§ 11.38 a.m.
§ Lord Sainsbury of Turville
My Lords, I beg to move that this Bill be now read a second time.
A recent book argued that the limited liability joint stock company was,the greatest single discovery of modern times".Your Lordships will not be surprised to hear that, as Minister for Science and Innovation, I have other suggestions for that accolade. However, no one can deny the importance of the company in the modern economy. The company is more popular than ever, and this Government are committed to reforming current companies legislation. We are taking forward the work of the independent Company Law Review in order to remove unnecessary regulation in the current law, to simplify the law, particularly as it affects smaller firms, and to make the law as a whole more flexible for the needs of the 21st century. Meanwhile, the much smaller Bill before your Lordships will increase the variety of companies by creating the community interest company, as well as making some amendments to ensure better financial reporting and conduct by companies.
There are now nearly 1.8 million companies in Great Britain. Companies account for around 80 per cent of economic activity, measured by turnover, and provide some 60 per cent of employment. But today's large companies have a double significance. They are the source of most goods and services and of many jobs, but they are also where much of our savings are invested in the form of pension contributions, life assurance and unit trusts, as well as individual shareholdings.
The extent to which our economy depends on companies makes it essential that they are run effectively and honestly and that we can rely on their accounts and reports as a guide for investors and for those doing business with them. When a company fails, it may trigger a chain of collapse as other businesses—especially small undertakings—are brought down by a bad debt or the sudden loss of a key customer or supplier.
The spectacular collapses in the United States in recent years, most notably of Enron, WorldCom and accountants Andersens, sent shock waves through the business world. If the audited accounts of large and apparently profitable companies were little more than works of fiction, what else was waiting to be uncovered? The situation at Parmalat, where accounting fraud is again a central feature, shows that similar problems can happen in Europe. We cannot be certain that a comparable situation could not occur in this country, despite the differences in the business and regulatory 259 environments in Italy and the UK. In any event, Parmalat underlines the importance of the reforms—legislative and non-legislative—which we have made and are making in corporate governance, accounting and audit regulation.
We had already asked Derek Higgs to review the role of non-executive directors. He subsequently made important recommendations aimed at improving corporate governance, some of which were then reflected in changes to the Combined Code on Corporate Governance. But when the Enron and WorldCom scandals broke, confidence was shaken here almost as much as in the United States. The American reaction was to rush through the Sarbanes-Oxley Act. We thought it right in our circumstances to take a different approach.
Once the details of the Enron scandal started to become known, the Government set up the Co-ordinating Group on Audit and Accounting Issues to review the UK's arrangements for audit and accountancy regulation. The group was jointly chaired by the Financial Secretary to the Treasury and the then Minister for Competition, Consumers and Markets. Its membership comprised independent regulators such as the Accountancy Foundation, the Financial Services Authority and the Financial Reporting Council, and independent academic experts. It also discussed its proposals with representatives of the accountancy profession to ensure they were workable.
The group reported in January 2003. Some of its recommendations are reflected in the Bill we are considering today. Overall it concluded that we have,a sophisticated and effective system of oversight in this country.Some changes were needed, but I think it is fair to characterise these as adjustments, building on and strengthening a system which is basically sound. Many of those changes are now in place. The role of the audit committee has been strengthened through revisions to the combined code. Audit firms have introduced more frequent rotation of audit partners, and a longer "cooling-off" period before an auditor can be recruited by a client. Audit firms are providing greater transparency in their annual reports. The Financial Reporting Council has been restructured and strengthened, with the Auditing Practices Board as the standard setter fully independent of the audit profession; and the Auditing Practices Board has just published its first draft set of tough ethical standards on independence and objectivity for consultation.
One early recommendation from the co-ordinating group was that there should be a separate review of the regulatory regime of the accountancy and audit profession. That review started immediately and also reported in January last year. It found that the current regulatory regime worked well, but that it would be desirable to increase the perception of its independence from the accountancy profession. I shall explain shortly how the Bill achieves that. The review also recommended that the regulatory structure should be simplified. The Financial Reporting Council should assume the role and functions of the Accountancy Foundation, thus creating a single, independent regulator responsible for setting, monitoring and enforcing accounting and auditing 260 standards and overseeing the regulatory activities of the major accountancy bodies. This restructuring did not require legislation and is already largely in place.
In short, instead of a British Sarbanes-Oxley Act, we have had a period of tough and detailed analysis by the Government in partnership with business, institutional investors, independent regulators and the accountancy profession. That reflection has led to a package of targeted measures, few of them requiring legislation, aimed at ensuring that we have very high standards of financial reporting and independent audit. The first part of the Bill implements the final pieces of that package as well as measures to strengthen the company investigations regime and make it more effective in uncovering misconduct.
Clauses 1 and 2 will ensure that there are independently set standards for auditing, and independent arrangements for monitoring and investigating auditors and imposing disciplinary measures where necessary. The professional accountancy bodies that are recognised to supervise auditors will have to sign up to such standards and arrangements.
Clauses 3 to 5 enable the function of recognising the audit supervisory bodies to be delegated to an existing body. We expect that this will be the Public Oversight Board for Accountancy, which is part of the Financial Reporting Council. It is an expert independent body which also has responsibility for oversight of the major accountancy bodies. The Government believe that the combination of these two functions will improve the effectiveness of oversight of the supervisory bodies.
Clause 6 amends the existing provisions on the approval of overseas qualifications for auditors. It will provide greater flexibility to approve those overseas qualifications that are at an equivalent level to those in the UK. For example, where an overseas qualification is approved, it will be possible to recognise auditors who gained the qualification after the date when it reached equivalence with British standards but not those with earlier qualifications.
Clause 7 implements a recommendation of the Co-ordinating Group on Audit and Accounting Issues and provides a power to require larger companies to publish a breakdown of the non-audit services which they buy from their auditors. That will increase company transparency, and enable interested parties to judge whether the auditors could be subject to a conflict of interest through the different aspects of their work for a client.
Clauses 8 and 9 will help auditors to obtain all the information they need to carry out an effective audit. Clause 8 enables auditors to obtain relevant information from specified persons who hold it, while Clause 9 requires the directors' report to contain a statement about the disclosure of relevant information to the company's auditors.
Clauses 10 to 12 and Schedule 1 are concerned with the enforcement of accounting standards, which is a task carried out by the Financial Reporting Review Panel. Clause 10 makes technical changes to reflect the reorganisation of the Financial Reporting Council. Clause 11 enables the Inland Revenue to pass 261 information to the panel. Clause 12 enables the panel to require information from companies and their auditors where there is a question whether the accounts comply with the law.
Clause 13 extends the power to specify a body to issue standards for financial reporting purposes. That paves the way for a standard for the new operating and financial review which the Government hope to introduce later this year and on which we shall soon be consulting.
Clauses 14 and 15 enable a body—in practice the Financial Reporting Review Panel—to be empowered to review the interim accounts as well as annual accounts of those companies for which it already has responsibility. Clause 14 also allows the panel's remit to be extended, so that it may examine the accounts of issuers which are not Companies Act companies but are listed in the UK. This will enable the same body to examine all major accounts, and will ensure better coordination between company and financial services law.
Clauses 16 and 17 are concerned with funding arrangements for the Financial Reporting Council, including a power to levy listed companies and the accountancy profession, in case the current voluntary arrangements for tripartite funding with the Government should ever break down.
Clauses 18 to 21 strengthen the powers of the DTI's company investigators to obtain documents and information and give them powers to enter and remain on premises. They also provide statutory immunity from liability for breach of confidence for individuals and businesses volunteering information in specified circumstances.
Clause 22 and Schedule 2 deal with minor and consequential amendments relating to Part 1 of the Bill.
Part 2 is concerned with a different subject, namely community interest companies. These were recommended by the Strategy Unit report Private Action, Public Benefit, as a new, purpose-made vehicle for some social enterprises. That idea drew on earlier work by several people and groups, including Stephen Lloyd, Roger Warren Evans, the Charity Law Association and others. My noble friend Lady Thornton, who is chair of the Social Enterprise Coalition, expertly explained social enterprise in the debate on the Queen's Speech. I do not need to add anything to her speech, other than to say that consultation has confirmed a real demand for the community interest company as an additional form for social enterprises, an alternative to charities, industrial and provident societies and ordinary companies.
We believe that the creation of the community interest company will help those people—and I am pleased to say that there are many of them—who want to start, and work in, organisations which do business for the ultimate benefit of the community or part of it. The community interest company will be the right vehicle for many organisations which wish to trade and to supply goods or services for a social purpose, such as local regeneration or providing training within 262 a community. It will be clearly identified as a community interest company so that everyone who deals with it will be able to see instantly that it has social aims. It will be subject to regulation at the minimum level necessary to maintain confidence in the form and to ensure that it uses its assets and profits for the community interest.
Clauses 23 to 26 and Schedules 3 to 5 define the community interest company and the main elements of the regulatory structure. Clauses 27 to 32 and Schedule 6 deal with the key distinguishing features of this new type of company, including the power to cap dividends and interest, the community interest test, which will help to decide whether an organisation can become a community interest company, and the annual community interest report which such companies will make.
Clauses 33 to 37 deal with the ways of becoming a community interest company: by formation or conversion from an existing company, including a charitable company. There are special provisions for Scottish charities as charity law is a devolved matter.
Clauses 38 to 48 and Schedule 7 set out the regulator's powers to intervene to ensure companies operate properly in the community interest. There are some obvious similarities with the powers of the Charity Commission in England but the level of regulation is intended to be much lighter than for charities and the regulator will be under statutory constraints to ensure that this is so.
Clauses 49 to 53 deal with conversion from a community interest company. The only way to cease being a community interest company, apart from winding up, will be to convert to another form which has a similar "lock" on assets to ensure that the proceeds of the business cannot be diverted to private benefit. These clauses therefore provide for community interest companies to convert to charitable status. They also enable the future introduction of a mechanism to allow conversion to an industrial and provident society with a lock on assets. The Government plan to consult shortly on the introduction of such a lock for certain industrial and provident societies.
Clauses 54 to 60 are supplementary provisions, covering matters such as the relationship between the new regulator and the registrar of companies. These clauses also specify the information gateways between the regulator and other bodies.
The final four clauses of the Bill are largely technical provisions and Schedule 8 contains repeals.
The clauses on community interest companies will need to be supplemented by regulations setting out more of the detail, especially on matters which are likely to require amendment from time to time in the light of experience and changing circumstances. The Government will make available a preliminary draft of the main regulations before the Bill reaches its Committee stage so that the House can see more of the detail of the proposal. The Government will, of course, welcome the assistance of the social enterprise sector in improving the draft regulations before they are formally laid before both Houses for approval.
263 Finally. I should mention one matter which is not in the Bill, namely the issue of auditors' and directors' liability. It is no secret that some in the auditing profession have lobbied the Government to use the Bill to change the law to allow auditors to limit their liability to companies for negligent audits. However, the Government wish to hear a wide range of views on the related issues of auditor and director liability and therefore published a consultation document on this subject on 16 December. The consultation runs until 12 March and the Government will decide any further steps in the light of responses.
This is an important Bill, the product of much consultation and expert input. The provisions on financial reporting and investigations will support non-legislative action already taken and will help to maintain confidence in the financial integrity of companies. At the same time, the provisions on the community interest company constitute a useful addition to the forms available to social enterprise. I commend the Bill to the House.
§ Moved, That the Bill be now read a second time. —(Lord Sainsbury of Turville.)
§ 11.54 a.m.
§ Lord Hodgson of Astley Abbotts
My Lords, I thank the Minister for his characteristically comprehensive introduction and for allowing us to have a brief meeting earlier this week for a preliminary canter over the ground.
