Auditing and Accounting

– in the House of Commons at 12:32 pm on 29th January 2003.

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Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry 12:32 pm, 29th January 2003

With permission, Mr. Deputy Speaker, I should like to make a statement about the report of the co-ordinating group on audit and accounting issues and the report of the review of the regulatory regime of the accountancy profession, which my right hon. Friend the Chancellor and I are publishing today. Copies of both reports have been placed in the Library.

Last year, the collapse of Enron, WorldCom and Andersen's in the United States appalled investors all over the world. Millions of people saw their savings and pensions collapse. As I told the House last year:

"Audit and accountancy standards in Britain are different from those in the United States: different and, as is now widely acknowledged, in some respects better."—[Hansard, 24 July 2002; Vol. 389, c. 1003.]

So there was no need for the UK to rush into a Hewitt-Brown version of the Sarbanes-Oxley Bill: but, equally, it would have been folly to sit back and say "It couldn't happen here".

Structures, standards and regulations can never be a complete defence against individuals determined to do wrong, nor can they wholly protect us against a culture of corporate greed and loose ethics, but we owe it to savers, investors and employees, as well as to all the honest business people whose reputations have been tarnished by those scandals, to ensure that our defences are as robust as they sensibly can be.

The reforms that I am announcing today, along with those proposed last week by Derek Higgs and Sir Robert Smith, will raise standards of corporate governance. I emphasise that these reforms, in essence, cover only listed companies. They will strengthen our accountancy and audit professions and provide for a more effective system of regulating the professions. Together, they make up a complete package of reforms that are comprehensive and mutually reinforcing.

First, I shall deal with boardrooms. Following Derek Higgs's proposals, the combined code on corporate governance will be strengthened to provide: that at least half the board, as well as the chairman, should be independent, as should all members of the audit and remuneration committees and a majority of the nomination committee; that the definition of an independent director should be strengthened and clarified; that the separation of the roles of chairman and chief executive should be reinforced; and that new descriptions should be given of the respective roles of the board, the chairman and non-executives.

Mr. Higgs's report showed a startling picture of the way in which top-level appointments are handled, with more than half of directors being appointed through personal contacts and friendships. I welcome his proposals to promote meritocracy through an open, fair and rigorous appointments process. As part of the follow-up to the report, a group led by Professor Laura Tyson of the London Business School will examine ways of bringing candidates, including women, from the non-commercial sector to greater prominence. It will report to me in May.

In revising the combined code, the Financial Reporting Council will implement the recommendations of Sir Robert Smith's group that the audit committee should: consist entirely of independent members, with at least one having relevant financial experience; monitor the auditor's performance, especially on independence and objectivity; and develop and implement policy on the purchase of non-audit services from the auditor, with reference to tough new ethical guidance. Following well-established practice, listed companies will be required either to comply with the provisions or to explain to their shareholders why they are not doing so.

The second aspect of our reforms concerns tougher measures to underpin auditor independence. Following the recommendations of the co-ordinating group, I can announce, in addition to an enhanced role for audit committees and a tightening of the provision of non-audit services by auditors: that the professional bodies have already changed their regulations so that the lead audit partner has to be rotated within five years; that partners and senior employees of audit firms will not be able to take up employment with a company they audit within two years of leaving their audit firm; and that most of the UK's large audit firms have already agreed to publish an annual report, to provide management and financial information; and, in particular, to reveal levels of dependency on single clients, including how the firm handles conflicts of interest and interdependence issues. We think that that will work on a voluntary basis. If not, we will make such disclosures a condition of auditing listed companies.

I am also calling for the standards and ethical guidance for auditors on the provision of non-audit services to be toughened even further.

We will also strengthen the enforcement of accounting standards. At the moment, the financial reporting review panel steps in only if particular concerns are raised with it. However, the co-ordinating group recommends, and we agree, that enforcement of those standards must be proactive. From now on, the Financial Services Authority will help the financial reporting review panel on enforcement—especially by identifying the high-risk cases that most merit investigation. The FSA and the panel will need to agree as soon as possible a memorandum of understanding to clarify their precise roles and responsibilities.

