies rose by 31 per cent.

In 2001 there was another dramatic upward shift in directors' pay. Indeed, in the 10 years to 2003, the average rewards for chief executives in British boardrooms rose by 288 per cent when workers' average salaries grew by 45 per cent. Share options and long-term incentive schemes added incrementally to salary increases. Beyond share options were bonuses, incentive plans and, even further, pension plans. A House of Commons Select Committee reported in 2002 that massive payments for termination of contracts were not in any way justified or required. The Secretary of State, Patricia Hewitt, criticised management for rewarding itself massive pension entitlement increases, about which she said that, they were feathering their own pensions nests while slashing the pension security of their workforce". Often there are other benefits such as cars, chauffeurs, enormous housing relocation allowances and so on.

This new phenomenon is not just a cause for envy, as has sometimes been said. It is socially divisive. Society has become relatively more unequal over recent years. The differential between executive pay and ordinary workers' pay has been growing and is still increasing. Productivity in Britain is still flagging and workers and their unions are complaining. Unions contrast the £9.2 million reward of a CEO with a low-paid worker's £10,500 year—and less for women. The Times referred to the, seemingly unstoppable rise in executive pay and pay-offs for dismal performance". Quite why all this was not confronted by the Company Law Review is rather surprising.

There are some restraints, such as independent non-executive directors to act as monitors. Indeed, we have been talking recently about non-executive directors. There is more disclosure, some shareholder activism, new shareholders' rights to pass an "advisory" resolution, but "rent extraction" continues to rise. I expect that in response to the amendment we shall be told about the existing restraints. However, it seemed to me and to my noble friend Lord Wedderburn that there is good reason to look at all this again and to consider what further steps might reasonably be taken. So we ask, not for the first time: "What about the workers?". Our amendment seeks to involve the workforces through their representatives. I emphasise that this is TUC policy and has been, I understand, since 1995.

I must stress that this is not an attempt to return to the 1970s and the discussions we had then about the Bullock report. We are not seeking a version of the German "Mitbestimmung"—co-determination—although many years ago when I was a union official I spent some time in Germany looking at the way it worked over there and was quite impressed. This is a different approach. We are seeking involvement in the area of remuneration where the workers would have a legitimate interest.

In the UK, there has been much emphasis on the need for greater shareholder involvement, and that has had some limited results. However, I shall quote a US academic on the matter of co-determination—it is one that I like—who says that, employees may have made a much greater investment in the enterprise in their years of service and have much less ability to withdraw and may have a greater stake in the future of the enterprise than many of the shareholders". On the agenda for reform should be the right of workers to have a voice in the machinery of the company regarding the development of managerial "rent extraction". It is getting out of control and is not being reached by the traditional methods of monitoring or external consultation. In 2001, when the value of their companies fell by 16 per cent, executives in top British companies increased their salaries by 12 per cent and bonuses by 34 per cent. The time has come for a new approach, and hence the amendment. I beg to move.

5.30 p.m.

Lord Wedderburn of Charlton

I rise to support my noble friend on these amendments, to which I have attached my name. I speak in particular to Amendment No. 65, which sets out the meat of the matter.

It has only recently occurred to me that we have been prompted to introduce this perhaps somewhat unusual subject into the Bill, representing only a small morsel of company law reform, because of the slow pace of company law reform in general. I look forward to the day when the Minister presides over a big companies Bill, one brought forward in 2005, 2006 or 2007—no doubt he will still be in office—but so many matters are now urgent in company law reform that some have now overtaken the Company Law Review. That is one reason for initiating a debate via this Bill by tabling these amendments, in particular Amendment No. 65.

There is no doubt about the facts. Survey after survey has shown that, over the past decade or so, the mark of the modern elite of executives in large companies—international and trans-national groups, as well as large domestic enterprises—is an escalating rate of overall reward of a kind which my noble friend said is very socially divisive and difficult to justify.

Of course I appreciate that we have not reached the position of the United States, with its very different culture and, in many ways, its very different form of capitalism, where a few years ago John Kenneth Galbraith was able to describe the pay of a chief executive officer of a large corporation as, not so much a reward for achievement as a warm, personal gesture by the individual to himself". But we are rapidly approaching the point where some overall rewards give rise to the same criticism. Moreover, research has shown that the problem of excessive executive reward is not, as many analysts have thought for some years, merely a phenomenon of Anglo-American dispersed shareholder capitalism with the so-called "divorce"—the separation of ownership and control. Evidence is emerging from France, the Netherlands and Germany, not least in the trial of Mr Ackermann, that this problem has surfaced even in those varieties of capitalism—as the literature has it—which are not usually designated as part of the dispersed shareholding phenomenon as evinced in our system.

This led the trades union movements in Britain, Germany and Holland, the TUC, DGD and FNV, to make in May 2003 a joint statement to the European Commission and the governments of their respective countries stating: Excessive executive pay is now an issue pressing at the very heart of European capitalism. [These] decisions can only be prepared in relevant subcommittees when employees' representatives are involved". I shall not try to repeat any of the other evidence on the matter of excessive executive pay because I promised my noble friend at the Dispatch Box that I would deposit a much longer paper on the matter in the Library. I shall do so and send him a copy. However, the evidence is overwhelming that directors are benefiting from salaries, stock options, incentive plans and a vast range of other benefits including, as the TLC pointed out only last week, enormous pension entitlements. Even the Secretary of State, who is not given to Bolshevik statements, recently criticised directors for, feathering their own pensions nests while slashing the pension security of their workforce". The Company Law Review did not face up squarely to this new phenomenon, one that has taken on a new qualitative characteristic since 1990. One of its members, Professor Davies, of London University, has stated in one publication that it did not discuss directors' remuneration fully because the Government had the matter under review which, in effect excluded [the Review] from looking into the matter". I do not suggest in any way that there is a national or indeed international conspiracy of directors, executive or non-executive—such discussions are silly—but directors do sit on one another's remuneration committees and a leading fund manager commented, quite rightly, last year that whatever the performance figures of companies, directors arc deciding their own pay. They sit on each other's boards … they are pushing only one way". The curve goes on going up. It is all very well for the Government to say that it is a problem of rewards for failure. We are not concerned merely with rewards for failure of the kind that the noble Lord, Lord Simpson, was found to exemplify at Marconi. We have had enough of them. The Government have no answer to that, and they certainly have no answer to the real problem of overall excessive reward.

In my own research I have been very interested to find out how much evidence there is of persons leaving the board of directors to become consultants because in that way they avoid disclosure. The Minister looks interested. I am very glad about that. It is impossible to deal with the conventional answers to the problem in the scope of the few minutes available. Disclosure is arguably as much about encouraging competition to be in the top quartile of peers as it is about anything else.

Ministers have enjoyed a luxury of hope over experience on shareholder activism for many years. Mr Stephen Byers, when he was the Minister in 1999, said, we arc seeing the beginning of the shareholder activism that exists in the United States". I do not know what comparative travails he had but we have certainly not seen anything of the kind, and naturally so. Apart from rewards for failure, shareholder activism and the right to move advisory resolutions are manifestly unlikely to be a method of curtailing excessive reward, as many academic writers have shown in the past 15 years. Nor, for many reasons, are institutional investors necessarily suited to that task. Although in certain situations they have an interest in looking at the matter critically, their main duties are to their beneficiaries.

As to the fashionable solution of independent non-executive directors, I understand the problem of getting such directors to fulfil the tasks that they ought to fulfil. As one American writer put it, the board of Enron was a splendid board, with 14 members and only two insiders; all the rest were independent non-executive directors. You could hardly expect the independent non-executives to form a wall against the remuneration committee structure as it stands.