I begin by declaring some interests. I am a non-executive director of Britain's largest regional brewer, a company listed on the Stock Exchange, and of a mutual building society; I am also a non-executive chairman of an engineering company listed on the alternative investment market and of three private investment companies. In several of those companies I serve variously on audit, compliance, remuneration and nomination committees.
On 27 November, the debate on the gracious Speech, which was devoted to the economy and industrial affairs, was opened by the Minister and closed by the noble Lord, Lord McIntosh of Haringey. The noble Lord, Lord McIntosh, teased noble Lords on this side of the House about what he saw as the small number of speeches which focussed on the macroeconomic position of the country by referring to this as, to use his phrase,the dog that did not bark". —[Official Report, 27/11/03; col.85.]Today we have another dog that did not bark. Because what we are discussing here are but two small—very small—parts of what should be two major Bills that the Government have yet to bring forward regarding the reform of company law and the reform of charity law.
As regards company law, the Government have taken the easy course and focussed on a narrow part of the reforms in a way which, no doubt, they hope and believe will win them the plaudits of their Back-Benchers in the other place. Directors and auditors are always easy targets. But the Government are only too aware that company law as a whole urgently needs an 264 overhaul. We know this because the Secretary of State has told us so. In the preface to the paper Modernising Company Law published in July 2002, Patricia Hewitt wrote:When British company law was created in the 19th century, it was a source of competitive advantage. Now it has become a competitive disadvantage. The law has become encrusted with amendments and case law over generations. It has failed to adapt to meet the changing role of small enterprises, IT and international markets…So the law needs to change. It needs to modernise and reform. It needs to be fit for the 21st century and beyond".If one leaves aside the ghastly, cliché-ridden style—if I have to listen to anyone else talking about "fit for the 21st century and beyond" I shall go mad—this is a fairly ringing endorsement of the need. It was written in July 2002 and we are now in January 2004. So where is this reform that the Secretary of State says is so urgently needed?
This strategic failure has a knock-on impact even on the narrow measures we are discussing today. The first impact is that these measures, if enacted, will increase the burden of responsibilities carried by company directors. If we are to attract men and women of quality to serve on company boards, they are entitled to seek protection by means of insurance. Yet not only is insurance increasingly expensive or simply unavailable, but Section 310 of the Companies Act 1985 is also unhelpfully drafted.
That section is also of relevance when considering the issue of auditor liability. As the Minister said in his opening comments, the DTI has issued a consultation paper on both director and auditor liability. I note that the closing date for consultations and submissions is 12 March. It would be helpful if the Minister could indicate more clearly than he was able to do in his opening remarks whether the Government have any intention of tacking on provisions as regards this issue at a later stage in the progress of the Bill—assuming the outcome of consultation is satisfactory.
The second impact of the failure to reform company law is the incomprehensibility of the legislation as a result of its successive layers of change and amendment. Reference to the Companies Acts 1985 and 1989 require one to crawl over a multitude of other texts, with cross-referencing and outdated sections littered everywhere. The Bill should have, as all Bills should have, a careful scrutiny in your Lordships' House. But it is extremely hard to unpeel the layers of legislation to find the real impact. The Minister, with his team of officials, may not find this too hard but we certainly do.
I hope that when the Minister winds up the debate he will be able to give us more definite news as to when the Government expect the good ship "Company Law Review" finally to reach harbour.
Before I turn to the specifics of the Government's proposals, I shall make a couple of important points that are an important background to our discussion of the first part of the Bill. The first is that all new regulation comes with a cost attached. The regulation may be entirely laudable, but there is a cost—a cost that has an impact, however marginal, on the 265 competitiveness of UK plc. It is important for us always to bear in mind that an accumulation of costs, each of which may individually be marginal, can result in an increase in total costs that is not marginal.
An example is the Licensing Act 2003, which your Lordships passed in the most recent Session. Ministers were inclined to downplay the costs of those new regulations, but I must tell the House that the brewery of which, as I said, I am a non-executive director is putting aside £1 million in the current financial year to cover the costs of the new Act.
I shall not re-run the arguments about the Act, but I draw your Lordships' attention to the practical results of our work in this House. For that £1 million does not come out of thin air: it must be paid for. It is paid for by shareholders in the form of reduced profits; by customers in the form of increased prices; or by staff in the form of loss of jobs, because efficiencies have to be made up in other ways. The effect on their business for UK companies, which are competing on an international stage with companies based overseas that do not have to bear those cost burdens, can be substantial.
The second general point is the need always to distinguish between fraud and risk. Fraud is unacceptable: it is theft that causes agony and heartache to employees, shareholders, suppliers and customers. It must be rooted out. But risk is another matter. Risk is an important part of the market economy by which new ideas, products and services come into being. Some succeed but, inevitably, many fail. A risk that does not work is not a fraud. Our economy will work better if there are what my business school professor used to call—I think that he was in turn citing Professor Schumpeter—"gales of creative destruction", however painful they may be in individual cases.
The issue of risk is addressed fairly and squarely in the combined code to which the Minister referred, and which I suspect we shall discuss at length in Committee. Section A.1.1, which addresses the role of the board, reads:The board's role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls".I emphasise the use of the word "entrepreneurial", which indicates and implies a preparedness to take risks. Accordingly, where the Government propose legislation that effectively targets fraud and malfeasance, of course they have our support, but if the proposals are no more than box-ticking exercises that inhibit entrepreneurial flair and increase the regulatory burden for UK plc, we shall be less happy.
So we shall measure the Government's proposals against four tests, the first of which is: are the proposals proportionate? The final report on the regulatory regime of the accountancy profession, published in January 2003, some of which the Minister quoted, but not all, states:The UK's existing regulatory system is widely acknowledged to be among the best in the world. During the course of our work, we found no evidence that the system was seriously flawed".266 So we must be certain that the proposals meet real needs and are not just knee-jerk reactions to one-off events.
Secondly: are they balanced? For example, Section 447 of the Companies Act 1985 already gives considerable investigatory powers to the Secretary of State. Do those powers really need the enhancement that is found in Chapter 3? For example, how are we to prevent them being used in future for fishing expeditions and how do we ensure a proper level of confidentiality?
Thirdly: are the proposals clear and workable, from the point of view not just of the director, whether executive or non-executive—and that difference is itself an issue—and the auditor, but of more junior employees who are for the first time to be swept up in the provisions of Clause 8? Fourthly and finally: are they effective? For example, there is the issue of how to deal with overseas subsidiaries. I understand the serious issues involved in extra-territorial jurisdiction and in no way do I minimise them. But, as the Minister said, so far in this country we have had few Enron-type scandals. The case that probably came the closest was the collapse of Barings Bank. How did that come about? Not because of anything done in the UK but because of an overseas subsidiary—on that occasion, in Singapore.
The Minister referred to the well publicised problems with Parmalat in Italy that have emerged during the past few weeks, which on present evidence seem to revolve around money held in offshore banking centres. Is he convinced that the Bill will provide an adequate net to catch such cases?
It is no good creating a system so detailed that it becomes a box-ticking exercise in which directors have to commission reports on reports to protect themselves. Such a system corrodes trust and undermines the willingness of directors to take risks and exercise judgment. We need high quality, knowledgeable and experienced people as directors of companies. We may be reaching a position where people are discouraged from putting their names forward because the personal and financial risk and that to their reputation is too high.
Further, in their zeal to avoid conflicts of interest, the Government may create a situation where the only qualification for being a non-executive director of a company is to know nothing about it. In many—although not all—cases, conflicts of interest can be perfectly satisfactorily addressed by disclosure. In that way, one can use the expertise and knowledge of those with an interest in the success of the company to the best advantage of the whole.
This is not an issue for party-political point-scoring. I can conclude, summarising our concerns about this part of the Bill, by quoting from an article by Patience Wheatcroft which appeared in the Times on Thursday 27 November. She wrote:The same contradiction between the Government's claimed intention of reducing red tape and its unstoppable practical drive to add more control, regulation and cost at every turn is evident in its plans for company law. Expert and indefatigable efforts have been made by various inquiries over the years, including lengthy 267 and detailed recommendations from this Government's own commission, to simplify and modernise company law. Some widely agreed proposals date back decades.Patricia Hewitt, the Trade and Industry Secretary, used to sound terribly keen on this modernising project. Yet it seems to have been relegated to an as yet unscheduled Part 2 of proposed legislative changes. Part 1, which takes precedence this year and may be the only part that reaches the statute hook, adds more burdens and controls …The emphasis of the Part I Companies Bill will be to strengthen regulatory powers, which seems unnecessary. It will force directors to make legal statements that they have not forgotten to disclose anything, which mainly increases potential punishments and will put off more potential non-executive directors.So, although we do not object in any way in principle to what the Government have in mind, we shall be tabling amendments to tease out the thinking behind the provisions to ensure that our tests of proportionality, balance, clarity, workability and effectiveness are met.
I turn now to the second part of the Bill, which concerns the establishment of community interest companies. In passing, I note that that, too, is a minor—some would say very minor—part of the Government's proposals to reform the law on charities. There is a sense of carts before horses. It would probably have been better and more effective to have a debate on CICs after the major debates that will undoubtedly take place on charity law reform. It is hard to believe that those debates will not throw up issues and concerns that will affect CICs. Sadly, by that time, the legal shape of CICs will be enshrined in statute and one hesitates to estimate how long it will be before parliamentary time can be found for any statutory changes that may be needed.
Accordingly, it would be helpful if the Government could outline their thinking on the likely scale of the CIC movement. In his opening remarks, the Minister referred to there being a "real demand", but presumably, in drawing up the legislation and preparing the financial numbers given in the Explanatory Notes, the Government made some estimate of the number of CICs that are likely to be set up during the next few years. Perhaps the Minister would care to share those figures with the House when he responds.
That having been said, we approve of legal structures that have the flexibility to respond to local conditions. So we are happy to give them a welcome in principle. However, we have areas of concern that we will want to discuss in Committee. First, will there be a level regulatory playing field for CICs and private limited companies? I had the pleasure of listening to the knowledgeable speech made by the noble Baroness, Lady Thornton, on CICs during the debate on the gracious Speech. She said that she hoped CICs would compete with limited companies—quite right, too. But that means that there must be no regulatory advantage or disadvantage to one side or the other.
Secondly, the new CICs will need the right regulatory. touch. Many will be set up by groups of people relatively unversed in company law and possibly also in commercial activity. They will need advice, particularly in the early years, before custom and practice have evolved. When I was involved in 268 setting up the original regulatory regime in the City, as a founder director of the Securities and Investments Board (SIB), one of the issues that most infuriated smaller firms was the SIB's inability to give helpful advice. When asked about a particular course of action, our only answer was to the effect of, "We cannot help you. We suggest that you go ahead, and if we don't like it we will test it in the courts". If a similar situation prevails here—from my reading of Clause 34, I think that it may well do—it will represent a considerable disincentive to the emergence and development of CICs.
The third issue is skeleton primary legislation, which has bedevilled our debates on many Bills in the past year. To have an informed debate about the proposals, we need to see more detail about what the Government propose. The Minister said that the Government intended to have draft regulations available by Committee stage. That is good news, for which I thank him and his officials. We look forward to having a chance to read those regulations, preferably some way ahead of Committee stage, so that we can get appropriate responses from external bodies affected.
In summary, we want the United Kingdom to be a good place to do business. That means striking the right balance between too much and too little regulation. We shall want to be sure that the proposals in the Bill achieve that difficult reconciliation. We are disappointed at the continuing delay in the overhaul of company law. That long-overdue change would certainly improve the United Kingdom's competitive position. We see many advantages in CICs but wonder, if the regulatory regime is kept as proposed, how many will emerge in the event. We look forward to giving those important issues a thorough airing in Committee.
