Financial Services

Part of the debate – in the House of Commons at 7:27 pm on 15th February 1994.

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Photo of Austin Mitchell Austin Mitchell , Great Grimsby 7:27 pm, 15th February 1994

I am saying that there are too many overlapping institutions; self-regulation has not worked, and has no adequate and firm base on which to work; and we can be effective against fraud only by replacing self-regulation with an independent, statutorily based regulator who has the power to strike hard, rather than obfuscating everything with the plethora of regulations in the financial sector.

We cannot rely on auditors to be the effective police force that will be required under these rules. We do not even have an effective definition of whom the auditors are responsible to. What the Government are proposing is the bare minimum. As it is so minimal, we must ask whether they are serious about dealing with the sort of fraud that has lead to this attempt to close the stable door after the horse has bolted.

Effectively, we know little about what went wrong with BCCI and especially the audit of it, because, in this country, we have not had an inquiry into what went wrong. That case is the justification for these rules. We do not know exactly what happened because the Government have not seen fit to institute an inquiry. We need the information.

When there was a banking crisis in the early 1970s, the last Labour Government instituted a series of inquiries. There were inquiries into London and Counties and London and Capital. The information from those inquiries was published. We knew what went wrong, so we knew how to deal with it. In this instance, there is nothing.

Lord Justice Bingham specifically said that he was not pursuing the matter of audits because it was not his responsibility. The Government should have repaired that omission by pursuing the matter and inquiring into what went wrong. Ministers say that the Serious Fraud Office is looking into the matter. However, that has not precluded inquiries into other cases such as London United Investments and Maxwell. There should be an inquiry into the audits of BCCI so that we know exactly what went wrong.

During debate on the Companies Bill in 1989, the Minister argued that for any system to be effective, there had to be a distance between the regulators and the regulated. However, the only people who have inquired into BCCI, is the Mafia regulating the Mafia. It is auditors trying to regulate auditors. There is not that distance which the Minister asked for in the Committee on which we both sat in 1989.

The only inquiry into BCCI has been the American one. That was handicapped because the British partners of Price Waterhouse did not pass either to that inquiry or to the American partners of Price Waterhouse their information on what had gone wrong. Therefore, the inquiry was inadequate; but it is the only one. What that inquiry found was appalling. The report states: BCCI's accountants failed to protect BCCI's innocent depositors and creditors from the consequences of poor practices at the bank of which the auditors were aware for years. That is a crashing indictment of the auditors BCCI provided loans and financial benefits to some of its auditors … Those benefits included loans to two Price Waterhouse partnerships in the Caribbean. In addition, there are serious questions concerning the acceptance of payments and possibly housing from BCCI or its affiliates by Price Waterhouse partners in the Grand Caymans, and possible acceptance of sexual favors"— the report is more interesting than the book written by the hon. Member for Derbyshire, South (Mrs. Currie), although it does not have as much sex— provided by BCCI officials to certain persons affiliated with the firm. That is an appalling situation. BCCI's books were certified by the auditors as a true and fair record from 31 December 1987 forward. That meant that people had confidence in BCCI. We are told that the auditors gave certificates as a true and fair view and, therefore, encouraged people to invest, yet before 1989 Price Waterhouse knew of gross irregularities in BCCI's handling of loans, especially to CCAH which was the holding company of First American Bank shares. All that was known to the auditors, but they did not spill the beans. Why have we not had an inquiry to reveal what happened in BCCI so that we can base proper and effective regulations on that inquiry?

The Government feel that they can rely on audit firms to protect the interests of shareholders, creditors and other stock holders. That reliance, which is strengthened by the rules before us, has always proved inadequate because poor auditing practices are always covered up. There is no way for anyone to know how good or bad an audit is as long as the company survives. We have not developed the proper institutional framework to regulate auditors effectively arid make them accountable. In debates on the Building Societies Bill and the Financial Services Bill, Labour Members proposed much stronger provisions on the detection of fraud.

These rules have been introduced much too late because the Government are continuing to rely on an industry and a framework which have a history of failure. They cannot rely on the auditors, who are, effectively, a replacement for regulations.

In the United States, state inspectors quite rightly visit and monitor banks. That is the only effective way in which we can know what is going on. There should be such a requirement in Britain instead of our relying—as we do by the statutory instruments—on the auditors themselves.

I mentioned earlier that Price Waterhouse partners in this country would not give evidence or provide information to Price Waterhouse partners in the United States. The Government can only deal with that by effective regulation of auditing, and by an effective independent regulator. A banking commission is needed to take those functions away from the Bank of England, which performed so poorly and was shown to have done so by the Bingham report.

My preference is for a securities and exchange commission, as in the United States. That would be an independent commission, with a banking commission and an accountancy commission under it. That would provide an effective framework of independent regulators to whom auditors could report when they found fraud.

My hon. Friend the Member for Edinburgh, Central (Mr. Darling) said that the gaps in regulations do not cover Lloyd's, pension schemes and funds, or banks that are not domiciled in the United States. I have pointed out to the Minister that unless there is a duty to detect fraud as well as to report it, it is doubtful whether auditors could perform their functions.