It was with some prescience that the Trades Union Congress, in its evidence to the Greenbury committee, said that there was one constituency, largely unrecognised by British company law, that offers an untapped resource in introducing a pressure of a countervailing kind—that is, employees, whose lives are as much bound up, if not more so, as stakeholders within the enterprise, as my noble friend has said. For many years the programme of the TUC has been that employees should be represented on remuneration committees, at least to the extent of having a voice. It is a voice that the amendment calls for. So far as anyone can discover, it is not clear what the response of the Department for Trade and Industry has been to this call, which has been repeated many times since 1995. There does not appear to be an official response. I am not asking the Minister for a definitive response today—I hope that he does not give it, as I fear that it might be the wrong one—but one would have expected some response to this very modest suggestion.

That is especially so when, 20 miles across the Channel, workers send representatives from the comité d'entreprise to attend both shareholders' and directors' meetings of large companies. They have the right to all the documents of those meetings and to appoint experts to examine them. They have a voice. Twenty miles is not a long distance, but it could be the planet Pluto so far as British company law is concerned. The Company Law Review Group and the Government even want to abolish Section 309, where employees' interests are recognised.

We cannot possibly have a full debate on the matter today. Our amendments rest on a very conventional device; they say that one must tell the auditors whether one has had representatives of employees involved in the process of discussing the overall reward of directors. I remember the Minister saying many times that the important thing is to get the contractual arrangements right. I cannot think of a better group who might help to get the contractual arrangements right than representatives of the employees, who might take a more general view of reward in a corporate enterprise. Behind that, we have traditional machinery that says, like the Combined Code does, "comply or explain"—if one has not had such representatives, explain why not.

A Grand Committee is not a very suitable cockpit for prolonged discussion of such a fundamental theme. Whether we should entice a wider audience to debate the matter on Report will depend very much on what the Minister says. I hope that now or on a future occasion some answer can be given of a reasoned kind, not merely one that says that employees have no place, when the conventional wisdom of the Government is that they are partners in the enterprise. Partners would like a voice on what is being taken out and on what my noble friend has called, using the Americanism, "rent extraction".

Although I agree that these amendments are somewhat odd in this Bill, I hope that they will be taken as a serious attempt to stimulate a debate about a proposition that is as modest as it is sensible.

5.45 p.m.

Baroness Noakes

I am sure that the noble Lord, Lord Wedderburn, and the noble Baroness, Lady Turner, have enjoyed talking about excessive executive pay. I do not wish to get into a debate on whether pay for executives is excessive, but they may be slightly out of date on what happens in remuneration committees. It is not a case of people sitting on each other's committee and conspiring to pay them ever-large amounts. In my experience, committees have a genuine desire to ensure that executives are remunerated for what they do and are not remunerated for what they do not do. Over the past couple of years, we have seen very significant changes in the boundaries of what is the correct remuneration for that.

I wish not to debate excessive pay, but to put a specific question to the noble Baroness and the noble Lord. What would the people to whom the noble Baroness, Lady Turner, referred as "workers" do on the remuneration committee? I resent slightly the term "workers", because in my experience the executive directors about whom we are talking are the ones who have no regard to the Working Time Directive. They are very hard workers for the companies of which they are directors. I struggle to see what would be added by getting one or more workers on to a remuneration committee, when very technical issues about the design of long-term incentive plans are discussed and a detailed appraisal is carried out of the market in which we are trying to set pay.

As I understand the amendment, these individuals will simply, attend and participate in all the meetings". It does not say whether they would have any voting power at the meetings in determining the recommendations from the remuneration committee to the board. It is the board that makes the decisions. I am struggling to understand the practical effect of the amendment, although I concede that it has provided an excellent opportunity for noble Lords opposite to have a little rant about executive pay.

Lord Hodgson of Astley Abbotts

My Lords, I agree with the noble Lord, Lord Wedderburn, about the importance of company law review. On these Benches, we are entirely with him on that. It came up at Second Reading and in Grand Committee. I am sure that the issue will come up again. All power to his elbow in that regard in persuading the Secretary of State to move it up the agenda.

The noble Lord will be less surprised that we, on these Benches, cannot support the extension of mandatory employee involvement to these new areas. That is not to argue that there have not been unacceptable cases of executive pay; there have. All one can say is that those cases have been given a lot of publicity. Perhaps less publicity has been given to the many, many cases where pay is reasonable, rewards are properly earned, and so forth. Of course, big news stories are about the bad things that have happened.

From our point of view, the present legislation—the companies Acts and so forth—provides more than sufficient statutory provision in that area. As in so many of the issues that we have been talking about during this Bill, the key is the question of disclosure; that is, the voice that the noble Lord, Lord Wedderburn, talks about. Disclosure gives the voice to the shareholders. Shareholder power has greatly increased in recent years, as, again, we have seen in the newspapers, encouraged by various interests and pressure groups that now professionally advise shareholders on their rights and on the suitability and compliance that is being achieved. "Comply or explain": a body should provide that all the time.

As we have already said, we are increasing the director's liability with the addition of the report under Clause 9. A further report that the directors will be required to approve is another increase in their liability. As my noble friend Lady Noakes said, we are seeking ways to encourage good quality people to serve as non-executive directors. This will not be an incentive for them to do so. Therefore, we cannot support this group of amendments.

Lord Sharman

I, too, express my sympathy with what the noble Lord, Lord Wedderburn, said about company law review. In this context, it is particularly important. Clearly, the noble Lord and the noble Baroness, Lady Turner, seek to raise an issue about which they feel very strongly. I feel strongly that this is the wrong place. The Bill is about auditing. Whether or not one agrees with the thrust behind the amendment, the issue is about worker or employee participation in the overall direction of the enterprise. It should not be restricted merely to attendance at a remuneration committee. In my view, that is the wrong structural approach.

One may or may not agree with employee participation; I think that there are very good ways of dealing with it. But if one is arguing for employee participation, it is not right to incorporate it into a subcommittee of the board. The reason that we have such difficulty is that in this country we do not have the overall reconsideration of corporate legislation. As I said at Second Reading, we are dealing with company law that is 50 years old. The nature of the corporate enterprise and the corporate endeavour has moved on in those 50 years. There are different views now about what is needed for the overall governance of the enterprise. The right way to deal with these issues is through a fundamental restructuring of company law.

Lord Wedderburn of Charlton

Before the noble Lord sits down, I very much appreciate what he has said. What falls from his Benches is of course of particular importance in these matters. I was about to ask whether the noble Lord would give us marks for managing to get our amendments within the Long Title of the Bill, but I shall refrain from that.

Although the noble Lord and I no doubt differ as to whether this is a proper matter to discuss with the Bill, did I understand him to say that a stakeholder approach of some kind is more appropriate to modern corporate law than the old-fashioned approach, which unhappily has dominated the company law review?

Lord Sharman

We shall come later to an amendment that I have tabled which deals with social and environmental reporting. It will demonstrate that it is not different but has similar factors; it reflects the way in which the view of the enterprise has moved.

Perhaps I did not make myself clear. In my view, the nature of the enterprise and society's view of it has changed and developed in the 50 years since the law under which we now operate as corporations was first put on the statute book. We need a comprehensive review of company law to reflect those changes. We should be debating how, why, where and when the various developments and changes should be incorporated into the new company law.

Lord Sainsbury of Turville

I am pleased that my noble friend Lord Wedderburn is looking forward to the day when I will bring forward a new companies Act. My personal view is that I hope I will have been sacked or some other act of God will have intervened before such a happy occasion takes place.

I am not at all surprised that the noble Lord has managed, very cleverly, to introduce these amendments to the Bill because he is extremely adept at legal matters. However, I am slightly surprised that he has any doubts about what the Government's response will be because we have consistently put forward our view on these particular issues.

