§ 7.22 p.m.
§ Lord Henley rose to move, That the draft regulations laid before the House on 15th December be approved [4th Report from the Joint Committee].347
§ I understand that it will also be convenient to discuss at the same time the following Motions: that the draft Auditors (Financial Services Act 1986) Rules 1994, laid on 15th December 1993 be approved; that the draft Building Societies (Auditors) Order 1994 laid on 15th December 1993 be approved; that the draft Auditors (Insurance Companies Act 1982) Regulations 1994 laid on 17th January 1994 be approved.
The House will recall that Sir Thomas Bingham's report on his inquiry into the supervision of BCCI was published in October 1992. It concerned perhaps the largest ever fraud in the history of banking. When BCCI collapsed in 1991 it left behind it a trail of deception and criminality on an epic scale. Sir Thomas Bingham drew some clear lessons from his inquiry and set out a list of recommendations. When he introduced the report in this House, my noble friend Lord Caithness made it clear that the Government accepted them all and was committed to carrying them out. One of the regulations before the House today represents the culmination of our actions to give effect to one of Sir Thomas's recommendations that the existing right (in Section 47 of the Banking Act 1987) for auditors to report relevant information to the Bank of England should become a statutory duty. Sir Thomas was persuaded to this view by, in part, the Treasury and Civil Service Select Committee which, in another place, concluded that:
although the existing permissive nature of Section 47 has worked well … it seems desirable to tighten the wording of the Act so that there can be no doubt, either from the point of view of the auditor, his client or the regulator, as to an auditor's duty to report.
§ In the debate in another place in November 1992 the Economic Secretary to the Treasury announced that a similar duty should be introduced for auditors of building societies and financial service companies and he reported that the President of the Board of Trade would want the approach extended to the auditors of insurance companies; hence the four statutory instruments before us today.
§ Since that debate, the Government have taken the decision to introduce the duty into a fifth regulated sector, friendly societies, and a negative resolution order, under the Friendly Societies Act 1992 is also currently before the House.
§ There are a number of reasons for taking action across this wide front. First, and most important, the relevant provisions in the various Acts are very similar and if we are to bolster the arrangements in relation to banks then we should do the same for the other sectors entrusted with the public's investments, or with insuring their daily risks. It would be difficult for Ministers to have to defend leaving things unchanged in those other areas, if the effect of having done so were subsequently to lead to a case of fraud in an investment firm, building society or insurance company, which the existence of the duty would have helped to prevent. Extending the duty across the board will maintain a level playing field, which is something that is becoming increasingly important with the growth of cross-sector competition in the provision of financial products and services.
§ Once the scope or the duty had been determined, the Government published a consultation document at the beginning of March last year. That made clear that it 348 was not the Government's objective to alter fundamentally the relationship between auditor and client. Nor were we looking to increase the costs of audit. Our objective was the same as Sir Thomas Bingham's: to clarify and strengthen the position of the auditor, not to change it. So the Government held back from imposing a duty on auditors to seek out fraud, malpractice or wrong-doing. That would have meant straying too far from the auditors' traditional role.
§ The responses that we received to the consultation document were considered carefully and officials discussed the issues raised with the Auditing Practices Board and with other interested parties in the regulated sectors. Some comments could be dealt with readily by changes to the draft statutory instruments. But others were not so easy to resolve as they raised more fundamental questions. In those cases officials were able to explore with the Auditing Practices Board whether issues could be more easily addressed in the Statement of Auditing Standards, which was being developed to accompany the legislation, than in the statutory instruments themselves. I should like to take this opportunity to pay tribute to the cooperative attitude that the APB displayed in what were often long and complex discussions and to thank them for the very clear and helpful statement which they shortly plan to issue.
§ Once the extensive consultation process was over the Government circulated amended versions of the draft statutory instruments for a second, more limited round, before setting them in their final form. In producing the drafts we bore firmly in mind the fact that if this duty on auditors is to be effective, then it is vital that auditors can continue to rely on the trust of their clients. Therefore, we have tried to set the duty at a level which makes it clear to those who seek to commit financial crime that they are more likely to be caught, but which does not impose additional reporting burdens or costs on those who conduct their business honestly. We believe that that is most important.