§ 12.12 p.m.
§ Lord Sharman
My Lords, I declare an interest as chairman of two companies listed on the London Stock Exchange. I am on the board of two other companies, in which I variously function as a member of the audit committee and the remuneration committee.
I generally welcome the fact that the Government are addressing the subject matter covered by the Bill. But I make no apologies for returning immediately to the subject matter raised by the noble Lord, Lord Hodgson: there is a major concern about where we are on the desperately needed overall reform of company law. The Government seem to be taking a "nibble" approach to the reform of company law. In the previous Session, we nibbled off a piece with the Enterprise Bill, which dealt with insolvency, bankruptcy and such matters. This time we are looking at audit regulation and creating a new type of company—another nibble, imposing yet further burdens on those concerned with the management of companies, their officials and offices.
The Bill contains 17 clauses on the reform of regulation, five clauses on improving company investigations and 37 clauses establishing community interest companies, and incidentally creating yet 269 another regulator. But it does nothing to help the beleaguered company director, who, as the noble Lord, Lord Hodgson, said, must dig his way through reams and layers of legislation enacted by way of amendments to previous legislation to find out what he should or should not be doing. That is all very well if you are learned in the law, but most company directors are not. That only provides for the future wellbeing of the legal profession—something that my colleagues may endorse but which I do not find necessarily good. It is critically important that we help our directors by modernising company law. We must reach that position very quickly. An enormous amount of work and consultation has been done on the matter, and the proposals should not sit waiting to be enacted.
My three comments on the Bill's contents almost certainly arise from the complexity of the layers of amendments to legislation. First, I simply cannot understand from reading the Bill how the standard-setting process will work. The Bill requires all sorts of people to become involved; it mandates them to do work. It mandates the institutes, where relevant, to participate. But who will set the standards; who will ensure that they get set; and who will be responsible for paying for that?
That leads to the second issue—costs. Very wide-ranging powers are being vested in the Financial Reporting Council and the Financial Reporting Review Panel. The information states that in 2006–07 we are looking at costs of some £12 million. My immediate reaction to that figure was that it was low. It might be useful to look at what the much-quoted Sarbanes-Oxley Act provided for in the United States. The Public Company Accounting Oversight Board in the United States, which was established by Sarbanes-Oxley, had a budget for 2003 of 68 million dollars, and for 2004 its budget is 103 million dollars; in 2003 it had 126 staff, and in 2004 it plans to have 284. Those are significant figures. I do not suggest for one moment that the Bill takes us to the position of Sarbanes-Oxley, but if we are not very careful, as in all such situations the costs will grow and grow. Will the Minister comment on the future funding of the costs? I understand that the existing informal arrangement is for one-third funding from government, one-third from the accounting profession and one-third from listed companies. Is it intended that that should be adhered to in future, or what provisions will there be for funding the costs?
The third issue on the content of the Bill regards the obligation that the Bill imposes on individuals to provide information to the Financial Reporting Review Panel and, in Clause 18, the Secretary of State. What appears to he missing is a reasonableness test. Perhaps the complexity of the legislation causes me to say it, but my reading is that there is no requirement for a reasonableness test in pursuing an allegation. Does that mean that the FRRP will pursue every allegation, whatever its foundation, or will it be obliged to take a test of reasonableness first? Otherwise, I foresee a situation in which boards of directors are inundated with requests for information 270 because of spurious allegations through all sorts of channels. If that arises, we will quickly ensure that the £12 million estimated costs will be on the low side indeed. Will the Minister, in his winding-up speech, say whether the reasonableness test will be there?
The Minister touched on the operating and financial review, on which I wish to ask him a question. He said that the Government intended to consult on that part of the annual report later this year. Can he tell us more about the timetable for that; when the likely imposition of the new requirement for company reporting will take place; and, most importantly, the degree to which the Government envisage that it will form part of an annual report that will be verified or attested to in some way? Here, again, we are looking at further burdens on boards of directors without necessarily helping them by simplification of company law.
There are a number of matters of detail within the Bill, in particular with regard to the establishment of community interest companies. We shall pursue them in Committee, but I shall not raise them now. In his opening remarks, the Minister referred to the public consultation that has been embarked on regarding director and auditor liability. He said that the consultation period ends on 12 March. I shall assume that in normal circumstances—from my perspective, it is highly unlikely that the consultation will come forward with a consensus or a clear answer—there will be time to include amendments in the latter stages of the Bill to reflect any changes that need to be made. But, more importantly, can the Minister confirm, or otherwise advise us, what would be a likely timetable to enact the results of the consultation on liability?
With regard to auditor liability, it was my understanding that the Department of Trade and Industry had embarked on a discussion with the major accounting firms regarding further transparency of their affairs. What progress has been made on that? In that context, perhaps I may explain that I am not just looking for information about the operating performance. It is very important that the market-place should understand the quality processes and internal disciplinary procedures under which these firms operate. I should be very interested to hear his comments on that.
In summary, the Bill tackles a number of issues that need to be addressed. They are a little piece of the total picture of company law reform that needs to take place. I welcome it for that. But I leave the question: what about the rest? How long does the British business community have to wait for a modern framework of company law, which it so desperately needs?
§ 12.20 p.m.
§ Baroness Thornton
My Lords, I welcome the introduction of the Bill. I think that it is safe to say that this is a Bill in two parts. As one of the DTI Ministers said at a recent meeting, this Bill concerns saints and sinners. I intend to address my remarks to the more saintly part of the Bill—Part 2—that concerns the 271 establishment of a new type of company; namely, the community interest company. I should also like to declare an interest as the unpaid chairman of the Social Enterprise Coalition, the national voice of social enterprise representing all the major organisations that promote and develop social enterprises. I should like to thank my noble friend the Minister and others who have mentioned the work of this organisation.
We have before us a proposal that has already benefited from wide consultation. As has already been mentioned, the Bill needs to be seen in the wider context of both the reform to charity legislation and the updating of IPS legislation. So we have the DTI, the Treasury and the Home Office working in harmony—I hope and expect—to drive forward an agenda which will encourage the growth of enterprise co-operatives and community regeneration.
I believe that we can look forward to an interesting debate on both the principles and the detail of CICs when the Bill moves into Committee. I was very pleased to receive, in the past two days, briefings from both the CBI and the Local Government Association that welcome the introduction of the CIC. Interestingly, both organisations recognise the contribution that CICs might make. Perhaps I may say that the CBI has stated that it would be,for the benefit of the local community … such as in childcare provision, social housing, leisure and community transport".Indeed, the CBI continues:This will be of interest to some member companies wishing to set up CICs for their corporate responsibility activities".I think that that is a very interesting comment. Indeed, the Local Government Association states:This form of company could be a useful tool for local authorities, particularly in asset based economic regeneration and in developing the role of the voluntary and community sector in service delivery".There appear to be three key features of the new company that distinguish it from either a charity or a traditional company form. First, CICs will have an asset lock. Secondly, they will be expected to work for a community. Thirdly, they will be expected to report on the work that they do for that community. For many people, the single most important feature of the CIC is a strong, transparent lock on assets and profits, along with the power to ensure that the lock is meaningful. That is intended to give people real reassurance about what CICs are set up to do.
At present, many social enterprises are set up as companies limited by guarantee, sometimes with a custom-made lock on assets in their constitution. That is not an easy process. Few lawyers are familiar with it and their advice can be very expensive. Often, it is a case of reinventing the wheel over and over again. From the work that has been carried out by the Social Enterprise Coalition and its members, I know that this is a major barrier faced by newly emerging social enterprises. It also creates real uncertainty among third parties, such as banks, funders and investors, about the status of this type of enterprise. So the asset lock not only will provide a lock for the assets but also is intended to give the new 272 company a brand, which would give confidence to third parties. During the course of the Bill, we will need to test whether the proposals, as outlined, will do the trick.
The second key principle of CICs is that they should serve community interests and should he transparent in what they do. Serving the community means that there will be a test before one can join the CIC "club". It is called the community interest test. The key issue will be to strike a balance between creating a slow, bureaucratic process and having a community interest test that is robust enough to protect the good name of the CIC. It is proposed that aspiring CICs should have to make some declarations when they apply. We will need to test whether the declarations, as outlined, will do the trick.
The real focus will be on community interest; it is what CICs are meant to do. In many ways, the test will be what they will do when they are up and running. If there is a genuine concern about whether a CIC is serving the community within the meaning of the Bill, the new CIC regulator will be able to take rapid action to address that—for instance, by safeguarding assets or removing directors. So CIC status is not something to be taken on lightly. Will the Bill ensure that the regulator will hold people to the promises that they make?
The third key principle is that CICs should be transparent. It is proposed in the Bill that CICs should report each year on what they are doing for their communities and that that should go on the public record. Again, it is vital that that does not just produce red tape. The report should be straightforward to produce and integrated with the current company reporting process. It should be able to give the public a feel for what CICs are doing to deliver on their aims. But it will also show how CICs are engaging with the people affected by what they do—that is, their "stakeholders"—and it will address concerns, such as directors' pay, which are sensitive not only in the wider world but also in the social enterprise context.
There are further questions. Will the sector that has been involved in bringing the Bill forward also be involved in the appointment of the regulator? We will need to examine how the proposed asset lock will work. What information should be included in a CIC's annual report? Where will the cap for the dividend payable on "investor" shares be set? The regulatory framework that will follow from the Bill will be very important. I am pleased to have the Minister's assurance that the consultation process will start immediately.
I believe that the Bill is the product of a successful consultation process. Certainly, the Social Enterprise Coalition has felt that that was the case. Also, all the way through the process we have stressed the importance of the reform of the industrial and provident societies' legislation, which must go in tandem with the creation of the CIC. In the same way that there needs to be a level playing field with traditional companies, so there should also be a level playing field with the industrial and provident societies, which cover co-operatives, housing co-operatives and other forms of social enterprise. It is 273 not acceptable that there should be a nice, new, cheap, easy-to-use vehicle in the shape of the CIC when the legislative and regulatory framework governing cooperatives and others is, at best, somewhat creaky. However, I hope that the Treasury will build on the work that my honourable friends Gareth Thomas, Mark Lazarowicz and Mark Todd have done in the past two years in their Private Member's Bills and that some proposals will come forward from the Treasury soon.
Our job, therefore, is to test and improve the new CIC in its passage through the House and, when the Bill is enacted, to add it to the family of different ways to set up social enterprises, co-operatives and community enterprises. The Government will then have the task of promoting that new form of company across government departments and industry. I would like some reassurance that resources will be made available to do that, because if the new law is not widely promoted, it will fail. I look forward to working with your Lordships on the Bill in due course.
§ 12.30 p.m.
My Lords, I am glad to follow the noble Baroness. She will forgive me if I do not follow her remarks on community enterprise for I intend to restrict mine to audit and company law issues. In so doing, I should remind your Lordships of my relevant interest as a company director as declared in the Register of Members' Interests. For the sake of completeness, I should perhaps declare also the interests of my wife. She is a company chairman who serves on the board of four public companies, two of which are in the FTSE 100. However, I assure your Lordships that her Ladyship and I operate a strict Chinese duvet policy as far as disclosure matters are concerned at home.
Perhaps I may join my noble friend Lord Hodgson, who made an excellent speech, and the noble Lord, Lord Sharman, in expressing my disappointment that the DTI has yet again failed to bring forward a proper company law reform measure in a seemly and timely way. It is not the first time that I have said that I find the DTI asleep on the job in such matters. It aestivates in the summer months and it hibernates in the winter months.