Let me explain our position. This group of amendments deals with employee involvement in company discussions involving the disclosure of the remuneration of the directors of a company and the reporting of that involvement. Amendments Nos. 46, 47, 49, 50, 51 and 54 are consequential to Amendment No. 65 which contains the main provisions. This amendment requires the Government to legislate to create the legal right for two or more employee representatives to attend any committee or other group within the company which discusses the disclosure of directors' pay in relation to Schedule 6 or Schedule 7A of the Companies Act 1985.

The Government have consistently made it clear that directors' pay is a matter for companies and their shareholders under UK corporate governance structures. It is for companies and their shareholders to decide on the nature and extent of any consultation with employees or their representatives. Nevertheless it is clear that directors face a conflict of interest in the setting of their remuneration, which is why the Financial Reporting Council's Combined Code on Corporate Governance includes a number of principles and provisions in this area.

The revised Combined Code was introduced for listed companies with financial years ending on or after 1 November 2003. The code was developed following the recommendation of Derek Higgs's review of the role and effectiveness of non-executive directors and is the result of extensive consultation. Code main principle B.2 states that, no director should be involved in deciding his or her own remuneration". Code supporting principle B.2 states that the chairman of the board should ensure that the company maintains contact as required with its principal shareholders about remuneration. Code provision B.2.1 states that the board should establish a remuneration committee of at least three members, who should all be independent non-executive directors. The definition of "independent" given at code provision A.3.1 specifically excludes directors who have been employees of the company within the last five years.

The Government fully support the operation of the Combined Code and the key role that it plays in UK company law and the corporate governance framework. The amendment is in accordance with neither the overall approach of enlightened shareholder value taken by the Company Law Review, nor the principles and provisions of the Combined Code.

The Government strongly support the general principle of employee involvement in the workplace. Employees should have the chance to be informed and consulted on management decisions affecting their future. That is why we are committed to a full implementation of the EU directive on informing and consulting employees. The implementing legislation will come into force next year. That follows extensive consultation with stakeholders representing the interests of employers and employees. Indeed, noble Lords will have the opportunity to debate the issue of employee consultation as part of their scrutiny of the employment Bill, which includes a power to introduce the information and consultation legislation.

The draft regulations published for consultation last year were based on a framework agreed with both the CBI and the TUC. It is an approach designed to promote better workplaces and more committed staff. It provides plenty of opportunity for management and employee representatives to reach agreement on the precise nature of the information and consultation arrangements and the topics for discussion.

I shall now deal with remuneration of directors, as I want to make it clear that the Government share the genuine investor concern about the need for proper accountability, transparency and performance linkage in directors' pay. We remain concerned that there should be a very clear link between directors' pay, the remuneration market and performance. There should also be control by shareholders. If we look at the total amount and the speed of the increases in recent years, it is not always clear that the remuneration of directors is either linked to performance or the market, or controlled by shareholders.

We continue on those grounds to be concerned about what has happened with directors' pay. That is why the Government have taken significant action in the area over the past two years. In August 2002, the Government introduced the Directors' Remuneration Report Regulations. Those require quoted companies to produce a detailed annual directors' remuneration report which is put to a shareholder vote at each annual general meeting. I do not agree totally with the noble Lord, Lord Wedderburn, that that is obviously not effective. Directors are very concerned that such matters should be voted on at annual general meetings, and that will begin to show results. We need to see those results coming through as soon as possible.

The UK now has a comprehensive, transparent and accountable framework for directors' pay which surpasses other corporate governance regimes in similar market economies. But that latest legislation has been in place for only one full financial year, and more time must be given for it to take full effect.

In addition the Government have recently consulted on the specific issue of "rewards for failure". That took place in response to continuing investor concern about situations where directors leave companies which have performed poorly but receive excessive compensation packages when their contracts are terminated. The Government's response to that consultation was announced by a Written Statement on 25 February this year. It included announcing the monitoring of compliance with the Directors' Remuneration Report Regulations, which shows that we are still very much concerned about the issue.

The enlightened shareholder value approach recommended by the Company Law Review states that the primary responsibility for directors is to run the company in the collective best interests of its shareholders. In deciding what will be in those interests, directors must consider all relevant factors. Those include those areas that are important to companies in a modern economy, such as the company's relations with its employees and its need to maintain its business reputation. That ties in with the Company Law Review conclusion that the approach of enlightened shareholder value provides the best conditions for the proper exercise of business judgments in order to achieve the best means of securing overall prosperity and welfare, and that a pluralist model of company law would not be as effective in delivering improved competitiveness and thus the efficient creation of wealth and other benefits.

I should comment on why so long has been taken. The task is, of course, extremely complicated. In seeking to take forward the detailed proposals within the framework of a completely new companies Act, we found that we necessarily had to address questions of how the elements would be built up. In doing so, we are not in any way seeking to depart from those Company Law Review principles, which, as we have said, remain as relevant as ever. However, it is apparent that if, as part of the process, we change the basic concept of our company law, that could have practical consequences on how companies operate that were not explored fully in the Company Law Review. We remain committed to the process and to making proposals, on which we should properly consider such major issues.

We do not think that the amendments are the right way in which to deal with directors' remuneration, but it is an issue that we are keeping under review.

6 p.m.

Lord Wedderburn of Charlton

I listened very carefully to what my noble friend said. One advantage of the extraordinary scope of the Department for Trade and Industry is that one can ask the Minister to leap about from the law on employment consultation to company law, and his advisers can cover both areas and, indeed, many others. I would like to ask him two questions.

The Minister mentioned the forthcoming regulations on consultation under the directive, of which the Government kindly provided us with a draft. Did I understand him to say that he expected those regulations to give employees' representatives an opportunity to consult on proposed remuneration and rewards for directors in a company, before they were settled? That was not my understanding of the draft that I saw; no doubt I have not studied it sufficiently carefully. I do not want to ask him for an answer on the hoof, as it were, if he does not want to commit himself on that question, but it is a most important matter in which trade unions are very interested. If he does not want to answer it now, perhaps he could give us further information on the point.

The Combined Code sets out an approach for remuneration committees. Something that I found in my notes, to which I did not have time to refer, is taken from the annex to the Higgs report. and I think that it is the text in the Combined Code after all the discussions with the Financial Reporting Council. It states that, remuneration committees should be sensitive to broader issues, including pay and employment conditions elsewhere in the group … when determining annual increases", of directors' rewards. Does that not indicate that there is a place for input before the matter is settled from employee representatives?

Lord Sainsbury of Turville

I certainly did not say that full implementation of the information consultation directive would lead to consultation about directors' pay by the employees. I do not believe that it does, but I will check and, if I am wrong, I will come back to the noble Lord. I am afraid that I did not understand his second point about the reasons for employees being involved. Could he repeat it?

Lord Wedderburn of Charlton

I was struck by the phrase, which I believe has survived into the Combined Code. that, remuneration committees should be sensitive to … pay and employment conditions", not merely in the company, but in the group. So much of our discussion is about "the company" when we ought to discuss "the group".

The whole reward structure in an enterprise is of such importance these days. There is a great deal of feeling on the part of workers—I do not exclude directors or anyone else who works for a living from "workers"; I simply talk about those who are employed and not in the higher reaches of management—caused by the fact that excessive rewards have been set so often without regard to the balance in the enterprise between the upper and lower reaches. Many commentators have pointed out how that enormous increase in proportion in the past 10 years, which some people will not take seriously, has become divisive in a new way. If the Combined Code says that remuneration committees must look at pay and employment conditions overall in the company and the group when determining the annual increases at the top, would that not be a good place for those who are very interested in the overall balance of rewards in the enterprise to have a voice?

Lord Sainsbury of Turville

There is a distinction between what the Combined Code says that the people taking the decisions should bear in mind, and a further argument that suggests that a particular group of people should play a part. Those are two quite different issues. I totally support the first, but my initial arguments suggest that the second is the wrong approach.