Those measures will be underpinned by the third element of our reforms—more effective regulation of the professions. The Financial Reporting Council will assume the functions of the Accountancy Foundation. That will create a unified, independent UK regulator with three clear roles: setting accounting and audit standards; proactively enforcing and monitoring them; and overseeing the self-regulatory professional bodies. The Financial Reporting Council has, under the chairmanship of Sir Bryan Nicholson, developed an excellent reputation. The Accountancy Foundation, led by Lord Borrie, has also done valuable work. I thank them for that.The new combined body will build on both their achievements.

After wide consultation, the DTI's review team made three recommendations, with which I agree. First, the Auditing Practices Board should take over from the professional bodies the responsibility for setting standards for independence, objectivity and integrity. Oversight of other ethical standards will become the responsibility of a new professional oversight board. The Ethics Standards Board will be wound up in due course. I greatly appreciate the work that its chairman, Christopher Jonas, and his colleagues have done to take forward the ethical agenda and to provide the basis for the new board's work.

Secondly, a new independent inspection unit, located within the FRC, should take over from the professional bodies responsibility for monitoring audits of listed companies, major charities and pension funds.

Thirdly, the long-delayed investigation and discipline board should come into operation quickly to provide a truly independent forum for hearing significant public interest disciplinary cases.

It is vital for the new structure to have clarity of accountability and responsibility together with the appropriate powers to operate effectively in the public interest. There is a strong case for statutory underpinning to make the new body work. We will consider that further and report our conclusions to the House.

The proposals that I have outlined are substantial and mean significant changes to the way in which companies and auditors carry out their work. The package should be implemented as quickly as possible. Changes to the regulatory structure will be made immediately. The Department will lead an implementation steering group, on which Sir Bryan Nicholson, Lord Borrie and Peter Wyman, president of the Institute of Chartered Accountants in England and Wales, have kindly agreed to serve.

An FRC with enhanced responsibilities will need more investment. The Government will pay their share of core running costs, but I also expect companies and the profession to contribute. It is in all our interests to make the changes work and it is fair that we all pay for the improvements.

The changes to the combined code that arise from the Higgs and Smith reports will be made in the early summer once the FRC has consulted on the precise wording. All those measures will be taken forward alongside our long-standing programme of company law reform following last year's White Paper.

The proposals are not a response to short-term market movements. They are about strengthening the foundations of our capital markets for the long term. I want to thank Derek Higgs and Sir Robert and his group for their excellent reports as well as all those who participated in the co-ordinating group under the joint chairmanship of the Under-Secretary of State for Trade and Industry, my hon. Friend Miss Johnson, who is responsible for competition and consumer affairs, and the Financial Secretary. I pay tribute to the officials who so swiftly took forward the review of the regulatory regime.

The overall package is tough when that is needed but measured and proportionate. It will ensure that our corporate governance structures remain among the best in the world for the benefit of millions of pensioners, savers and businesses that depend on them.

Photo of Tim Yeo Tim Yeo Shadow Secretary of State (Trade and Industry)

I am grateful to the Secretary of State for making a copy of her statement available to me this morning.

I broadly welcome the Government's approach. As I said last July, when the interim report was published, there are significant differences between our approach in Britain and that in the United States. Our principles-based approach is right and should continue to be championed.

I hope that the Secretary of State will agree with me on four broad principles. First, no regulatory system, however stringent, can provide total protection against the consequences of human greed, folly or corruption. In auditing and accountancy, as in all matters of corporate governance, the best safeguard against fraud, abuse and incompetence is the integrity and conscientiousness of the men and women in positions of responsibility.

Secondly, any change to existing practice must be scrutinised for its effect on Britain's competitive position and whether it makes wealth creation easier or harder. The purpose of regulation of auditors and accountants, the role of non-executive directors and so on is to provide some protection for lenders, investors, employees and customers. However, it cannot replace the duty of all those people to carry out their checks and responsibilities. Care must be taken not to increase business costs unnecessarily.