What do the Ministers in the DTI do all day long? Your Lordships should be told. The Minister should give a pledge that there will be a company law reform measure before the next general election. If he is not able to do that, it will clearly be a matter for the incoming Conservative government under the leadership of my right honourable friend Mr Michael Howard, who has extremely detailed experience of taking complex and complicated financial measures through the other place, going back to the 1980s. He and the rest of my noble and right honourable friends understand business in a way in which it is clear less and less, alack, this Government now do. They have produced a headline-grabbing measure.
As a backdrop to my remarks, I should join my noble friend Lord Hodgson in saying that capitalism and markets are a great force not only for material 274 good, but also for moral good, when properly conducted. I take as my touchstone the valedictory remarks of the Bishop of Hereford to this House during the debate on the gracious Speech on 27 November. The much-missed Bishop said,as far as capitalism is concerned, my opinion is that, if properly regulated, like hunting, it is morally all right". —[Official Report, 27/11/03; col.71.]That is good enough spiritual guidance for me.
However, the question is: what kind of regulation is right and to what degree? In corporate life, as in any other part of public or private life, people sometimes do bad things to enrich themselves. That is part of human nature, but in market economies, accidents happen. Failure is a natural part of a market economy, whether that failure is innocent, bad luck, misjudgment or due to blatant corporate theft.
When scandals blow up, governments tend to respond by introducing legislation to make sure "this never happens again". There is scant chance of that. All too often, ill-thought-out regulations are introduced that do not prevent malfeasance happening again. Therefore, we need to test the Bill's proposals very carefully. My noble friend on the Front Bench set down four criteria. I have four slightly different ones: need, effectiveness, common sense and cost—but while always reaffirming the benefits of the market system.
As the Minister said, certain issues must be addressed. One has to go no further than the current issue of the Economist. Page 5 features a billboard not just of companies in trouble, but also of accountancy firms under some stress. Halfway down the page, we learn that KPMG has quit as auditors of Hollinger Incorporated. Further down, we read that Grant Thornton has claimed that it was the "victim" of a fraud, some time before it could possibly have conducted an internal investigation of what went on in its Italian partner. However, that is what it claimed. Those two stories offer the inelegant spectacle of two otherwise distinguished professional services firms publicly running for cover—of auditors running to the hills as fast as they can.
The noble Lord, Lord Sharman, referred to a strong feeling among many audit practitioners, some of whom I count among my friends, that they need to have their responsibilities and liabilities limited. I hope that my noble friend Lord Freeman, who comes from that background, will continue to regard me as a friend after I have finished my speech. The Minister referred to the consultation process on liability that was launched on 16 December. I advise the Government to approach liability reform with extreme caution. Why should auditors have that protection, while others in business, be they executive or non-executive, are perhaps denied it?
Related to that issue is the fact that 97 or 98 per cent of the top 350 companies in this country are audited by just four auditors. All of the top 100, and all bar eight of the next 250, are audited by the "big four". That is perilously close to 99 per cent. Some people see that as unhealthy or anti-competitive; others put it down to the excellence of the "big four"—they do contain many 275 great auditors, to whom I pay tribute. Others attribute it to fashion, or even to the fact that company finance directors think that they had better play safe and go to the "big four", because the "big four" have big pockets and if liabilities do arise, they stand some chance of having some of them met. However, capping liabilities would greatly diminish those firms that audit risk-takers. Risk is extremely important, as my noble friend pointed out. No risk, no profit. Auditors should not he allowed to become the cosy, cosseted species in the way in which some people are lobbying.
I end on a note of further disappointment that the DTI seems to be doing so little to promote better and more widespread ethical practices in this country. Sometimes, alas, there is a thin line between ethical or unethical behaviour, whether in business or in politics. When the rewards are big enough, no amount of ethics training or corporate ethics officers will deal with the issue. However, what makes the market system work is trust, and individuals and companies doing what they say they are going to do. Building an ethical code into a company's life helps to make sure that people pause and think, often about simple things. They may ask themselves: "Hang on. Would I like to tell my wife and children what I am about to do and why I am doing it?" Or "Just a moment, would I like to read about this action I am taking in my office in the media tomorrow?" One reputable US company of which I have personal experience has taken ethical training and ethical matters so seriously that everyone has ethics checks and training every year, not just for the shop-floor but also for the chairman, the chief executive and the whole of the board. In companies such as that, ethical considerations become part of the warp and weft of corporate life. It is not a matter for PR-conscious, corporate special interest areas such as corporate social responsibility or corporate environmental policy, worthy and important though they are.
I therefore conclude by urging on the Minister more encouragement of that approach. I mean "encouragement", but please, at all costs, not some new, government-inspired, Higgs-style report on ethics that is all about process and box-ticking rather than substance. Business has had quite enough of that, as it has had of over-regulation.
§ 12.40 p.m.
§ Lord Phillips of Sudbury
My Lords, I am grateful to the Minister who, in opening this debate, paid tribute to Roger Warren Evans and Stephen Lloyd for having invented the concept of the community interest company, the CIC. The Bill before us follows substantially the skeleton form that they produced three years ago. It is not often that we are in the business of creating a new corporate vehicle and I think this could be the first entirely new corporate category since the 19th century.
So fascinating is the Bill that over the past 24 hours I have managed to miss one train and, on two other occasions, travelled past my intended station—including this morning. It is a riveting read. And a period of around seven minutes is not long enough to cover all I want to say at this stage of our consideration. I suspect that the 276 noble Baroness, Lady Thornton, and myself may be the only speakers to address Part 2, covering community interest companies.
Before turning to my main points, I want to say briefly that I believe that there should be a greater entitlement to information for members of such companies than is the case for normal companies, and that we should provide for that. Further, we should consider providing for a more open memberskp of such companies than is the case for traditional business entities. Again, no provision has been made for that. I should also be grateful if the Minister would consider making gifts from one CIC to another exempt from stamp duty because on distribution following a winding-up, surplus assets will have to he sent to another CIC or a charity rather than put in the pockets of the members. Will the Minister consider allowing capped interest paid by CICs to be treated as pre-tax charges, as is the case for industrial and provident societies? Finally, could capped dividends enjoy the same tax relief as that allowed under enterprise investment relief schemes?
The first and most important point I want to consider relates to the whole principle of preventing a CIC also being a charity. Clause 23(3) states that:A community interest company established for charitable purposes … is to be treated as not being a charity".Complicated provisions set out in Clauses 36.37, 51 and 52 deal with this confusion this paradox, as I see it—together taking up some three-and-a-half pages of text. This is the first time in English history that a body established for exclusively charitable purposes, with a constitution entirely in accordance with the requirements of charity law and which operates exclusively as a charity, is to be prohibited from registering as such.
The existing law has always been simple. Whatever the form of the charity, the factor which determines whether it is or is not one is the substance—its activity and purposes. That is why in this country we have a wider range of charitable options than any other in the world, and it is why the other Anglo-Saxon jurisdictions have followed us. That is in stark contrast to the Napoleonic code countries where entitlement or status follows form. The freedom that this has given the charitable sector in this country, along with the unique protection afforded to the public, will be subverted if the clause is passed.
I think I understand the reasoning: I suspect that there is a desire to prevent what might be seen as confusion in the public mind over the nature of a CIC. However, I urge Ministers to look at this again, no matter how attractive that argument may be at first blush. If the prohibition stands then let us make no mistake: we will then have the bizarre state of affairs whereby the type of company most distant from that which the public conceives of as a "charity"—namely, a typical company limited by shares, which is the standard vehicle for a private benefit business—will continue to be permissible as a vehicle for charity, while a CIC—expressly a community interest entity 277 with controls on the distribution of its assets—cannot be used as a vehicle for a charity. That is extremely confusing.
What is more, we may get into an "Alice in Wonderland" situation whereby a CIC with charitable purposes—that is admitted as a prospect in Clause23—will not be able to be a charity, but none the less will be able to blazon abroad as much as it likes the fact that it has charitable purposes. I put it to noble Lords that that is daft.
Furthermore, if CICs are allowed to be charities, as are all other forms of company, trusts or unincorporated associations, they will also have to comply with charity law. They will not be able to pay directors and they will be subject to many other provisions that will inhibit their freedom of action.
Not only do I see no downside to continuing with the age-old system vis-à-vis charities, but there is a huge advantage in it. In time, I believe the CIC will prove to be a more popular vehicle for corporate charities than any of the existing forms, given the ethical match between a CIC and a charity. It should also considerably shorten and simplify this Bill. A number of noble Lords have already referred to its length and complexity.
My second main point concerns the absence from the protection provisions in the Bill of any control over remuneration. Part of the Government's case set out in paragraph 159 of the Explanatory Notes declares that they want to provide the public with,a clear assurance of non-profit-distribution status".To allow the unlimited remuneration of the directors or employees of CICs would be to drive a coach and horses through any attempt at controlling the distribution of the assets of a CIC. That is because Clauses 27, 28 and 29 as drafted only inhibit levels of dividend payments and interest payments. They also control the distribution of assets on a winding-up, but they do nothing at all to constrain the remuneration, level of bonus payments or salaries of members of a CIC board. I urge the Government to deal with that.
Perhaps I may refer briefly to the discretionary power given to the regulator under the terms of Clause 27(3)(b) to,set different limits for different cases",by which it means that the regulator will be able to say, "I am going to allow this particular CIC a capped interest rate of 10 per cent", while all other CICs are being allowed to pay only up to 5 per cent. Alternatively, he could consider different categories of CICs and put limits above and below the norm on the distribution of dividends and interest. That would be a first in English law and I see no reason at all why either the regulator or the Secretary of State should have such a power. What are his or her qualifications, and why should the state be able to favour one kind of activity over another? That is as invidious as it would be to allow the Registrar of Companies to set differential corporation tax rates between one type of business and another. I urge the Minister to review this point.
278 I want to toss out the thought that the regulator should be subservient to and part of the registry of company arrangements. Nothing in the Bill makes it necessary to create another free-standing bureaucracy. The Registrar of Companies has a good reputation and I believe that significant administrative and cost savings could be made if the Bill is reconsidered so that much, if not all, of the bureaucracy could be put into the companies registry.
Finally, I want to refer briefly to the definition of a "community interest company". I wonder whether we need to have one at all. The definition proposed in Clause 32(2) is astonishingly wide indeed, the whole Bill needs to be looked at because so much is expressed in bland and widespread terms; namely:A company satisfies the community interest test if a reasonable person might consider that its activities are being carried on for the benefit of the community".That is very helpful! But since many of these companies will be new and will not have undertaken any activities—they will have merely a constitution—and in particular since this should concern not simply the type of business being conducted but the manner in which that is done, I suggest that we could do without such a definition.
Of one thing we can be sure: no one seeking to line their pockets will set out on the road of business or enterprise in the form of a CIC, because of the controls on dividends and interest and, I suggest, remuneration. Again, this would save a whole lot of hassle, bureaucracy, frustration and expense. What is wrong with that?
§ 12.49 p.m.
§ Lord Brennan
My Lords, the Bill is a welcome step to strengthen corporate governance through reform of auditing and accounting procedures. I regret to say that I consider it to have been a necessary step. It was a little less than two years ago that we debated in this House, in the aftermath of Enron, the effect of such a collapse on the public interest—the public interest expressed in the investment of pensions and public funds into major enterprises. The year after that we debated the progress that had been made in this country after the Higgs, Smith and other reports. So now we debate the legislation, which is a consequence of these matters.
This legislation has the task of trying to reconcile private interest—commercial, capitalist—with public good. That balance is expressed in what meets the public interest. I commend the Bill as a sensible step to meet the concerns that affect the public interest, the need for trust and integrity of companies in this country.