Baroness Turner of Camden

I thank Members of the Committee who have taken part in the debate, which has been very interesting. In particular, I thank the noble Lord, Lord Sharman, who at least was syrnpathetic but thought that the amendment was in the wrong place. I am also glad to learn that the Government have at least some concern about the imbalance in directors' pay. I believe that they still say that companies are controlled by shareholders and that pay is a matter for the company and its shareholders. Nevertheless, the Minister mentioned the concern about rewards for failure, excessive packages for pay and the widening gap between workers in enterprises and very senior management.

We would like to examine what the Minister said very closely. We may want to come back with a rewording on Report, because the issues are sufficiently important for us to have a discussion on the same question then, even though there is a view that our amendment might be better attached to some other legislation. I do not know about that, but the issue is very important. We would like to have a debate on Report but, in the mean time, I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

[Amendments Nos. 47 to 54 not moved.]

Lord Hodgson of Astley Abbotts moved Amendment No. 55: Page 12, line 5, after "no" insert "material

The noble Lord said: Clause 9 is on the statement in the directors' report. Amendment No. 55 is concerned with proposed new Section 234ZA, which appears at the top of page 12 and is entitled: Information to have been disclosed to auditors before directors' report approved".

It is a small amendment but nevertheless important. As the Bill is drafted, the new statement in the directors' report requires the inclusion of a statement that, at the time at which the report is approved, there is no information which has not been disclosed to the company's auditors.

That is an extraordinarily wide and far-reaching definition and requirement. In the real world, I suspect that more or less every director of every company could be hung on such a provision. I hope that the Minister will not argue that there is no need to worry about the unamended clause because if the information were not material the courts would not use it. That would be an unsatisfactory reply.

The amendment inserts "material" into proposed new Section 234ZA(1) under Clause 9, ensuring that at the time of the approval of the directors' report there is no "material" information which has not been disclosed to the company's auditors. It offers the Government a helpful alternative approach to our Amendment No. 53, which we discussed earlier. I beg to move.

6.15 p.m.

Lord Evans of Temple Guiting

I do not think that there is a great difference of principle between us here. We are in agreement that we do not want to require the directors to overburden the auditors by providing them with everything they know about the company. Clearly, that would be counter-productive and result in both auditors and directors spending too much time and costs in providing and assessing large amounts of irrelevant information.

However, we do not consider that this amendment is necessary. Subsection (5) of Clause 9 inserts a new Section 234ZA into the 1985 Act. Subsection (2)(b) of that new section restricts the information to which the statement relates to information that the director knows—or ought to know—is relevant for the purposes of the auditor's determination (in accordance with Section 235). In other words, the information must be relevant to the audit opinion; that is, that the accounts have been properly prepared in accordance with the Act, and in particular that they show a true and fair view of the state of affairs of the company and of the profit or loss for the year. We think that that provides the right balance—so that the directors have to provide the information that is of real relevance to the auditor's work, but are able to make the required statement without providing excessive amounts of information.

Nevertheless, a director may say that it is difficult to know what he or she ought to know is relevant for the auditor to reach an opinion. We do not require the directors to put themselves in the position of the auditors. We require them to use a minimum level of common sense which might be expected of a person in their position and to use any particular knowledge they may have.

Baroness Noakes

The Minister said that the requirement that the director "ought to know" that the information would be relevant is to do with common sense. Is that a definitive explanation of the Government's interpretation of that clause?

Lord Evans of Temple Guiting

I think this comes back to our earlier discussion when we were talking about the level of expertise of directors who guide the affairs of companies. They are not fools. They are intelligent people, and we require them to use a minimum level of common sense which might be expected of a person in their position. I think that that is a perfectly reasonable part-answer to the issue raised.

Baroness Noakes

Perhaps I can take that further. We are talking about what is relevant to auditors in terms of the reasonableness of how they perform their functions, not about what directors themselves do. We are talking about the directors needing to understand what is relevant to an auditor. That is why I am struggling in terms of the test for a director when he or she is trying to find out what would be relevant to the auditor. That is why my noble friend's amendment, which refers to the materiality of information, takes us to the heart of how to ensure that directors disclose material matters. It does not mean that directors have to know the mind of the auditor. We will return in a later amendment to the need to know the mind of the auditor. I find it extremely difficult to know how any director, even one with some knowledge of accounting or auditing, would be able to see into the mind of the auditor at any given time.

Lord Evans of Temple Guiting

I think that we are going to disagree on this. I return to the earlier point—that we are talking about well-organised, well-structured companies with boards of directors who are aware of the audit process. I would be amazed if directors in the sort of companies we are talking about were not aware of the audit process. They would be aware of the necessary probity for their position and the need to exercise governance. All we are saying is that—returning to an earlier point on which we disagreed—we have a very high regard for those who run these companies and the level of their intelligence. We would expect them to have the common sense to be able to determine for themselves as a board and as individuals what auditors would expect from them.

Lord Hodgson of Astley Abbotts

I have to say that I am disappointed with what the Minister has said. What we are dealing with in new Section 234ZA is a balance of new provisions, to which the noble Lord referred. The phrase "ought to know" has been causing Members on this side of the Grand Committee a lot of concern. One of the ways to lessen our concern about the phrase is to say "no material information" instead of "no information". That would provide some more protection in this balance. I cannot see how the addition of materiality to this new section would weaken the position. It would reassure directors, executive or non-executive, that they cannot be hung on a figment or a small event. As the new section is presently drafted, I think that that could happen.

The Minister will say that that will not happen in reality. While that is fine to assert when sitting comfortably in the Moses Room on a nice March afternoon, there will be times away from here when people have to face the reality of what we are discussing. To be honest, I do not think that the Minister has mounted a convincing argument to explain why materiality should not be a qualification on information.

Lord Evans of Temple Guiting

Perhaps I may add a further word. The new section restricts the information to which the statement relates to information that, the director knows or ought to know … relevant for the purposes of the auditors' determination (in accordance with section 235)". The director should be able to tell whether the information is relevant to the auditor's opinion.

As we stressed in Grand Committee yesterday, we are keen to see, wherever possible, consensus on the Bill. Obviously there are strong feelings on this point. We shall take the matter away and think on it further before returning to it on Report.

Lord Hodgson of Astley Abbotts

That is a very fair offer, which we gratefully accept. I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

[Amendment No. 56 not moved.]

Lord Hodgson of Astley Abbotts moved Amendment No. 57: Page 12, line 8, leave out from "information" to end of line 10.

The noble Lord said: We are working our way through proposed new Section 234ZA entitled, Information to have been disclosed to auditors before directors' report approved".

This amendment relates to subsection (2), which explains how the director should know about information for the auditor.

Amendment No. 57 seeks to leave out the lines reading, it would be reasonable for a director of the company to obtain the information by making enquiries".

This implies that a director has to take on a role with potentially very far-reaching demands. Without harking back, the issue of materiality is raised again here. What is reasonable to expect a director to enquire about and what is unreasonable is a pretty grey area. It would be helpful if the Minister could enlighten the Committee on the Government's thinking on how this is to be determined. I beg to move.

Lord MacGregor of Pulham Market

Perhaps I may add a word, because earlier I gave the general context in which I approach these matters, and this is a relevant point. The Minister's words have been extremely comforting and soothing: there is no unreasonable requirement; a reasonably diligent director has nothing to fear; a minimum level of common sense. I must say that the phrase, "a minimum level of common sense" was the one that worried me, suggesting as it does that there is no heavy test at all. However, I suspect that when it comes to real issues, the "minimum level of common sense" will be much debated.

This amendment, along with our debate on the words "ought to know", draws attention to the heart of my concern. Let us take, for example, a UK company with a large number of overseas subsidiaries in the Far East, Japan, Australia and the United States. That is not an unusual situation for some of us. Sometimes it is impossible, when an issue arises in an American subsidiary with a different audit, to know as a non-executive exactly what is going on in that area unless it is drawn to one's attention by the executives involved. Taken at face value, it would sound as though a director now in an audit committee should be making all sorts of inquiries over and beyond the papers that are put in front of him, just to be absolutely sure that he is safeguarded against any subsequent attack or litigation.