§ Before I sit down, I should also like to mention that there is a European dimension to this issue. In November 1992, the Vice-President of the EC Commission, Sir Leon Brittan, sketched out some general proposals for Community legislation in response to the BCCI affair. Those proposals were subsequently turned into a Commission proposal for a directive, one element of which would be to require member states to impose a duty on auditors of financial undertakings to report breaches of laws or regulations or other adverse circumstances to supervisors. As the House will know, following discussions in Brussels, political agreement has been reached in the Council on an amended draft directive, which, if implemented in its present form, would impose on auditors a slightly wider duty to report than that contained in the regulations that we are currently debating. However, the proposed European directive has a number of further hurdles to negotiate before it can be finalised; and even when it is, it is unlikely to be implemented before 1996. Even though some minor changes may subsequently be necessary in order to conform with the directive, the Government do not want to risk a further period of delay before bringing these necessary measures into effect.349
§ Given the widespread support of the recommendations of Sir Thomas we believe that we should now act promptly to pass those changes into law.
§ I conclude by once again expressing our gratitude to the APB and the many other professional bodies which were involved in considering the legislation. We believe that those measures will greatly strengthen and clarify the position of the auditor and represent an important step forward in the fight against financial wrongdoing. I commend the Motion to the House.
§ Moved, That the draft regulations laid before the House on 15th December be approved [4th Report from the Joint Committee.]—(Lord Henley.)
§ 7.30 p.m.
§ Lord Eatwell
My Lords, the Serious Fraud Office estimated that the amount of money lost due to management fraud in 1991 was double the loss due to household burglary. Fraud is big business and it is a growing business. If fraud were a legitimate business the Government's long hoped-for recovery would be well under way. Tackling fraud effectively is an essential part of building confidence in our financial institutions and of enhancing and sustaining the flow of savings into private business; in short, an essential part of building an efficient market economy.
Any measure concerned with the detection of fraud is a matter of the greatest public interest. As the noble Lord, Lord Henley, pointed out, the regulations grow out of the BCCI affair and implement in part—but not in whole, as the Economic Secretary suggested in another place—Sir Thomas Bingham's recommendations in his report into the affair.
To begin with, it should be remembered that it was not part of Sir Thomas Bingham's brief to conduct a general examination of the role of auditors and their relationship to supervisory bodies. He specifically ruled that out, suggesting that those questions,may well, at some point in the future, call for consideration in depth".Given his terms of reference, Sir Thomas did not examine those issues in the depth that they deserved. But that is no excuse for the Government to fail to give them that attention. The regulations are a minimalist response to the problems raised by the BCCI affair and totally fail to address the wider issues of growing fraud and the role of the audit in the elimination of fraud.
I wish to ask two technical questions concerning the regulations and will later pose some related questions on the wider policy issues which the Government are apparently trying to avoid. First, with regard to the technical issues, why do the regulations only implement the first of the two recommendations contained in paragraph 3.45 of Sir Thomas Bingham's report? They embody recommendation 3.45 (iii) (a), but not recommendation 3.45 (iii) (b). Sir Thomas clearly regarded the two points as legally distinct. Why was the second neglected?
Secondly, while introducing the regulations in another place, the Economic Secretary to the Treasury took great pains to define in the widest possible terms the statutory responsibility now imposed on someone 350 acting "in his capacity as auditor". That would include the responsibility to report information discovered in work other than the audit itself (such as tax advice or business consultancy), work by other partners in the same accounting firm, and work on other audits of other companies which reveal information relevant to the first audit. That wide interpretation would seem, in common sense terms, to be at odds with the phrase, "acting in his capacity as auditor". Will the Minister confirm and justify his honourable friend's wide interpretation?
I turn to the more general issues to which I referred earlier. The noble Lord, Lord Henley, repeating the words of his honourable friend the Economic Secretary, stated that,the Government held back from imposing a duty to seek out fraud, malpractice and wrong-doing".—[Official Report, Commons,15/2/94; col.853.]Why did the Government hold back? Why did the Government fail to recognise that there is a vital public interest served by auditors and that the responsibility which auditors bear to the public interest should be embodied in statute?
In that respect the difference between the responsibility of auditors of private companies as set out in the regulations and the responsibility of auditors as set out in Section 15 of the Local Government Finance Act 1982, could not be more striking. That Act places a duty upon auditors to seek out wrongdoing and waste and report it. Will the Minister tell us what is the rational basis for imposing a duty upon auditors to seek out wrongdoing in the case of local authorities and not in the case of banks, insurance companies, building societies or other financial service companies? Why does the public interest deserve protection in the first place and not the second?