Thirdly, self-regulation should always be the preferred option for professions such as accountancy. The statutory route should be taken only when it is clear beyond doubt that self-regulation is inadequate.

Fourthly, even when we rely on self-regulation, any codes of practice or guidance systems must acknowledge the need for flexibility and understand that requirements that may apply to companies of a specific size or type are wrong for many other businesses. A one-size-fits-all approach is damaging.

I welcome much of Derek Higgs's report. The Secretary of State referred to listed companies. Does she include alternative investment market listed companies, off-exchange market companies and foreign companies that have a listing in London in that category? There are wide variations in the size and nature of the businesses even among the fully listed companies. The Higgs recommendations do not entirely acknowledge those differences.

I am worried that, for example, the recommendation to require a senior, non-executive director to develop an independent relationship with shareholders, separate from that of the chairman, chief executive and other executive directors, may be a recipe for division and conflict. That will not improve standards of corporate governance.

I am also concerned about the requirement for some smaller listed companies that half the board, or, if the chairman is included, a majority of the board, shall be independent. I am concerned that that recommendation is onerous, expensive and unnecessary. Further consideration should be given to both those recommendations before they are incorporated in the combined code.

Since institutional investors already have the power to address many of the concerns that Higgs has focused on, does the Secretary of State have any practical suggestions about how those institutions can be encouraged to take a more active role beyond the lip service that is so frequently paid to that need?

I welcome the recommendations of Sir Robert Smith, and particularly the involvement of an entirely independent audit committee in scrutinising the purchase of non-audit services from an audit firm. That, coupled with a little more transparency, should remove the need for greater restrictions on the freedom of clients to employ their auditors for non-audit work—a freedom that I believe is often in the best interests of shareholders, as when, for example, a client wishes an auditor to help with due diligence work on a proposed acquisition. The Secretary of State says that she would like guidance relating to non-audit services to be toughened still further. Will she explain exactly what she has in mind in that respect?

Looking at the issue of auditor independence, I warmly welcome the steps that the profession has taken on a voluntary basis to meet public concern and maintain confidence.

On the issue of standards, can the Secretary of State clarify exactly what role she expects the Financial Services Authority will play? She says that she is asking the FSA to agree a memorandum of understanding with the financial reporting panel. Will she clarify what issues she thinks that memorandum should cover?

Turning to the regulation of the professions, I welcome the extensive consultation that has taken place and pay tribute to the institute and to its president, Peter Wyman, for his role, and also to the work of the Financial Reporting Council.

Although the Secretary of State referred to a unified, independent regulator with clear roles, it would be helpful if she could explain how she thinks the distinct roles of five different groups will be defined and how their work will interact. I refer to, first, the FRC itself; secondly, the independent inspection unit to be located within the FRC; thirdly, the Auditing Practices Board; fourthly, the professional oversight board; and, fifthly, the investigation and discipline board. Is there any risk of duplication? Will their responsibilities really be clear to outsiders? Is there a danger that what starts to look like a proliferation of bodies may obscure accountability?

There is also the crucial question of cost. At a time when company profits are under pressure, not least because of the extra burden of tax and regulation imposed on them by the Government, there will be concern that audit fees and other charges may rise significantly because of these proposals. What does the Secretary of State expect the effect on profits to be? What will be the Government's contribution to the budget of the FRC?

In addition, when will the Secretary of State be able to say whether legislation is needed to implement the proposals? What timetable is envisaged for their implementation? Does she agree that after a period of consultation there is every advantage in quickly resolving the uncertainty that has inevitably existed in recent months?

Britain has a real chance to lead in the setting of standards for audit and accountancy. We must continue to champion our principles-based approach and the success of much of the self-regulation that has prevailed here. Both the nature of new legislation in the United States and the confusion over key appointments to regulatory bodies there are a warning of what may go wrong when a hasty reaction to a corporate scandal occurs.

I hope that the areas of remaining uncertainty in the Secretary of State's statement will soon be addressed. In the long term, the interests of shareholders and management should be aligned. Since every member of a pension fund and every holder of a life insurance policy has an interest, both in the standards of corporate governance and in the profitability of businesses, today's proposals affect almost every man, woman and child in the country.