I wonder again whether the words the Minister is using square with what is in the Bill. That is my concern. If one ought to know what the auditor is seeking and one does not know what is going on in one of the subsidiaries, where does that leave one'? That could be an extremely onerous requirement. It is those two provisions, combined together, that lead to my worries.

Lord Evans of Temple Guiting

As we have discussed under previous amendments, the statement in the directors' report provided for in this clause is above all a way of focusing the attention of directors on the question of whether relevant information has been disclosed to the auditors. The amendment introduced by the noble Lord, Lord Hodgson, would remove a detailed provision designed to ensure the effectiveness of Clause 9. We believe that to accept it would weaken the clause significantly.

The amendment concerns new Section 234ZA(2)(a), which states that, in certain circumstances, information may still fall within the scope of the directors' statement when the director is not initially aware of the information but—this is the crucial phrase—it is reasonable for the director, to obtain the information by making enquiries". The test here—which brings us on to the foreign subsidiaries—is that if it is impossible to know, then it is not reasonable. If something is happening in a subsidiary in Peru, for example, it is unreasonable to expect the director to know about that. The test is reasonableness.

That is very important because it means that a director cannot say, for example, "I did not know about that particular information concerning the value of the company's stocks, though I know that it was important to the auditors. I also know that Mr X knew all about it, but I never bothered to ask him. However, the test in law is simply whether or not I was aware of the information—and clearly I was not, so I have done nothing wrong". In such a case. we believe that it is reasonable to expect the director to make inquiries.

In other words, the provision in new Section 234ZA(2)(a) is necessary to make this clause effective. But, it is fair to ask, does it impose too uncertain a test on a director? Can it not be argued that what is reasonable to one person is unreasonable to another and that the director does not therefore have enough certainty to know what is and is not unlawful? I do not accept that argument. There is no expectation or implication in the provision that a director needs to make inquiries down every avenue that may yield relevant information. It is only where it is reasonable for the director to do so. We are all used to thinking in terms of what is reasonable. The particular circumstances will determine what is reasonable in each case.

I do not accept that in practice a director will find that difficult to work with. If he or she is uncertain, it must be sensible to discuss the matter with others and get a second opinion on what is reasonable. In the vast majority of circumstances, however, I believe it will be perfectly obvious to the director when it is necessary to make inquiries and when it is not.

This is not an entirely new and novel approach to the problem that we are now adding to the law. The concept of making reasonable inquiries is used, for example, in Section 80(3) of the Financial Services and Markets Act 2000, which concerns disclosure in listing particulars. I hope that, with my explanation, the noble Lord will be prepared to withdraw his amendment.

6.30 p.m.

Lord Wedderburn of Charlton

Does not my noble friend also agree that what is much overlooked in these discussions is that subsection (3) makes it perfectly clear that the knowledge that one would expect a "reasonably diligent person" to have must be judged also in relation to the functions fulfilled by a particular director in the corporate enterprise? The test is what is expected of a person carrying out the same functions as carried out by the director in relation to the company.

Lord Evans of Temple Guiting

I agree absolutely with the point made by my noble friend Lord Wedderburn. In an earlier amendment we made the distinction between what a finance director should know and what a sales director should know. So I agree with my noble friend on this.

Lord MacGregor of Pulham Market

Can the noble Lord explain why paragraph 48 of the Explanatory Notes states that: Each director will have to think hard about information, of which he or she is aware but the auditor is not"?

Lord Evans of Temple Guiting

Again that is a perfectly reasonable and sensible proposition for the directors of a company to embrace. We are not dealing with a group of stupid people; we are addressing highly intelligent people who run very successful companies. The line of questioning seems to suggest that they need in some way to be taught how to do their jobs when it comes to governance and probity, and how to recognise audit problems that may emerge within their organisations. I am slightly bewildered by that line of questioning, but that may be my problem.

Baroness Noakes

I was interested in the noble Lord's reference to making inquiries in relation to listing particulars. I am sure the noble Lord is aware that, when listing particulars are finalised, directors are surrounded by armies of lawyers carrying out detailed due diligence checklists. I should like to explore with the noble Lord whether he thinks that that is the direction of travel for boards of directors and, in particular. for audit committees. Will we end up with a process that involves advisers going through individual items and possible lines of inquiry, checklists of questions to put to the auditors about what they know and do not know, and questions in relation to all the subsidiaries? That is what the analogy to listing particulars implies in practice, although one would not get that from reading the law.

Lord Sharman

Perhaps I may add a word to what has been said by the noble Baroness, Lady Noakes. I think that it is almost beyond peradventure that we are headed down the route of verification notes as regards information in the directors' report. When we consider what is to come with the OFR, we are headed down the route of verification notes. It is inevitable. However, noble Lords should not take from my remarks that we are doing anything other than providing full employment for the legal profession. I can envisage circumstances in which it will not be possible to hold a board meeting without a lawyer sitting in. We need to understand that, and I think that it should be taken as a given.

Lord Evans of Temple Guiting

When I referred to the Financial Services and Markets Act 2000, I did so because the concept of making reasonable inquiries is contained in that Act. It was not an analogy; it was simply an example of another Act which uses the same wording. I thought that might be helpful given that there is some surprise and worry about what is meant by "reasonable".

We are talking about what directors are aware of. If they are not aware there is no responsibility. This point has been made before.

Lord Freeman

With great respect, that is not what is stated in the text of the Bill. It would help matters greatly if the Minister could confirm the Government's intention in regard to the fact that directors ought to know what the auditors do not know? Is that responsibility—to which my noble friends, with their vast experience, have referred—directed at, for example, the finance director and the audit committee? Can the Minister confirm that it does not apply to non-executive directors and others who do not have direct dealings with the auditors and that there is no intention for them to be caught?

Lord Evans of Temple Guiting

Clause 9(5) makes the situation clear. Subsection (3) of new Section 234ZA states: For the purposes of subsection (2)(b) and (c), a director ought to know a matter if it would be known by a reasonably diligent person having both— (a) the knowledge, skill and experience that may reasonably be expected of a person carrying out the same"— executive or non-executive— functions as are carried out by the director in relation to the company, and (b) the knowledge, skill and experience that the director has".

Lord Hodgson of Astley Abbotts

Did the Minister say "the same executive or non-executive functions"? That is not in the Bill.

Lord Evans of Temple Guiting

I added that simply to clarify the position. We are not looking at a difference, as postulated by the noble Lord, Lord Freeman, between the non-executive and the executive director.

Lord Sharman

From what the Minister has said, and the way I now interpret the clause, it seems to me that we have different levels of responsibility and expertise expected of different directors, be they executive or non-executive, dependent upon their background, skill, knowledge and so on. That introduces a situation which is directly at variance with the situation that has arisen under the Sarbanes-Oxley Bill, where the US approach has been that even the designation of an individual as the financial expert on an audit committee does not attract any greater degree of liability. I can assure the Minister that, if my interpretation is right, there will be no more financial experts on audit committees.

Lord Wedderburn of Charlton

Before my noble friend replies to that somewhat extraordinary notion, would he reflect on the fact that when a consultant surgeon goes in to operate and the doctors who assist him go in to operate, they expect to operate as reasonably diligent persons, with proper experience and a proper mind to inquire into matters. That does not require them to go into a huddle with lawyers before they perform the operation.

Lord MacGregor of Pulham Market

I am sorry to continue the debate but the point raised by the noble Lord, Lord Sharman, is one that I raised earlier in relation to subsection (3). I was going to come to it later but, as the noble Lord has raised it, let me deal with it now.