I propose to deal with two central matters to do with auditing and accounting. The first is the supervision and regulation of such work. In the first few clauses of the Bill, the Government seek, through the means of regulatory and supervisory bodies, to establish proper standards. That involves, it seems to me, two requirements. The first is that the standards should be reliable. What I am about to say might sound—or 279 might have sounded—trite before Enron and Parmalat, but it now needs to be said. The standards should enable those investing to understand the balance sheet of a company and to assess the true extent of its liabilities. It is remarkable that in 2003, at the beginning of the 21st century, we should have to express such a need in such simple words. Only a year ago, Merrill Lynch advised investors not to invest in Parmalat because its finances were so opaque. How on earth can we allow such a state of affairs to persist?
Secondly, in reaching for reliable standards that involve transparency, surely we must identify, as a competent, innovative commercial society, the devious means by which companies can seek to avoid serving the public interest and achieve reliable standards that prevent that. Why should we discover, in 2000–2001, the vehicle of a specific purpose entity which hides the debt obligations of Enron as if it were some wholly unconceived attempt so to achieve an internal result for the benefit of the company, the directors who were involved as guilty parties, rather than the community in general?
The first issue is reliable standards; the second is international standards. It is inconceivable that we can balance American standards through the FASB and European standards through the IASB if they are different in such a way that will serve the public interest. I give two examples. The first is stock options, with which I had a fateful encounter years ago in trying to understand the Black-Scholes formula for valuing them. Stock options are a major aspect of company life—surely the existence of those options and their value as an expense should figure in a company's accounts. Not so in America, but it is the case here. On the contrary, in Europe we value derivatives at purchase price, often next to nothing, whereas in America they apply a market valuation.
I have chosen stock options and derivatives as examples because each—probably the latter more than the former—plays its part in the way in which those who are determined to make a wrongful profit from a company can achieve it. We must have international standards and guard against those risks.
My third point on supervision and regulation in terms of standards is that the grant that the Government give to bodies concerned with such standards should be properly spent. We want a results-based analysis. Is the system working? If not, how can we best change it?
Next, for my second main theme, I turn to the enforcement of accounting and reporting standards. On overseas subsidiaries, Clause 8(3), as I read it, gives a full power to a UK auditor to investigate a UK parent company's activities wherever it may be carrying them on, through whichever subsidiary. That is to be welcomed.
Secondly, in dealing with international finance and enforcement, surely auditors, as professional men and women, should exercise competent judgment. How can a cash-strapped conglomerate like Parmalat produce, if it is correct, a sheet of paper saying that in an offshore account of a company somewhere in a tax 280 haven there is a holding of several billion euros in cash without the auditor questioning it? It seems very difficult to understand. Moreover, how can so much money transfer itself from one part of an entity to another without explanation being demanded?
I close by inviting the Minister and, through him, the DTI, to consider the broader picture. None of these events could have occurred without the client/banker relationship existing, as it must have done, in Enron, Parmalat, and so on. When are we to expect standards from the banking system? It is difficult to understand how Citigroup, JP Morgan and Deutsche Bank could have failed to have had any questions to ask about the derivative deals they were carrying out for Parmalat to the tune of hundreds of millions of euros. I close.
§ Lord Freeman
My Lords, I am very grateful to the noble Lord for giving way before he sits down What about the credit rating agencies and their role in this?
§ Lord Brennan
My Lords, the noble Lord is in rightful anticipation of my two other institutions for checks. Financial advice to investors clearly should be the subject of standards, as should credit ratings. Standard&Poor's credit rating for Parmalat was good up to the beginning of December. All that picture is the financial picture; it is not just auditing and accounting.
As I have suggested before, I invite the Government to consider founding here in London, financed by accounting firms, City firms and/or the Government, a centre for financial standards and corporate governance. Its role would be to scrutinise the present regulatory state of affairs and determine whether change was needed, to educate the commercial world about proper standards and to promote, wherever necessary, reform.
I welcome the Bill. Two years after Enron, action has been taken by wide consultation, by balanced consideration of what is necessary and a piece of effective legislation. It is the stuff of effective government—we should have more of it.
§ 12.59 p.m.
§ Lord Freeman
My Lords, it is a particular pleasure to follow the noble Lord, Lord Brennan. I agreed with both the thrust and the detail of what he had to say. Obviously, he speaks as a lawyer and not an auditor or an accountant, but his summary was excellent. He touched on the key point of why the legislation is welcome in principle—because it helps restore confidence and sets standards.
I declare an interest as an accountant, but my brief remarks today are my own. I do not speak for the profession, or for my firm, PricewaterhouseCoopers, of which I am still a consultant, or for any of the companies of which I am a director. I strongly agree with the comments of my noble friend Lord Hodgson, on the Front Bench. I shall not repeat any of his points except strongly to endorse them from the Back Benches.
281 This is a modest Bill, but its principles are correct. Detailed examination in Grand Committee, if that is where it goes, is extremely important. There is one very small point: I hope that, in future, when regulations are introduced, particularly for companies, they can be introduced simultaneously on fixed dates in the course of the year. That is a small point but, I understand, the Government are now working on such a reform.
I believe that your Lordships had hoped that in this Session we would debate a major company law reform Bill. The noble Lord, Lord Sharman, always uses his words very carefully, and I noted what he said—he said that such a Bill was desperately importantly needed. I find it very difficult to explain to my colleagues in the accounting profession, in the City and in business why we are going to spend weeks and weeks on a House of Lords reform Bill, when we are still not able to proceed with a company law reform Bill, although much of the legislation is in excellent shape in draft form.
I shall make three very brief points on the Bill, which I welcome. The simplification of the oversight procedure through the Financial Reporting Council and the Financial Reporting Review Panel is exactly right. The previous system was complicated, and the Bill makes progress in that regard. Secondly, the provisions on the duties of directors not to mislead auditors are correct and welcome. Finally, the devil will be in the detail of the provisions on community interest companies. Your Lordships will want to look not only to the Minister but also to the noble Baroness, Lady Thornton, to ensure that we do not end up with complicated legislation that is difficult to understand and over-regulated for those whom it is intended to benefit.
On the issue of liability of auditors and directors, my noble friend Lord Patten spoke in typically robust fashion, although he was a trifle unfair in his remarks on the accounting profession. He may have misunderstood what should happen and what should be the correct response from the profession to the consultation paper. No one is suggesting that one should not deal with auditors' and directors' liabilities simultaneously; I believe that to be right. No one is saying that either should avoid liability for their errors. The issue is the extent of the liability.
The Financial Times editorial of 7 January fell, if I may say so, into the same error, in misunderstanding the calculation of the liability, about which there is real concern in the profession. The liability is joint and several. When a company goes bust, one of the big four accounting firms will probably be sued first, because they are deemed to have the biggest pockets. Often the accounting firms end up as the only source of recompense for those who have lost money. That cannot be right. What surely is correct is that the liabilities of both auditors and directors should be proportionate—and, in my judgment, capped as well. Otherwise, even when the liability is proportionate, if the auditors or the board of directors are the only people who can afford to make recompense and there is no one else to share the blame, the amounts could be very considerable.
282 I believe that the noble Lord, Lord Sharman, has already referred to the fact that the European Union commissioner is considering placing responsibility on the auditor of the top holding company for the audit of all the subsidiaries within the group, irrespective of whether they have actually carried out the audit—for example, in countries abroad. That increases the responsibility and liability of the auditor.
The comments made about liability are clearly part of the consultation process, because the consultation will run until 12 March. I suggest for consideration that if the liability of directors and auditors is to be changed from the unlimited nature at present and should be both proportionate and capped, that the Minister by regulation asks the Financial Reporting Council to devise the methodology for capping. If that proceeds, I suggest that shareholders should approve the procedure in a general meeting. It would be perfectly possible for the Minister, at a later stage, when the Bill has gone to another place and has perhaps come back here, to propose a simple clause to remove the offending Clause 310 of the existing Companies Act. That clause could be repealed with very simple language, and the legislation would be enacted only when there was a proper methodology for introducing capping and proportionality. There is still time for that to be done.
I briefly turn to the question of non-executive directors. Part of the problem for the directors of smaller companies is that the cost of insurance against unlimited liability is now prohibitive. We are failing to deal with the problem of recruiting non-executive directors not only to large listed companies but also to smaller companies. That is an urgent matter, and I hope that the Government will deal with it.
§ 1.7 p.m.
§ Lord Grantchester
My Lords, I congratulate my noble friend the Minister and the Government on introducing this timely update to corporate regulation. I speak merely as a layman and an investor, but also with some experience of sitting as a non-executive director on several audit committees, although at present I sit on only one—Dairy Farmers of Britain.
I find it interesting when I hear noble Lords talk about the dangers of being an auditor. Some people find auditing the least inspiring aspect of accounting. Indeed, I have heard auditors described as similar to those who go round at the end of a battle checking the dead and bayoneting the wounded. However, that is not to deny that it fulfils a very important role in safeguarding the integrity of business.
The Bill is part of the Government's strategy to help restore investor confidence in companies and financial markets following various recent high profile corporate failures, most notably Enron and WorldCom. A new failure, Parmalat, is unravelling as we speak. While purposeful fraud will always be with us, lessons can always be learnt and procedures tightened up, so that non-compliance will flag up potential wrongdoing. That process has been continuing since the cases of BCCI, Polly Peck, the Maxwell companies and Wickes, among others.
283 The legislative changes amend relevant provisions of the Companies Acts 1985 and 1989. They are intended to complement various recent non-legislative measures designed to strengthen corporate governance and audit practice. Part 1 is intended to strengthen the independence of the system of supervising auditors by placing new requirements on the recognised supervisory bodies; the enforcement of accounting and reporting requirements; the rights of auditors to information; and the company investigations regime.
The new requirements placed on the recognised supervisory bodies are that they must participate in independent arrangements for the setting of auditing standards to underpin professional integrity and independence and the setting of technical standards; the monitoring of audits of listed companies and certain other companies; and the investigation and taking of disciplinary action in certain cases.
Clause 2 seeks to ensure the independence of these arrangements by providing that the recognised supervisory bodies, for example, the Institute of Chartered Accountants in England and Wales, cannot be involved in the selection and appointment of those who carry out the standard setting, monitoring and disciplinary functions—that is, the Auditing Practices Board (APB) and the Accounting Standards Board (ASB). Most importantly, it also provides for transparency in the disciplinary arrangements by requiring that independent disciplinary hearings must be held in public. The practical effect of these clauses is to make the recognised supervisory bodies subject to a more independent regulatory regime in respect of the setting, monitoring and enforcement of auditing standards.
Part 2 makes provision for the establishment of a new corporate vehicle, the community interest company. This is intended to make it simpler to establish a business whose profits and assets are used for the benefit of the community. Social enterprises bring together the expertise and dedication of the voluntary sector with the flair and flexibility of the commercial world, and can be particularly relevant in the many activities where commerce and public service meet.
There are three major types of reason for accounts to be incorrect, which leads to investor lack of confidence. These are, first, quite obviously, error; secondly, deliberate fraud, on which I have already commented; and, thirdly, manipulation of accounts. It is to the third aspect that I shall address my remarks.
Manipulation of accounts includes the bending of accounting policies, the massaging of accounts, and the manipulation of profits—for example, capitalising brand values, the treatment of goodwill and so on. The work of the FRC in this area is crucial, so it is important that both its role and the extent of its reviews are going to be strengthened.
The main area of investor concern focuses on the potential compromising of the audit function brought on by a disproportionately high level of auxiliary non-audit services. Disclosure of fees for non-audit services, as opposed to fees for audit services, is a step in the right direction. However, it does not stop the problem. I do not suggest a complete block on auditors 284 carrying out non-audit services, as often it is the auditor who is best placed to give this other advice. It may be that some sort of cap is needed on these non-audit services. There is a need for the FRC, or the regulatory bodies, to look at the large level of non-audit fees in a set of accounts. No doubt an investigation could be triggered by a high level of such fees. The Bill seeks to address that issue somewhat. The FRC will he policing, to a greater extent than currently, inappropriate accounting policies and will have added powers.