In the six months since the issues were last discussed in the House, share prices have fallen and uncertainty in financial markets has increased. It is all the more important, therefore, that moves to rebuild confidence do not add excessively to the burden of cost and regulation. Our response to the problems must continue to be proportionate to the dangers involved. The essence of what is needed is not necessarily more regulation, but better regulation.

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

I am grateful to the hon. Gentleman for his broad support and welcome for the statement and the proposals. He began by setting out the principles. As I said, there cannot be complete protection against determined wrongdoers. The best defence against wrongdoing is the integrity and incorruptibility of the individuals concerned. That is why we want to strengthen not only professional standards but oversight, monitoring and enforcement of them. The reforms must be designed, and have been designed, to strengthen the competitiveness of our companies. At the outset of the work and report, Derek Higgs said that the reforms are about promoting the greater success of our companies, not least by strengthening the confidence of the people who invest in them. We believe in self-regulation where possible, legislation where necessary. That is what we have practised, and I think that the balance in the package is right.

Let me stress and develop what the hon. Gentleman said about the need to avoid one size fits all. Derek Higgs clearly acknowledges that. Perhaps I can clarify matters by confirming that the Higgs proposals apply to listed companies, pension funds and major charities. They do not apply to alternative investment market listed companies. However, he recognises, as we do, that the circumstances of companies, especially smaller companies, that fall within the scope of the combined code will be different. It is important for the FRC to reflect that in the wording of the revised code and it explains why we rely on comply or explain. There will be circumstances in which it is not sensible or appropriate for a company, especially a smaller firm, to meet every Higgs recommendation or combined code standard. They will be able to explain that to their shareholders. That is the great merit of comply or explain.

The hon. Gentleman asked about the implementation of Sir Robert Smith's recommendations, in particular the role of the FSA. The suggestion is that the FSA will extend its proactive enforcement role by conducting a risk assessment to guide the work of the financial reporting panel. Instead of the FRC simply waiting for problems to be drawn to its attention or worries to be raised, the FSA, having conducted a risk assessment, will draw the panel's attention to those audits on which it thinks the panel should focus.

Let me elaborate on the implications of toughening standards for the purchase and delivery of non-audit services. Sir Robert Smith's recommendations involve stronger policy and standard setting by the audit committees of the companies that purchase the services. Each committee will have to review that and set out company policy on it. On the other side of the fence, where the audit companies themselves are concerned, I am asking the Financial Reporting Council to consider the recommendations by my colleagues in the combined group who have suggested much tighter controls on what audit firms can sell. For instance, a prohibition on the supply of internal audit services by the external auditor might involve checking on management controls. Similarly, a ban on the provision of non-audit services might create a mutuality of financial interest and perverse incentives to distort either the audit or the non-audit services, or both.

The hon. Gentleman asked how all the different groups fit together. I draw his attention to the helpful diagram in the DTI review. By bringing the Accountancy Foundation and the FRC together, we are creating a single unified regulator under which will sit the Auditing Practices Board with its enhanced role, the investigation and discipline board with its strengthened powers, and the professional oversight board, which will include the audit inspection unit. That is a much simpler and more rational system than we have had until now, and because it all fits within the FRC, I think that the hon. Gentleman will find the complementarity of roles that we both want. Finally, he urged on me speedy implementation of the recommendations—that is precisely what we are now doing.

Photo of Mr Martin O'Neill Mr Martin O'Neill Chair, Trade & Industry Committee, Chair, Trade & Industry Committee

I welcome the Secretary of State's timely statement. She has avoided, as she said, the excesses of Sarbanes-Oxley, but at the same time she has been able to ensure a proportionate response to the drop in confidence in accounting services and the way in which businesses are run. Intriguingly, however, she missed one point that has been a matter of discussion in recent weeks—trying to avoid the practice of giving golden handshakes to failed executives. The issue provokes great bitterness and discontent, and I know that it will be a subject of a private Member's Bill later this week. However, I feel that my right hon. Friend missed the opportunity to address the issue, and wonder whether she could tell us why.