Where one is trying to recruit non-executive directors from a much wider field than normal—from the public sector, from charitable organisations, from minority groups and so on—the knowledge, skill and experience of some of those people would be very small in relation to the issues we are discussing, particularly in relation to audit committees. There would be two classes of people on the audit committee.

As the noble Lord, Lord Sharman, correctly said, one of the dangers would be that the people with the real knowledge, skill and experience would face problems about making reasonable inquiries, and all of the rest of it. They would have a much higher degree of responsibility than those with no financial experience. If my interpretation, and that of the noble Lord, Lord Sharman, is correct, it might be quite difficult to attract, as the Government and Smith want, former finance directors and accountants on to the audit committee.

Lord Evans of Temple Guiting

I return to the example raised before; that is. expertise for particular functions. The distinction between the specialist knowledge that the finance director and the sales director would have was raised. We have to come back to the notion of "reasonableness". Probably, we would not accept that the sales director would have a detailed knowledge of audit procedure. We would expect the Finance director to have that. We would not expect the finance director to be able to predict whether a product in stock will sell out within three months, but we would expect the sales director to have that information. The words "awareness" and "reasonableness", when applied, help us with the interesting problem that has been raised.

In other words, what it is reasonable to conclude a finance director ought to know is not the same as what it is reasonable to conclude a non-executive director ought to know. To take a small company, there is a difference between what the director running the business ought to know and what a fellow director who has little active involvement in the business ought to know. I do not think that it is extraordinary that when we hire an expert we should expect expertise. For that reason, and the others that I have given, I think that our approach is the right one.

Baroness Noakes

I do not want to prolong the debate, but I should record for today—I am sure that we will be debating this matter again—that what the Minister said has, in effect, sounded the death knell of audit committees being run by those who have expertise in the matter.

Lord Hodgson of Astley Abbotts

I am sure that the Minister is under no illusions regarding our concerns about this amendment and the provisions of this clause. What most concerns us about "reasonableness" is reasonableness ex ante and reasonableness ex post. Hindsight is a wonderful thing. "Reasonableness" in respect of what one should have done. looking back up the track six or eight months, appears incredibly straightforward, but at the time it was not quite as clear.

We have not got a clear guide from the Government on the shifting nature of reasonableness in relation to society or time. For my part, I was slightly further confused by the small and big company example and, indeed; the discussions about expertise. Without wishing to further belabour the Minister. I did not think that the FSMA example was helpful. Listing particulars are about raising money. They are about trying to entice the public to put money into a company. An annual report is reporting what the company has done to shareholders who are already owners of the business. It is a very different function, but we do not need to go any further on that.

Clearly, we shall come back and look at the issues in connection with this clause. In the mean time, I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

[Amendment No. 58 not moved.]

6.45 p.m.

Lord Sharman moved Amendment No. 59: Page 12, line 13, leave out from "determination" to end of line 15 and insert "of the form of his report under sections 235 and 237 of this Act:

The noble Lord said: We return, I fear, to subsection (2) of Clause 5. There appears to me to be a technical flaw in this subsection. As currently drafted, it does not fully reflect auditors' duties in regard to their overall reports on financial statements and annual reports. The information disclosed to the auditors before the directors' report is approved under new Section 234ZA(2)(b) should not be restricted to the information required by auditors for the purposes of the auditors' determination in accordance with Section 235 of the 1985 Act, which deals with the preparation of accounts. It needs to be extended to include the information that auditors require to meet their responsibilities under Section 237, which deals with the accounts and other matters on which they have to report in respect of the auditor's report. I should be very grateful if we could clear that up.

Lord Evans of Temple Guiting

We recognise that, as currently drafted, new Section 234ZA(2)(b) does not reflect the full range of material which must be covered in an auditors' report set out in the Companies Act 1985. The reason for this is that the principal purpose behind this clause is to ensure that the auditors have all the information relevant to determining their opinion on the annual accounts; that is, whether the annual accounts have been properly prepared in accordance with the Act, and in particular whether they give a true and fair view.

However, we have some sympathy with the noble Lord's amendment. In particular, I find it difficult to argue why this particular provision should not also refer to information relevant to the determination of the auditor's opinion in relation to the directors' remuneration report, as required by Section 235(4) of the 1985 Act. I am not convinced, however, that we need to include information relevant for all of the auditor's duties under Section 237.

I therefore hope that the noble Lord, Lord Sharman, will accept my undertaking to look at the point raised by this in more detail and to bring forward an appropriate amendment for consideration at Report stage.

Lord Sharman

I am grateful to the Minister for that response. I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Lord Hodgson of Astley Abbotts moved Amendment No. 60: Page 12, line 16, leave out "ought to know

The noble Lord said: We come now to new Section 234ZA(2)(c), after hammering away at subsections (a) and (b). Paragraph (c) introduces yet another complexity that lies at the heart of our differences. We thought very carefully about "ought to know" in connection with subsection (2)(b), which states: the director knows or ought to know that the information would be relevant for the purposes of the auditors' determination". We decided that, on balance, it was fair to leave that in. However, when we got to subsection (2)(c), which states, the director knows or ought to know that the auditors are not aware of the information", we thought that it was a bridge too far.

The director is in a very difficult position if he is being asked to decide what the auditors ought to know but in fact do not. So we felt that Amendment No. 60 was right to seek to remove "ought to know" from this part of the Bill. We are quite content with the penalty for a director failing to disclose information that he knows is relevant to the audit and where he also knows that the auditors do not know it. However, asking a director to take responsibility for information that he ought to know the auditors do not know is a step too far. It is very difficult to see how a director is to avoid being charged with being reckless in such circumstances, particularly in the modern litigious environment in which we live. I beg to move.

Lord Evans of Temple Guiting

The amendment tabled by the noble Lord, Lord Hodgson, would, like his earlier Amendment No. 57, remove a detailed provision designed to ensure the effectiveness of Clause 9. Again, we think that this amendment would significantly weaken Clause 9. The provision that Amendment No. 60 would remove introduces the concept of what a director ought to know in relation to what information the auditors are not aware of. Let me explain why I think that necessary to make the clause effective, and why it does not impose an unfair or disproportionate burden on directors.

Without the references to what a director ought to know, we are left with a test which it is very difficult in practice to demonstrate has been met. Whether a director knows that the auditors are not aware of certain information is difficult to prove. A director might say, "I realise that a reasonably diligent person in my situation would have known that the information was not known by the auditors by, for example, checking lists of disclosures that had been made to them. I should have realised that but as a matter of fact I did not". I am clear that the references to "ought to know" and its meaning in proposed new Section 234ZA(3) are necessary to make the clause work effectively.

Again, it is right to consider whether the provision imposes an unfair burden on the director, and again our answer is that it does not. I would have been sympathetic to that concern had we simply included the reference to "ought to know" without further explanation. However, proposed new subsection (3) carefully defines what is meant by "ought to know" in the context.

There are three elements to that. First, the director does not have to be a superman or superwoman; he or she is expected to know only what a reasonably diligent person would know. Secondly, in reaching a view of what a reasonably diligent person would know, the clause does not lump all directors together, but says that it is to be determined in relation to the knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as that director. In other words, what it is reasonable to conclude that a financial director ought to know is not the same as what it is reasonable to conclude that a non-executive director ought to know. That point has been made several times this afternoon. Thirdly, what a reasonably diligent person would know is determined also in relation to the knowledge, skills and experience that the particular director actually has.

Our aim is to produce legislation that is carefully balanced—that will be valuable and effective in supporting the statutory audit but will not impose unreasonable requirements on directors. We believe that the provisions meet those aims. The very first point on the first day—it seems like last week—made by my noble friend Lord Sainsbury was that one of the purposes of Committee is to listen carefully to what everyone says, take it away and consider the discussions and arguments.