Inappropriate accounting policies have been central to certain high profile corporate failures, notably Enron and Wickes. In both cases, a key issue was the organisation's policy on income recognition. The FRC has an increased role in monitoring the work of auditors, which must be a step in the right direction in this regard. This is bound to encourage auditors to check more carefully the compliance with basic and fundamental policies, such as income recognition.
Increasing the auditors' access to information, a matter with which the Bill assists, is also a step in the right direction. However, giving the auditors wider access may not stop a Maxwell recurring. Whistle-blowing should surely be made easier and more effective. It may be sensible for auditors to be required to have discussions with a certain number of employees each year. I note with dismay the treatment of whistle-blowers in the European Commission. I remind noble Lords that the EU auditors have refused to sign off the Commission accounts for the past nine years—surely a scandal that dwarfs the combination of all the most recent corporate failures put together.
Recognising the importance of the ASB and having it controlled by the FRC is also hugely beneficial. It should ensure that speedy and effective responses are made to large corporate failures, such as Enron, where the importance of income recognition accounting policies was heightened following the failure, causing auditors as a result to become more sensitive to the appropriateness of income recognition policies. Fast and effective responses to problems, and the plugging of holes, should occur under a stricter and more robust regime.
Also as a result of Enron and the lessons now learnt from it, warning lights are now triggered for auditors where there are large, complex group structures. Auditors now have to look hard behind the structure to understand the movement of transactions around the group and the reasons for those movements, to ensure that there is transparency in this regard.
Audit committees need to be more robust, to stop cases of executives bullying and controlling companies in a manipulative way. It is essential that auditors meet with the audit committee without the executives present and can have confidential discussions with it. It is also important that at these private meetings probing questions are asked of the auditors by the audit committee. The improvements to corporate governance brought about by Higgs and Smith have been steps in the right direction, though more are probably needed.
285 It may, for example, be sensible to have a list of questions for audit committees to ask their auditors because, in practice, it can be difficult for auditors to get their concerns across. Particularly where there are strong, dominant characters involved, auditors can find it inhibiting to initiate criticism. It is likely to be easier for them to address concerns in response to questions and in a more informative way. It can be difficult for them to get their concerns or suspicions across with no tangible basis without it sounding like a personal attack on management.
Examples of the sort of questions that would be useful are, "Do you feel the accounts department and its staff are suitably qualified and competent? Do you feel there are sufficient resources in the finance department? Do you have any concerns about bullying by management or executives? Have you had any indications from staff about bullying? Do you feel there has been a desire to manipulate the accounts in a particular direction?" That is particularly relevant if there are profit-related or share option schemes in place.
The mere existence of sample questions would better aid corporate governance, as management would be made aware that such questions are to be asked and that such issues are to be considered by the auditors and discussed with the audit committee.
Executives should not have anything to do with the appointment of auditors, but in practice they often manage to have an input. If, for example, an auditor is critical of management or of the chief executive and the audit is going to go out to tender in the short or medium term, the chances are that that auditor will not be reappointed. It is vital that the appointment of auditors is seen to be independent of the executives. It may be an idea for the auditors to have to include in their report reference to the extent of their private meetings with the audit committee each year.
The audit threshold is about to rise from £1 million to £5.6 million. I understand this change is due to come into force through a statutory instrument later this month and to be operative for company accounts for the year ending March 2004. My only reservation regarding the changes we are now contemplating is that raising audit thresholds is likely to be the most significant in removing the major deterrent against fraud and money laundering. That needs to be carefully considered in a strategy of raising investor confidence.
Creditors are one of the major users of audited accounts of companies with turnovers of less than £5.6 million, and arguably they are the ones who are likely to have concerns about the lack of an audit. Small and medium-sized companies are a growing part of the enterprise culture that we are seeking to improve. These company failures can impact on companies of all sizes due to the knock-on effect. Perhaps the £5.6 million threshold should be reconsidered and any future changes limited to the amount of increase in inflation.
286 While the audit threshold is not strictly relevant to the Bill, it is nevertheless part of the picture. Large companies can go under if a major debtor defaults—credit worthiness having often been assessed by reference to audited accounts. As a director of Dairy Farmers of Britain, I can confirm that checking customer accounts is a very important part of determining whether and to what extent Dairy Farmers of Britain will trade with small companies. I may not have to remind the House of the difficulties in the dairy sector in recent times, where there have been company failures, notably Lancashire Dairies, Amelca and United Milk.
The relevance of audited accounts is usually that third parties rely on them to confirm the accuracy of accounts and the strength of companies' balance sheets. Often the audit report will also give an indication of any going concern problems or other problems, which a simple review of the accounts might not otherwise reveal. Disclosure of financial information may not be complete if the accounts have not been subject to an audit, in that an audit, as well as looking at the accuracy of the figures, also looks at compliance with recent relevant legislation and accounting standards. It may be that certain important financial information is omitted from the company's accounts, either deliberately or through lack of knowledge for example security of borrowings, loans to directors or transactions with related parties. Such omissions should not exist where an audit takes place. I applaud the commendable changes being proposed in the Bill and the strengthening of existing measures to raise investor confidence. I welcome the support given to the Financial Reporting Council, and I wish the Bill a safe passage.
§ 1.20 p.m.
§ Baroness Carnegy of Lour
My Lords, I will not follow the noble Lord, but I shall confine myself to just two brief, general points and ask the Minister two questions on Part 2 of the Bill. My noble friend on the Front Bench has already commented that this is a somewhat strange time to introduce Part 2. The community interest arrangements are closely linked with charity law. The Government, we understand, are planning shortly to bring Parliament's attention to the matter of charities again. It appears that they are perhaps putting the cart before the horse, entirely unnecessarily.
From the Scottish perspective, the Government's timing of Part 2 is even more peculiar, if not constitutionally wrong, I might suggest. Under the Scotland Act 1998, company law is a matter reserved to Westminster. As the Minister pointed out, Scots law for charities is devolved and is already different from charity law south of the border. It is absolutely right that this Bill, a company law Bill, should, as it does, include Scotland as well as the rest of the UK. At the same time, it happens that the Scottish Executive, like the Westminster Government, I think, hopes to change charity law in Scotland, and issued a consultation paper in May 2003, with a view to legislating. What do the Government do here at Westminster? For their own good reasons, they go ahead with this Bill, drafting it so that, provided the 287 Scots Parliament does what it is expected to do on charities, Part 2 can in these respects be brought into line in Scotland.
The relevant powers to achieve this are in Clause 23(3) and Clause 27(9). An explanation is given in paragraph 205 on page 48 of the Explanatory Notes. Unlike in England and Wales, any changes to Scots charity arrangements will be made by a different parliament from the parliament responsible for this Bill. That is self-evident. Who knows what the Scots Parliament will decide? Their current charities culture and system is a different starting point from that south of the border. There are no charity commissioners in Scotland. Decisions are made by the Revenue and the courts. The Scots Parliament may, I suggest, when the time comes, disagree with its Ministers. It has already been known to do that several times in its short life. It may wish to make charities decisions that render much-needed community interest companies inoperable in Scotland. What happens then? It is surely not Westminster's job to hem the Scots Parliament in on a devolved matter just because of bad timing on the United Kingdom Bill. One could say that the timing is not only inapposite; it may even be constitutionally wrong. That is my first point.
My second point is that the so-called social enterprise culture is particularly strong in Scotland. It forms an integral part of local economies and cultures. Since the early 1990s, much of the pioneering work being built on elsewhere has begun in Scotland. There is a long-standing desire north of the border for a statutory framework for the sector. In spite of all that, the Government seem to pay less attention than they should to Scots' needs. In Scotland, because of the lighter-touch charity law, most social enterprises are registered charities. As the law stands, those charities cannot change their status; they simply cannot apply under the Bill. Should they, as the Government intend, become legally able to apply, few, if any, could, in practice. afford to do so, as they depend on tax and rates relief to survive.
From my many years of experience chairing a quango that was a company limited by guarantee, I know that there is a deep belief in Scotland that social enterprise should be governed by voluntary unpaid boards and should involve stakeholders in a democratic way. Those characteristics are, as far as I can see, allowed for under the Bill, but, undoubtedly, they will not be the norm.
During the consultation on the Bill, those and other important points were made to the Government by the sister organisation of that chaired by the noble Baroness, Lady Thornton, the Scottish Social Enterprise Coalition. It seems to me that the coalition has been largely ignored by the Government, so I have some questions for the Minister. First, how do the Government justify the timing of the Bill, when its operation in Scotland depends on future legislation in the Scots Parliament being framed in a certain way? Is that somewhat bullying approach, in fact, unconstitutional? Secondly, why have the Government ignored the advice of the Scottish Social Enterprise Coalition, making it likelier that few, if any, existing social enterprises in Scotland will be able to avail themselves of the new arrangements?
288 I hope that the Minister will be able to answer those questions. If he feels that he cannot, will he, perhaps, write to me?
§ 1.28 p.m.
§ Lord Razzall
My Lords, it is noticeable that virtually every speaker in the debate has begun by declaring an interest either as a director of a listed or unlisted company or as a chairman or member of an audit committee. I join those who have done so and declare my interest, as set out in the Register of Members' Interests. In passing, I must take up the reference made by the noble Lord, Lord Freeman, to House of Lords reform. It is a great shame that, in debates such as this, some Members of your Lordships' House who accept the honour and title associated with being a Member of the House and have significant high-profile business careers never seem to find the time to come and give us the benefit of their expertise. I want to record that, and I know from remarks that have been made from other Benches that several of your Lordships share that view.
In effect, as noble Lords will have understood and several have said, this is two separate Bills. Apart from the fact that they both come from the Department of Trade and Industry, they seem to bear no relation to each other. I suppose that that is a modern trend, as the Minister fights for his share of legislative time, and there has been a brilliant accretion of DTI Bills in recent years. However, I think we have to accept that the two Bills reflected in this one Bill have nothing whatever to do with each other.
I turn to the first Bill, as it were, which concerns audit and investigations. As my noble friend Lord Sharman indicated, noble Lords on these Benches broadly welcome that part of the Bill. I believe that the CBI said that no one could fail to support a robust system of company law and governance based on integrity, openness and transparency. I believe that all noble Lords share that objective. Indeed, at the weekend I wondered why that did not appear in the credo of the Leader of the Opposition, if not to the strains of a Batchelors' song. No one can doubt that action has to be taken to ensure that the scandals typified by Enron and WorldCom in the United States cannot be replicated here. To that extent no one could object to the Government taking the necessary steps.
The strength, however, of the United Kingdom system, not particularly the English system—I bow to the noble Baroness, Lady Carnegy, in this respect—is a combination of statute, common law and a voluntary code. The recent company law review recommended the continuation of that approach. I believe that all the different parties in your Lordships' House accept that that should continue to be the approach towards these matters. However, the company law review stated that that required the immediate modernisation of company law.
It is noticeable that speaker after speaker in the debate has tried to get the Government to say when we shall see the comprehensive reform of company law that we all wish to see and that industry and the public demand. I 289 have no doubt that when the Minister replies to the debate, he will not be able to give us a commitment on that. I have no doubt that he will say that the Government remain committed to reform of company law. However, the decision on when a comprehensive Bill will be brought forward is undoubtedly out of the Minister's hands and will, I suspect, be subject to the vagaries of electoral politics as his lords and masters consider the timing of the next election and decide whether the Bill can be introduced in that period of time. Nevertheless, the Minister should take on board the overwhelming view of your Lordships that we need a comprehensive reform of company law; and that we need that Bill soon.