The Local Government Finance Act 1982 imposes both duties, and the audit industry was in favour of that at the time. The industry saw that it would be able to get its fingers into local authority audits, and so was prepared to accept it then. The industry is only now balking at the proposition, and saying that it is horrendous and it cannot do it.

The firms are advertising fraud detection services all the time. KPMG Peat Marwick advertises that investigating financial frauds, and rectifying and recovering from them, requires specialised accounting skills. KPMG Forensic Accounting offers: experience of the techniques of fraudsters and the procedures they may have followed; awareness of the indicators of possible irregularities; the resources needed for a fast and accurate investigation; experience of the quality of evidence required to support a successful case, and the expertise to assemble and present that evidence … we can assist in tracing funds and unravelling the most complex international cases". The firm can provide all that for a fee. Why cannot the firm do it as a compulsory and necessary part of the service? The Minister may claim that it would be more expensive.

If a proper audit is done, it cannot be more expensive as it is the effective way to detect fraud. That needs to be a requirement which is imposed on the industry.

I have pointed out that, at present, auditors are not effectively regulated, Lord Justice Bingham said that the relationship between client, auditor and supervisor raises an issue of policy more appropriate for decision by parliament than by the accounting profession. However, that is subject to control by the Auditing Practices Board, which is not a statutory body. We have already been told that the board will impose passive requirements on auditors in this very difficult area. Passive requirements are just not adequate for the detection of fraud.

The board's draft standard states: the duty to make a report direct to a regulator does not impose upon auditors a duty to carry out specific work". It does not have to do specific work, and it has been told not to do anything. That is ludicrous. Unless the board does the work, it cannot make the report. The standard adds: no auditing procedures in addition to those carried out in the normal course of auditing the financial statements … are carried out …auditors are not responsible for reporting on a regulated entity's overall compliance with rules with which it is required to comply nor are they required to conduct their work in such a way that there is reasonable certainty that they will discover breaches. The board is not actually required to go out and look for things—it will just sit there, be passive, and it will all come pouring in.

Fraud does not work that way. A fraudster will not rush in saying "Here's the evidence, Mr. Auditor!" It is all well concealed, and unless the auditor has an obligation to hunt fraud down—become the "white hunter" of the British economy—fraud will not be detected. A passive approach to audit, such as the Audit Practices Board is recommending, is simply a recipe for further disasters and further audit failings.

The Government should surely have clarified the responsibility of auditors. Whom are they responsible to and to whom do they owe a duty of care? It is no good saying that they can report fraud to the regulator. Auditors should be responsible also to shareholders and to everyone involved in a company. In fact, they are not, and they have responsibility to no one except the directors who appoint them. The company's shareholders are given little information, and the choice of auditors is firmly in the hands of the directors. The depositors, consumers and employees have no say in the appointment of auditors.

Recent legal cases such as Caparo, Al Saudi Banque and Berg Son and Co. Ltd. have shown that auditors do not owe a duty of care to individual shareholders, potential investors or current or potential creditors, even though that information is supposed to be there to help markets understand what is happening to that company.

The Government have given no indication that they want to reverse those judgments, but they should do so. There should be a specific responsibility attached to auditors to give them a duty of care, so that information is spread more widely and the shareholders and stakeholders know what is going on, as well as the bank or financial institution.

My hon. Friend the Member for Edinburgh, Central quoted the President of the Board of Trade's book "Where There's a Will"—there's a corpse. The President stated that there should not be a conflict of interest and that accountancy firms should not do other work. That should be a paramount objective of the financial institutions, because DTI inquiries have indicated that work is less adequate when it relies on a man checking either his own figures or those of a colleague. The DTI report on Burnholme and Forder was critical of audit reports in that context.

None of the auditors who have been criticised by DTI reports over the years has been disbarred from practice. What kind of sanction is that to make auditors do their jobs properly? We need an effective, independent regulator, not the Mafia regulating the Mafia and saying, "It was quite understandable—we'll let you off this time." That is what happens now with the Institute of Chartered Accountants as a recognised supervisory body.

We must have effective control and discipline of auditors. In a written reply to me, the Secretary of State said: there has been no occasion where criticism of a company's auditors by my Department's inspectors in reports published since June 1979 has led to an audit partner being excluded from membership of a professional accountancy body".—[Official Report, 26 March 1990; Vol. 170, c. 25.] He added in another written reply to me: no auditor criticised in an inspector's report has been debarred from auditing as a result of information in that report."—[Official Report, 22 November 1991; Vol. 199, c. 341.] The Government have never initiated any criminal proceedings against auditors criticised in DTI report, so there are no effective sanctions. For all those reasons, the instruments are inadequate—they are too little, too late.

The Opposition cannot vote against them, although the hon. Member for South Hams seemed inclinded to vote against them. I only wish that the hon. Gentleman had the courage of his convictions. The Opposition are far more responsible that than. Voting against the measures might give an indication that we were as much in favour of fraud as Conservative Members are. We are not in favour of fraud, and we welcome any progress in its detection. That progress includes measures that we asked for when the relevant legislation was passed. For that reason, we must welcome the instruments, but they are just not good enough.