Baroness Noakes

What the Minister says is clearly extremely encouraging but, before my noble friend decides what to do with his amendment, I want to probe a little more about the practical implications of the paragraph. It suggests that the director knows or ought to know that the auditors are not aware of the information. It contains nothing about being able to rely on reasonably diligent auditors.

What one ought to know that the auditors did not know would be different if one had highly competent auditors or non-competent auditors. The clause is not balanced by any counterbalancing assumption that the director can make, because we are in effect talking about hypotheses that the auditors are acting reasonably. Without some balance, the provision will result in severe practical difficulties for those charged with considering the matter. I shall return to audit committees: I should have declared an interest a long time ago as a chairman and member of a number of them. Such considerations bear heavily on my mind.

I do not know what procedures I would have to undertake to ensure that I knew or ought to know that the auditors were aware of information. I find that particularly difficult to contemplate in the context of what level of skill they are expected to demonstrate in the way in which they conduct their audit. I feel that we are going into unknown territory. To reinforce the point that I made under an earlier amendment, that will make the job of anyone wanting to be involved in an audit committee so undesirable as to set back corporate governance by a decade. I shall be interested to hear what the Minister says.

Lord Freeman

Before the Minister replies, may I add a brief comment to what my noble friend Lady Noakes has just said? There is a great emphasis at the moment on training or attempting to train non-executive directors in an effort to recruit a higher quality and wider range of directors. Before we come to Report stage, will the Minister reflect on the effect of the provision?

Unless the Bill is amended, I can tell the Minister that it will have a very serious effect on our ability to recruit more people to serve on boards of public companies. Despite the words of reassurance the Minister has given the Committee, the reality of the situation is that all directors—not only those serving on audit committees, with whom there are separate problems—will have to be warned about their responsibilities. I assure the Minister, from my experience, that that will have a deleterious effect on the legitimate aspirations of the Secretary of State for Trade and Industry to recruit more experienced directors, including those with perhaps no direct experience of business—those coming from the teaching profession, from quangos or academia, for example. They will be put off by the requirement of "ought to know". I seriously ask the Minister to reflect on that before we come to Report stage.

Lord Evans of Temple Guiting

First, I shall speak to the interesting point made by the noble Lord, Lord Freeman, when he asked us to reflect—which, of course, we shall do. I was rather concerned when he said that directors should be warned about their responsibilities. Good Heavens—that is part of the job of being a director!

Lord Freeman

I apologise for not making my point crystal clear. In training sessions for non-executive directors—in the excellent courses run by the Institute of Directors, for example—the lecturer will inevitably refer to what is in the Bill. The detailed explanation with which the Minister has favoured the Committee will not, I assure him, be gone into in great detail. The lecturer will quote Section 234ZA(2)(c), and will not necessarily go into the fine detail of all the exceptions and nuances. That is what will put off recruits.

Lord Evans of Temple Guiting

I hear what the noble Lord. Lord Freeman, says, but we disagree. I do not see the pool of non-executive directors drying up as a result of this Bill becoming an Act, but that is simply a difference of opinion.

All I would really like to say in relation to the points made by the noble Baroness, Lady Noakes. is that she postulates the idea of auditors who are not very good and a board that is not very good. However. what we are doing in the Bill is assuming—-I think rightly—that the auditors know, accept and embrace audit standards, and that the board of a company behaves as a board should behave. We are continuing to come back to how we define "reasonableness" and "awareness", how we establish a direct "need to know" in relation to the auditor, and what the auditor needs to know in relation to the board. Those are issues that we have been teasing out this afternoon, and we shall probably continue to tease them out for the next half hour and into Monday. They contribute to words that we shall all be reading over the next week or so.

7 p.m.

Baroness Noakes

I thank the Minister for that. Can I take him as saying that the interpretation of this section is that the director may rely on auditors complying with extant auditing standards?

Lord Evans of Temple Guiting

No, we believe that we have the balance right in this clause. but we will reflect on the points made today. I cannot go any further than that at this stage.

Lord Hodgson of Astley Abbotts

I am grateful to the Minister for his assurance that he will reflect on what we have discussed and on the points made. Whoever drafted his speaking note to say that, by removing "ought to know", the amendment would weaken the detailed provisions of the clause is overstating the case. The issue relates to "not", and whether a director ought to know that the auditors are not aware. Proving a negative has always been a very difficult task.

My noble friend Lord Freeman refers to the issues of attracting non-executive directors. For better or worse, high profile cases where non-executive directors find themselves in the firing line—there will be more if such legislation is enacted—put people off. Perhaps they should not, but they do. I was a director of a hospital company, which employed many nurses and whose essence was to provide people with medical care. We wanted to have on the board a senior nursing sister to provide an aspect of expertise. Before we got to the issues that we are discussing, it was difficult, even under current legislation, to discuss with the nurse, who knew nothing about finance—we asked her to join the board because she was a nurse—what her liabilities were and where her responsibilities began and ended, without what we are proposing here.

On this side of the Committee we thought carefully about subsection (2)(b). Those provisions, which are unamended subject to the points made by the noble Lord, Lord Sharman, state that, the director knows or ought to know that the information would be relevant for the purposes of the auditors' determination". That is a positive statement, which is fair enough. However, paragraph (c), which says, the director knows or ought to know that the auditors are not aware", pushes out the provision a bridge too far.

Although we shall withdraw the amendment this afternoon, we shall return to it. I hope that the Minister will give it very sympathetic and serious consideration in the mean time. I beg leave to withdraw the amendment.

Amendment. by leave, withdrawn.

The Deputy Chairman of Committees (Lord Geddes)

Before calling Amendment No. 61, I must advise the Committee that, if it is agreed to, I cannot call Amendment No. 52 due to pre-emption.

Lord Wedderburn of Charlton moved Amendment No. 61: Page 12, leave out lines 18 to 24.

The noble Lord said: This amendment is complicated, but I shall try to deal with it as quickly as possible, in view of the hour. Amendments Nos. 61 and 64 are an attempt to probe into a strange situation that has arisen in regard to directors' duties. With our usual helpful intention, my noble friend and I tabled the amendment with the helpful intention of getting the Minister off a peculiar hook of his own making.

I do not want to revert to previous discussions, but subsection (3), at page 12, lines 18 to 24, introduces an objective standard of the duty of skill, care and negligence on the part of directors. I say at once that that was proposed by the Company Law Review Group, with which I am totally at one on the matter. I therefore approve of the subsection that my amendment curiously purports to leave out. I shall explain why.

I could have done this in a previous century or in previous decades simply by saying that there is applied to professional people a very clear objective standard known under the heading of imperilia culpae adnumeratur. However, I know that today that shall not be enough, so I must explain the issue in longer language, and, as Mr Balfour said once, talking English not law. An accountant is judged by the standards of a reasonable accountant; objectively. A doctor is judged by the standard of a reasonable doctor. A nurse, who has been mentioned, is judged by the standard of reasonable nursing practice. So are all professions. It is directors who have been the exception.

I cannot understand the mystification of those who have vast experience of sitting on boards to be brought face to face with the fact that in new company law directors are to be brought into line with the rest of the law. There will be an objective standard of a reasonably diligent person with the knowledge, skill and experience that is to be expected of a person carrying out those functions. Exactly the same formula could be applied to the doctor, nurse, accountant and solicitor. Some scholars predict that the judges are themselves about to modify that matter and that there will be litigation—it is afoot already—where some of these questions will be aired. But that is the present position.

Since the Marquis of Bute's case in 1892, the position of the director has been judged on skill and care according to that director's knowledge and that director's experience—largely a subjective matter. The statute has modified it in various situations, such as insolvency, of course. A change is coming to company law.