There is clearly a danger of a piecemeal approach reacting to the scandals of the day or the fears of the day. An example of the continuation of that piecemeal approach to which a number of noble Lords referred is the current position on auditor and director liability. A consultation paper was issued in the autumn. We now have a Bill to deal with the audit and investigations element of company law reform. We do not know whether or not the Government will decide that they can tag on to the end of the Bill recommendations regarding auditor and director liability if the consultation period is completed before the Bill is passed and indicates a conclusive view regarding what the Government should do. That is an unsatisfactory state of affairs. If the Bill is passed without the question of auditor and director liability being dealt with, the Government will be faced with exactly the same problem in the next Queen's Speech; namely, whether there will be legislative time to deal with it. That cannot be a satisfactory way to run a railroad or even the Department of Trade and Industry.
As I indicated at the beginning of my speech, we, of course, support the Bill. We support its general aim and its general principles. In Committee we shall seek to check that the Government have the balance right between catching wrongdoers and imposing unreasonable burdens on business. Every clause needs to he looked at to check that that balance is right. Without going into the detail there are three particular areas on which I believe that we shall need to probe the Government.
First, in Clause 9 we shall need to probe whether or not the obligations of disclosure have a reasonable materiality test to avoid unnecessary burdens being imposed on perfectly honest businesses and businessmen. Secondly, in Clause 8 we shall need to probe how the mandatory disclosure requirements, particularly regarding subsidiaries, foreign subsidiaries and subsidiaries in the United States, can be squared with the obligations being imposed on directors. Thirdly, we shall need to probe the extensive provisions that permit Inland Revenue information to be made available to auditors and other bodies to check whether and to what extent appropriate protection is given to individuals regarding invasion of 290 their privacy. Those are three critical areas on which we shall want to test the boundaries of reasonableness as against the necessity to catch wrongdoers.
I turn to the second Bill, as it were, which concerns the community interest company. Again, noble Lords on all sides of the House welcome this part of the Bill. As my noble friend Lord Phillips indicated, we shall want to probe a number of areas in Committee, particularly the interrelationship between charitable law in its existing or potentially reformed state and the community interest company.
I should like to press the Minister on a substantial point. He will be aware that a number of local authorities responded to the consultation last summer in a very welcoming manner. A large number of local authorities have expressed an interest in using the CIC format to develop public services. Shall we pronounce it "kick"? The noble Baroness, Lady Thornton, used that pronunciation. Looking round the Chamber, I suspect, however, that we shall not continue to use that pronunciation. I am not sure how Hansard will record that. The Local Government Association specifically drew the attention of a number of noble Lords to Somerset County and Taunton Deane borough councils that think that the CIC format is a very good means of delivering a range of community based leisure and cultural services.
It appears that local government will regard the use of the CIC as a very essential part of their work in the community. The question that I should like to put to the Minister is, does he or does he not agree with the statement that I understand the Home Secretary made that, so far as he is concerned, the CIC will not be used in any way to provide services that are the responsibility of central government? If the Minister agrees with that statement, it appears that a big opportunity will be lost. In the National Health Service in particular, as the Government develop their proposals for devolution to community hospitals, CICs could play a major part in the development of those hospitals. I hope that the Minister will say whether I have misinterpreted the views of the Home Secretary, or, if I have not, that he does not share them.
§ 1.39 p.m.
§ Lord Glentoran
My Lords, this has been a very good debate. I wish to make a few brief points. It is the Government's duty to ensure that company law creates an environment where risk taking and entrepreneurs can flourish and where public confidence can be maintained in the knowledge that fraud and malpractice will be detected, controlled and punished.
Before I continue, like other noble Lords I need to declare some interests that I believe are relevant. Until I retired I was a director and chief executive of a number of Redland plc companies, some offshore. I am in my 10th year as a member of the Millennium Commission and chair both its audit committee and finance committee. I am also currently a non-executive director of the National House-Building Council and sit on its finance and audit committee. The NHBC 291 comes within the remit of the FSA as an insurance company. In the past, I also served on the board of the Ocean Youth Club, a national sail-training charity. The noble Lord, Lord Sharman, was at one time chairman of that board.
That is a varied mix of businesses, with some commercial, some charitable and some for the public good. However, they have one thing in common; namely, that they all are or were in the risk business. In one way or another, a number of noble Lords have supported the cliché of no risk, no profit.
Some people might like to think that the Bill is a technical Bill, the business of lawyers and accountants. It is not. It will impact on everyone, as the Minister pointed out. It is a people's Bill. It will affect jobs, pensions, SMEs, big businesses and, perhaps most importantly, the competitiveness or not of UK plc. We think it doubtful whether, in its present form, Part 1 gets anywhere near achieving what we had hoped were its intended aims. That has been clearly supported by noble Lords around the House.
The second part of the Bill proposes the establishment of a new type of Companies Act company which would exist primarily for community interest purposes. We welcome that. When first reading about the proposal for the creation of CICs I was quite excited. I thought that their creation could add something very positive to the community sector, with more flexibility for small enterprises and local companies focusing on the public interest. However, the implications of CICs are significant, especially as they cannot be charities and would be subject to a more stringent level of oversight than normal companies.
In practice, as a result of the establishment of a regulator, the Bill is effectively establishing an entirely new sector of community and company activity. That was pointed out by the noble Lord, Lord Phillips of Sudbury. The aim of the Bill appears to be to produce a form of corporate body which occupies the space between a Companies Act company and a charity. It would presumably have greater financial freedom than a charity and could borrow money or sell shares. We applaud that concept if it can be made to happen. However, the role of the regulator and his ability to intervene in payments or to transfer assets leads us to wonder whether a bank, or indeed any creditor, would feel that sufficient security could be obtained against loan capital. We wonder whether that would inhibit the desire not only of lenders to fund CICs, but of contractors and suppliers to trade with them.
It is also questionable how popular shares in CICs would prove, as opposed to other ethical investments. The regulator's powers could, in certain circumstances, constitute a significant infringement of normal shareholders' rights. Shareholders could find directors removed, management changed and new directors appointed, all without their approval. The use of the powers is carefully circumscribed in the Bill, but they are none the less very significant.
292 We must also wonder about the role of directors of CICs. Some noble Lords have already talked about remuneration of directors. Their ability to carry out their fiduciary duties could be compromised by the regulator. The regulator is specifically empowered to intervene in transactions and disposals if he believes that the community interest test is not being met. What if, for example, a C1C can balance its books only by compromising its community activities? Would the regulator prevent directors from doing so? Would that be recognised in company law? If not, could they find themselves unable to manage the CIC as they believe necessary or to meet their fiduciary duties? Presumably, they would have no option but to resign.
It is therefore difficult to understand the incentives for establishing a CIC from the Bill. The structures do not seem to offer any particular advantages per se, and the level of oversight and potential interference is significant. However, that is not surprising, as the Bill establishes only the legal framework, and we have not yet seen any regulations. As other noble Lords including my noble friend Lord Hodgson have pointed out, we have been promised the regulations. It is vital that we have them before Committee, or the debate will be fairly meaningless.
The CIC would seem to be a vehicle tailor-made for the kind of private-public joint ventures which the NHS is keen to establish, and which local authorities look excited about developing, as the noble Lord, Lord Razzall, pointed out. One area of control which could be problematic for CICs is the eligibility restriction on political parties or political campaigning organisations. That is a very broad definition. What is a politically campaigning organisation? Depending on the political issues of the day, that could vary from Greenpeace to asylum seekers' rights and the Ramblers' Association.
Under the proposals, CICs would be Companies Act companies and therefore subject to the Companies House regime. However, additional levels of oversight would be applied. Indeed, the Bill proposes the establishment of not one but three new offices—the regulator, the official property holder and the appeals officer. We understand that CIC directors would be appointed in the usual way for Companies Act companies. However, another significant issue with regard to the directors of CICs is the ability of the regulator to appoint new ones and dismiss existing ones. Although those powers can be exercised by the regulator only if the company default condition is satisfied, that could occur if the CIC puts financial concerns before community ones. I referred to that idea earlier.
We support the basic concept of CICs, but feel that that good concept is at risk of being undermined by detail and possible over-regulation, a point made by my noble friend Lord Freeman. Would it not have been wiser to have waited for the long overdue revision of the whole of charity law before launching this excellent initiative? Other noble Lords have also made that point.
293 We have had a wide-ranging and interesting debate at Second Reading of this rather inadequate Bill. We on this side of the House agree with many noble Lords who have spoken that, as a whole, company law urgently needs reforming. As the Bill stands, however, it will not lead to the modernisation and reform that is required to make it fit for the 21st century and beyond, as called for by Patricia Hewitt in 2002, and mentioned by my noble friend Lord Hodgson. The Bill increases the regulatory burden on directors. The noble Lord, Lord Sharman, pointed out that there was little clarification of company law to help directors.
Although we support all necessary regulation where justified, we do not support onerous regulation for regulation's sake. My noble friend made clear the tests that we shall apply to the Bill, and the noble Lord, Lord Razzall, made some very clear comments on the tests that the Liberal Democrats will apply to it in Committee.
It has been stated that the UK's regulatory system is widely acknowledged to be among the best in the world. By the time that the Bill leaves your Lordships' House, we must have ensured that the balance is fair and just.
§ 1.49 p.m.
§ Lord Sainsbury of Turville
My Lords, from what has been said today we can be certain that the Bill will be subject to a high level of detailed and expert scrutiny. The Bill has been the subject of extensive consultation with business, the accountancy profession and other interested parties. Yet today we have had a number of new perspectives and insights from speakers. Many interesting points have been raised. I shall try and deal with the key issues in taking the Bill forward.
The noble Lord, Lord Hodgson, instantly raised the question of the main Companies Bill as did the noble Lord, Lord Sharman. We are committed to such an important reform. We want to modernise and simplify UK company law to provide a flexible law with quicker and simpler processes for companies, reduce burdens particularly for smaller firms and start-ups and make the UK a good place to set up and run a business. We intend to publish a draft Bill for comment before we introduce it into Parliament.
However, there is an essential requirement to the main Companies Bill, which is that we obtain the right balance between giving companies stability, so that we do not put aside a whole raft of common law precedent while moving the law forward. That is a difficult balance to achieve. It is one that we are working on and we are committed to introducing the legislation as soon as possible. I do not think that anyone would want us to bring it in if it led to instability in that area.
My Lords, I am grateful to the Minister for going that far. Would he reflect on the fact that company law reform has been pledged as forthcoming since 1998 by the DTI? Would he go 294 further and define when "as soon as possible" is to be? Will the draft Bill be published before the next general election?
§ Lord Sainsbury of Turville
My Lords, it was with great care that I said "as soon as possible". If we could say precisely when that would be, it would mean that we had removed all the uncertainty about how easy it is to establish the correct balance and I cannot say, at this point, that we have done so. Therefore, we do not wish to introduce the new law until we have that balance right because it would be no help to the financial or industrial communities if a great deal of uncertainty were raised.
The noble Lord, Lord Sharman, described our approach as being "liberal", which he went on to define as being fragmentary, disorganised and dilatory. That was not my normal definition of "liberal". What we have done in this first piece of legislation is to tackle the difficult regulatory issues and try to make them right, with a careful balance between cost and effectiveness.
In answer to the noble Lord, Lord Hodgson, work has begun on a draft charity Bill, which is due to be published in this Session. The Treasury has already initiated changes to the industrial and provident society form, resulting from the Private Members' Acts in the past two Sessions of Parliament.
The noble Lord, Lord Patten, gave us an interesting dose of ideology and then went on to demonstrate that we actually need not ideology, but careful legislation for proper controls. I would have thought that it was an area where we can all agree that the financial and industrial systems need to have careful and thoughtful regulation that is both cost-effective and effective if that sector is to grow and be profitable.