A further significant difference as between the sectors covered by the regulations and the case of local authorities is in the appointment of auditors. In the case of local authorities auditors are appointed by an independent body—the Audit Commission. In the cases that we are considering the auditors are nominally appointed by the annual general meeting of shareholders but, as we all know, they are effectively appointed by the directors of the companies concerned. Indeed, how many times have we heard auditors refer to the directors of a company as "the client"? In law, the client is the body of shareholders.
The accounting industry is becoming increasingly competitive and the audit will typically be only part of the package of services which the accounting firm is attempting to sell to the "client"; that is, the directors. In those circumstances it is not surprising that an unhealthy relationship can develop between the directors of a company and the auditors. Surely it would be in the best interests of shareholders, as well as the wider interest of potential shareholders, employees, depositors and other customers, that auditors be appointed by an independent body so that the auditor is not relying for his or her future employment on the persons whom he or she is auditing.
The Government's approach to the problems of the appointment and responsibility of auditors has been to ignore the public interest and to effect the minimum 351 change upon a system which is failing to perform the task which the public have a right to expect of it. In recent years the accounting profession has been pressing for some limitation on the liability of auditors in fraud cases. Why do not the Government respond to the accounting profession's demand by requiring that, in return, auditors have a duty to the public to seek out fraud?
I well understand that imposing duties on auditors is an imperfect substitute for more effective corporate governance. But in bringing forward the regulations as their only response to rising financial sector fraud, the Government have ducked their responsibilities to legislate for an effective framework of accounting regulations; the sort of framework that would be an important element in building the confidence which is the ultimate resource of a successful financial industry. To secure that confidence, will the Government now initiate a proper inquiry into the relationship between client, auditor, supervisor and the public interest with the object of producing a Green Paper? We welcome the regulations as a step in the right direction. But they are only a small step; there is a long way to go.
§ Lord Henley
My Lords, the noble Lord stated that fraud is big business, and I agree with him. He also spoke of the importance of tackling fraud effectively. I believe that as far as possible we tackle these matters as effectively as we can.
I apologise on behalf of my honourable friend the Economic Secretary if he gave the impression in his speech in another place that introducing the orders was all we were doing, and that they totally implemented the recommendations in the Bingham Report. I do not believe that that was the impression he intended to give and certainly that is not the case. This is only part of bringing into effect what the Bingham Report suggested. We also made it quite clear that we agreed to introduce legislation, as soon as the parliamentary timetable allowed, in response to one of his recommendations to give the Bank express powers to refuse or revoke authorisation of banks where proper supervision was impossible, and in relation to other matters. This is just one ò f the matters that needs to be examined.
The noble Lord then went on to ask about specific recommendations. He asked why the regulations do not cover paragraph 3.45(iii) (b), but cover paragraph 3.45 (iii) (a). As I understand it—I am speaking on advice—the recommendation is covered. I would prefer to take this forward further with the noble Lord in correspondence, but my advice is that both (iii) (a) and (iii) (b), as recommendations, are covered.
The noble Lord asked what was meant by someone acting "in his capacity as auditor" and whether that covered the case of two auditors in the same firm working for two different clients. As the APB's statement of auditing standards made quite clear, auditors are not required to report to a regulator confidential information which arises from work undertaken by the same auditing firm for another client. However, as a matter of sound practice, auditors who become aware of matters in this situation which could 352 otherwise give rise to a duty to report would we believe normally make further inquiries to establish whether the information concerned is substantiated.
Moving on to the general questions of why we do not go so far as the Local Government Act to seek out wrongdoing and why auditors should not have exactly those powers, as I think I explained, we did not go so far as to impose the additional duty to seek out fraud in order not unduly to change the relationship between the client and the auditor. It represents the difference between the fact that we are dealing in one case with private money and in the other with public money. The same would be true when we come to the question of the appointment of auditors. The noble Lord felt that too often they are seen as mere clients of the directors rather than of the shareholders by whom they are appointed. It is a matter for the shareholders to appoint them. I hope that the noble Lord will accept that. Shareholders can obviously exercise their powers in that respect.
I hope that I have covered, albeit very briefly, the noble Lord's various points. Although he accepts that the regulations are only part of the way, I hope he recognises that they at least in part meet some of the recommendations of the Bingham Report. As we have made perfectly clear, both the Government and the Bank of England have fully accepted all the recommendations of the report and, as and when appropriate, we shall bring forward suitable measures so to respond. I commend the regulations the House.
§ On Question, Motion agreed to.