The difficulty for the Government is that subsection (3) of new Section 234ZA is ahead of the rest of events. The Government have out for consultation a document on director and auditor liability, on which the consultation period ended last Friday. In that document the Government have given a number of options for people to respond to, mainly either the proposal of the Company Law Review to introduce the objective standard or to opt for the disaster of an Americanised business judgment standard, with or without associated principles relating to indemnification and various other matters. I say at once that I can think of no greater disaster for company law than introducing the business judgment standard of the United States state jurisdictions which have adopted it.

I quote from page 20 of the consultative document where it accurately and summarily describes the business judgment rule: The court [under such a judgment rule] will look only to determine whether the directors—at least those directors making the decision—were disinterested in the matter, appropriately informed themselves before deciding, and acted with good faith belief that the decision was in the best interests of the corporation".

With the exception, perhaps, of part of the judgment on a duty to inform oneself, that is largely a subjective test, which would be a very backward step.

In fact, much of the argument today has been a subfuse and camouflaged argument in favour of the Americanised business judgment rule. By introducing this clause, the Government have set off what they can expect in the consultation. I very much hope that they will not give way to this pressure. We have even heard that if the same objective standards are introduced for directors as for other professions, they will take away their bat and ball and not sit on these boards at all. I find that quite extraordinary.

In the 21st century, it is clear that the objective standard must be adopted as at least the basis of the new company law. The problem is: where does that leave company law reform in general? Surely it would be better if the objective standard was firmly adopted by a measure of company law reform ahead of the rest of the companies Bill. Why do I say that? I say it because the Bill has introduced the issue. You cannot keep subsection (3) concerning reporting to the auditors and keep the Marquis of Bute's case for the rest. Directors will suffer a kind of schizophrenic attack trying to know what is their standard of care in the one matter and then in the other.

I am serious when I say to my noble friend that the object of this amendment is to ask whether it would be possible to act rapidly on the basis of a consultative document which the Government need now to consider and introduce a measure on directors' duties of skill and care, liability and negligence, as a preliminary reform, thus making some progress on company law generally. Into that, as Amendment No. 64 suggests, subsection (3) would fit very naturally if the objective standard were adopted in accordance with the recommendation of the Company Law Review.

The amendment is an attempt to get my noble friend to say whether, on the enactment of this Bill, we shall be left with an objective standard in one area—covered by new Section 234ZA—and the Marquis of Bute's case in the other. That would be a most undesirable development. Moreover, although I cannot say, the judges may well look at the whole matter again during the next few years. However, the Government should not rely on that, in particular in light of the relationship between some members of the Cabinet and the judiciary. They cannot pull all the chestnuts out of the fire.

I make a serious point in asking whether this subsection does not pre-empt the response to the consultative document that has been issued. Of course I would be quite happy if it pre-empted it and were more general than it is. That is the objective of these probing amendments: to ask for further statements about exactly where the duties of skill and care in general will lie on the enactment of the Bill. I beg to move.

Lord Sharman

I congratulate the noble Lord, Lord Wedderburn, on introducing this amendment because it goes to the heart of what we have been discussing over the past hour. I start by confirming to him that I have no problem with an objective standard of measurement of care. My problem is with the notion that the idea of "joint and several", which we have lived with for many years, is now to be replaced by a form of supple proportional liability without actually having the legislative backing for a system of proportional liability. That is what it seems the noble Lord is saying when dealing with terms such as "reasonably", "ought to know" and so forth.

I think that those issues of directors' responsibilities and duties of care are inextricably linked to the issue of liability and the consultation which the Government have been undertaking. At Second Reading I asked the Minister whether, if the response to consultation could be handled, it would be possible to table amendments to the Bill latter, either here or in another place, to reflect the outcome of that consultation.

What we are struggling with here is change which will be subtle rather than open, moving away from a situation that is known and understood by members of boards of directors to one where personal, individual responsibility and a proportional sense of duty becomes much more important—without that actually being incorporated in statute so that who ultimately pays whom can be interpreted by the courts. People are not worried about being judged, they are worried about having to pay for something they do not understand or they do not know about.

So I support the notion behind these amendments and look forward to hearing what the Minister has to say.

7.15 p.m.

Lord Hodgson of Astley Abbotts

I agree with the noble Lord, Lord Sharman. The noble Lord, Lord Wedderburn, has brought forward a valuable and interesting initiative. I shall not repeat what he has said but it seems to me that what is proposed in the amendments moves towards an answer to the issues that troubled us so much in our debates on Amendments Nos. 55, 57 and 60.

The need for clarification is important. Clearly, both sides of the Committee feel that it is critical. A statement outlining the nature of directors' duties has its attractions and I look forward to hearing the Government's thinking on how this may be pushed forward.

Lord Sainsbury of Turville

The essence of the amendments of my noble friend Lord Wedderburn is to bring forward a fundamental part of the companies Bill and that somehow this subsection pre-empts that. We take a different view. We see this as an issue that we need to solve. To see this issue—which has to be absolutely central to a companies Bill—as some kind of an adjunct or a separate issue is not the right way to approach the matter.

In effect, the amendments of my noble friend Lord Wedderburn seek to make a connection between the question of what is expected of a director in this relatively narrow context of providing information to the company's auditors and the much broader issue of directors' duties to the company. I think that, despite a superficial similarity, these are two quite distinct issues. The latter—that is, directors' duties to the company—very much belongs in the main companies Bill and not here.

As I said at Second Reading, we are committed to that important reform and we shall publish a draft Bill for comment before we introduce it to Parliament, but it is important to take the necessary time to get it right. We must achieve the delicate task of modernising and simplifying company law while avoiding unintended consequences—in particular, uncertainty—which could damage business and the financial markets.

Amendment No. 61 would remove new Section 234ZA(3), which defines what a director "ought to know" for the purpose of the clause. The meaning of "ought to know" in subsection (3) is closely modelled on the approach in Section 214 of the Insolvency Act 1986 for determining whether a person who is or was a director ought to have concluded that there was no reasonable prospect that a company would avoid going into insolvent liquidation. I am sure that is right.

However, the drafting of subsection (3) reflects the limited circumstances of this particular clause compared with the wider circumstances covered by Section 214. The only differences are the omission in this clause of words in Section 214 which have no application here.

It is surprising that my noble friend is suggesting with his Amendment No. 64 that we should drop from the Bill a perfectly good and useful definition and instead put a definition in separate legislation. Usually the Government are criticised for leaving detail out of a Bill and only supplying it later. Here it seems to be the reverse. I think it would be much better to leave the definition in subsection (3) so that everyone can see the whole picture. I can assure my noble friend that the much broader question of directors' duties to the company will be dealt with as soon as possible in its rightful place, namely the main companies Bill. To take it out of the companies Bill would be a strange way of proceeding. It is absolutely critical to any companies Bill.

Lord Sharman

Can the Minister answer my question about whether we can expect a statement on the plans for reform of directors' liabilities before the Bill is passed?

Lord Sainsbury of Turville

The answer is yes.

Lord Wedderburn of Charlton

I congratulate my noble friend on that statement, which is a very important advance. We shall get an answer, so I shall be caused such distress for only a limited time. I remain distressed that he insists on impaling himself on the hook that he has created, a hook that demands that he dangle between one standard of care under the Bill and a different standard of care, diligence and so on in the rest of company law. We shall have to deal with that as best we may.

The courts may well advance their jurisprudence in the light of whatever statement the Government make before the enactment of the Bill. That is a most important revelation. Whereas I thought that I would feel hopelessly lost, given the curious position, I now feel much comforted and am very grateful to the Minister. I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

[Amendment No. 62 not moved.]

Lord Evans of Temple Guiting

This may be a convenient moment for the Committee to adjourn until Monday at 3.30 p.m.

The Deputy Chairman of Committees

The Committee stands adjourned until Monday 22 March at 3.30 p.m.

The Committee adjourned at twenty-one minutes past seven o'clock.