My noble friend Lord Brennan, in his thoughtful speech, explained why the legislation was required and why we should look wider. That is a point we take on board—as he said, this is the stuff of effective government. That is to give such careful legislation to control the situation. My noble friend also raised the question of international accounting standards. I very much welcome his comments on the need for those and I hope that the one positive consequence of the Parmalat affair will be a greater impetus to implement international standards. The Government are working hard in the EU for the adoption of international accounting standards.
The noble Lord, Lord Hodgson, also raised the question of auditors' powers and other burdens on directors that I referred to in my opening speech. The new requirements could give a disincentive to non-executive directors.
I do not accept that Clauses 8 and 9, which deal with the auditors' rights to information and the statements in directors' reports, are overly burdensome or should discourage anyone from becoming a director. It must be right to require directors to tell the truth to auditors and to ensure that directors focus on whether they have provided the relevant information to auditors. These clauses strengthen existing requirements and I cannot see that a requirement to give this information 295 would in any way be a burden which would discourage anyone one would want to have as a non-executive director.
The noble Lord, Lord Hodgson, also asked about the costs of the legislation and proposed four tests. They were that it should be proportionate, balanced, clear and workable, and effective. I accept all those criteria, but I point to a slight note of complacency in his comments. We cannot be certain that such a collapse cannot happen in this country. Any costs of the legislation, which are minor, must be set against the costs and loss of investment to individuals were there such a collapse. If the noble Lord was speaking in that context. I am happy, but to describe it as a cost without putting anything on the other side of the balance sheet is a mistake. We should not be complacent that we will never see this kind of collapse in this country.
Equally, I say to the noble Lord, Lord Glentoran, that I see nothing in the Bill which would in any way stop people being entrepreneurial or risk-taking. It is not about people setting up new businesses, taking risks and developing new products. It is about people manipulating balance sheets and financial statements in order to mislead other people. I do not see that as being what entrepreneurship or innovation is about.
Also in that context, the noble Lord, Lord Hodgson, asked how many CICs there were likely to be. I see no way in which that can be calculated in any meaningful sense. All we can say is that during the consultation a large number of people expressed an interest in setting up CICs and this will create a new option for people to do so.
The noble Lord, Lord Sharman, raised the important question of accounting firms and where we are on that. The commitment by the major accounting firms to increase the transparency of their own reporting was one of the most important parts of the final report of the Co-ordinating Group on Auditing and Accounting Issues. A number of firms have already produced the report and a number of others are about to do so. We will be writing to all auditors of listed companies to obtain confirmation of what they are doing and to encourage those firms which have so far been reluctant to agree to such reporting to change their minds.
The noble Lord, Lord Sharman, also asked what would be included in the reports. That is set out in the final report of the Co-ordinating Group on Audit and Accounting Issues. In summary, the report should cover financial information, such as that already required for limited liability partnerships; an operating and financial review; governance, including international relationships; the basis of partner remuneration; and arrangements for quality assurance.
The noble Lord, Lord Sharman, also asked who is responsible for the standard setting process. In practice, we expect that the recognised supervisory bodies will comply with the additional standard-setting requirement set out in Clause 1 by requiring 296 their registered auditors to follow standards set out under the aegis of the new Financial Reporting Council specifically by the Auditing Practices Board.
The noble Lord asked whether there will be reasonable tests by the Financial Reporting Review Panel when it receives allegations about accounts. Yes, it already conducts such tests. All complaints are considered by the chairman and deputy chairman of the panel who decide whether there is a prima facie case for the panel to pursue. Of course, it can pursue the powers in Clause 12 to obtain information only where there is or may be a question whether the accounts comply with the requirements of the Act.
The noble Lord, Lord Sharman, also asked about the likely timetable for the operating and financial review. As I said, in the early part of this year the Government will consult on the draft regulations to introduce the requirement for economically significant companies to prepare an operating and financial review. To some extent, the timing of the introduction of the OFR will depend on the results of that consultation.
Another major issue is that of auditor and director liability—a matter raised by a number of noble Lords and, in particular, by the noble Lord, Lord Freeman. The department recognises that issues relating to liability are of concern to many people in business, including auditors, directors, investors and users of accounts. This is a serious and difficult issue and one where we must ensure that, if we are to maintain high auditing standards, the question of auditors' liability does not get in the way of good audits taking place.
We have listened to those who are concerned about this matter. My honourable friend the Minister for Industry, who has responsibility in this area, has already met the president of the Institute of Chartered Accountants in England and Wales to discuss liability and she has also had a separate meeting with representatives of the "Big Four" auditors. My officials have also held a series of discussions with preparers of accounts, users of accounts and regulators, as well as with auditors.
The upshot of that is that on 16 December we launched a formal consultation on auditor and director liability. The consultation is necessary for a number of reasons, among them the concerns recently raised by the auditors in relation to their potential liability and those raised by Derek Higgs in relation to that of non-executive directors. The Company Law Review examined many of the issues but considered that more work needed to be done. There has also been a significant change in the audit market with the demise of Andersen.
Ministers will, of course, carefully consider the responses to the consultation and, as I indicated in my opening speech, will decide on any further steps in the light of those responses. In answer to the noble Lord, Lord Hodgson, I can confirm that if the consultation shows that there is a clear case for reform, and if the case for reform is urgent in that sense, the Government will seek to bring forward amendments to the Bill. 297 However, the first stage is to see whether there is any agreement on the case for reform, but I do not believe that that will he a very easy process.
The noble Lord, Lord Phillips of Sudbury, raised a number of important and detailed points which we shall need to consider as we go through the Bill. Perhaps I may deal with just one or two of the key issues that he raised. He asked about the need for the new regulator. Our intention is that, for the most part, CICs will need to interact only with Companies House. They will submit their registration documents and annual returns to Companies House, which will pass them on to the CIC regulator. In effect, a onestop-shop will operate, with CICs having direct contact with the regulator only when he exercises his supervisory powers.
The Government considered whether an existing body should take on that role. Companies House maintains the register of companies and carries out related functions but does not otherwise have a regulatory role. The Charity Commission has a regulatory role, but our consultation confirmed that there should be a clear differentiation between CICs and charities. The CIC regulations are also not intended to be as proactive as charity regulation, which must maintain the confidence of public donors and beneficiaries. However, the CIC regulator will be able to draw on the expertise of the Charity Commission when performing his functions.
The noble Lord, Lord Phillips, also raised the question of the lack of controls on the remuneration of CICs directors and employees. In drafting the Bill, the Government had to take into account the need to protect assets in the community interest while not unduly restricting the ability of companies to compete in the markets. We recognise that directors' remuneration is a key concern, especially for a sector with strong ties to the voluntary and community sector, where, of course, in many cases remuneration is the exception. However, we believe that CICs should be able to attract the best people available for the job, and we intend to ensure that all CICs report directors' remuneration in the annual community interest report. That report will be available to the public so that concerns can be raised and addressed.
The noble Lord, Lord Phillips, also raised the important and interesting issue of the regulator not being able to set different limits on dividends in different cases. Responses to the public consultation on CICs stressed the need for flexibility in the arrangements in order to cap dividend payments. Clause 27 is intended to provide that flexibility. I should emphasise that the Bill also requires the regulator to undertake appropriate consultation before setting those limits and to have regard to their likely impact. For example, it may be considered reasonable by the social enterprise sector for CICs operating in a particular sector to have a different limit.
The noble Lord, Lord Freeman, raised the question of the timing of subordinate regulation. I listened with interest to what he had to say on the timing of 298 subordinate legislation so that it comes into force on only a couple of days a year. My department is already adopting that approach for employment law and we shall be considering this matter carefully to see whether it is a model that we should use in other areas such as company law.
My noble friend Lady Thornton asked that resources be provided to promote CICs. I can say that the Government are committed to promoting social enterprise widely. Making those who benefit from it aware of CICs and of the other changes to legal forms that are planned and under way will be an important part of that work.
The noble Lord, Lord Grantchester, raised the question of the audit threshold bringing increased risks that are not in line with our intentions for the Bill. This proposal will reduce the burden on small companies and release a further 69,000 companies from statutory audit. However, it will not be a free-for-all. Shareholders will still be able to require the company to audit its accounts if they consider it necessary. Creditors, such as banks, may want to look closely at company accounts before lending money.
I thank the noble Baroness, Lady Carnegy of Lour, for putting forward the Scottish perspective. She asked how the Government justify the timing of the Bill in relation to Scotland. New companies in Scotland and other parts of the country will be able to take advantage of this form. The noble Baroness is correct in identifying that Scottish charities will not be able to convert to CICs. The Bill acknowledges that and provides scope to make changes if the Scottish Parliament decides that Scottish charities can cease to be charities. The Government do not intend to bully the Scottish Parliament in this action; they are merely building in flexibility in order to avoid a situation whereby the Government must introduce primary legislation if changes are made in Scotland.
In conclusion, I believe that today's debate augurs well for the progress of the Bill. I look forward to detailed debate in Committee. In spite of what has been said, I believe that it is very largely a technical Bill and not one which engenders controversy on party lines. Nevertheless, it is an important measure which will help to ensure that our company regulation and financial markets continue to be regarded as among the best in the world. That is a source of considerable competitive advantage to Britain. We have not achieved that position through what is often termed "a race to the bottom". On the contrary, in many respects, our standards of financial reporting and corporate governance are significantly higher than those of our competitors. However, we combine high standards with flexibility and a minimum of bureaucracy, which makes it easier to set up and run a company in Britain. In other words, the law broadly strikes the right balance between freedom and protection.
The amendments in the Bill will reinforce the controls designed to achieve full and honest reporting. They will help to ensure that those who seek to abuse the privileges of the company form can be exposed 299 and dealt with. They will encourage and assist the development of a social enterprise sector. But they impose minimal additional burdens on business. Many of the provisions on financial reporting will apply only to larger listed companies and the community interest form will be voluntary. No one will be forced to use it, but we believe that some businesses will judge that the extra regulation is justified by the clear status that the new form will confer.
The Bill has been developed through partnership between the Government and interested parties, and I hope that it can pass through this House in a similar spirit of partnership.
§ Lord Razzall
My Lords, before the Minister sits down, I am not sure that he answered my question on whether he agreed with the Home Secretary's remarks that the CIC form should not be used in relation to the provision of public services.
§ Lord Sainsbury of Turville
My Lords, the noble Lord is quite right: I did not. I thought I was running out of time so I would give the issue a miss. The noble Lord is quite right to direct me back to the matter.
The Government's view on community interest companies is that they should be developed to meet the needs of local communities and complement core government services in areas such as childcare provision, social housing, leisure and community transport. In public services, where non-core ancillary services may be provided by third parties, it will be possible to use CICs to provide such services.
However, our view is—and this includes both the Home Secretary and the rest of the Government—that CICs should not deliver essential public services in core sectors such as hospitals and schools.
§ Lord Phillips of Sudbury
My Lords, I begin by thanking the Minister for his extremely careful response to a great many points made. As he reasonably said, he did not have the opportunity to respond to all the questions asked of him. Will he have an opportunity to do so before the Committee stage of the Bill, or, indeed, will he have consultations?
§ Lord Sainsbury of Turville
My Lords, I am very happy to have consultations with the noble Lord, who is obviously a great expert on this area, at any time before Committee. Indeed, I shall read his speech with great care. If there are any general points of principle which I have not answered, I shall write to him. I suspect we shall consider most of the noble Lord's points in very great detail in Committee. I shall leave those for the Committee stage because I think that that is the appropriate way to deal with them. If the noble Lord has a desire for consultation, I shall be very happy to talk to him.
§ On Question, Bill read a second time and committed to a Grand Committee.