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

I am grateful to my hon. Friend for his welcome for this package and for giving me the opportunity to comment on an issue about which, as I have said before, I feel extremely strongly. I have often said that big pay-offs for large corporate failures are unacceptable, which is why last year I introduced new company regulations requiring an annual shareholder vote on the directors' remuneration report for quoted companies. Company owners should, above all, take the matter into their own hands and sort it out. Of course, I am aware of the private Member's Bill proposed by Mr. Norman, whose aims I entirely support. We have had an opportunity to discuss his Bill, and I told him that I share the concerns, of investors in particular, about the way in which it would work in practice. We are assessing the impact of the changes that we have already made to company law, and I intend to consult on whether further changes are needed to deal with rewards for failure.

Photo of Vincent Cable Vincent Cable Shadow Spokesperson (Trade and Industry), Liberal Democrat Spokesperson (Trade and Industry)

May I, too, welcome the Minister's courtesy in giving us early sight of the statement? Like the Conservative spokesman, I agree that its contents are both good and controversial. It is a welcome follow-up to the Higgs report, requiring accounting companies to produce proper accounts, which they often have not done in the past, and the tidying-up of regulation.

Is that enough? There has been a crisis in capitalism and there is a fundamental lack of trust in corporate behaviour, particularly in independent audits. It is striking that on the three big issues that the Government had to confront—audit rotation, competition policy and conflicts of interests—they have not taken the robust action that one might have expected. I shall pose a series of specific questions. First, on corporate governance and Higgs, I welcome the fact that the Government are now taking the initiative to break up the magic circle and break the incestuous links between non-executive directors. As there will be a demand under the reforms for more non-executive directors, what action will be taken to ensure that the existing community does not take on excessive numbers, which is already happening? Why have the Government not responded to advice to set limits on the number of non-executive directorships and chairmanships?

Secondly, on rotation, if it is indeed impractical to rotate audit companies, do the Government not accept that there are great dangers from close personal relationships developing between individuals in audit companies and the companies that they are auditing? Why are the Government not taking steps to encourage or demand that, for example, all audit partners—all signing partners, not just the lead partners—are rotated and that all members of audit teams are rotated, to ensure that those incestuous links are broken?

Thirdly, on conflicts of interest, surely the Government accept that it is inherently unsatisfactory for an audit company simultaneously to carry out an audit role and seek to carry out or carry out big IT consultancy contracts for the same company? The issue is subtle and complex, but surely there should be action beyond the Government's guidance to ensure that the most obvious conflicts of interest are simply stopped? On competition policy, do the Government accept that having four groups auditing the accounts of the top 500 companies is inherently unsatisfactory? The problem is difficult because those companies are global, but do the Government have any plans to pursue with the European or American authorities a combined approach to competition policy to try to break up the groups or introduce more competition in the market?

Finally, why was there no reference whatever in today's statement to the Comptroller and Auditor General and the National Audit Office, as both the private sector and the NAO have suggested that there is a major role for the NAO in auditing private accounts, possibly nominating auditors? That would be an excellent way in which the public and private sectors could collaborate, so why is there no reference to it?

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

I see that the Liberal party is swinging to the left today.

The hon. Gentleman talked about widening the magic circle of directorships. I entirely agree. As I said both in my statement and when we announced the appointment of Derek Higgs to conduct the review, it is not satisfactory, however good the individuals, to have a limited number of people on the boards of our major companies. The hon. Gentleman asked whether there should be a statutory or regulatory limit on the number of directorships. I draw his attention to Derek Higgs's clear recommendation that a full-time executive director should not take on more than one non-executive directorship and that no individual should chair the board of more than one major company.

However, as I told the Conservative spokesman, one size fits all is not appropriate. To try to set a single figure as a ceiling for the number of directorships and non-executive directorships that one individual may hold would not take account of the fact that some directorships may be in much smaller companies and so on. Some non-executive directors, particularly chairs of audit committees, have a much larger company burden than other independent non-executive directors. So I believe that we have got the balance right.

The hon. Gentleman raised the issue of whether the entire audit team, as well as the lead audit partner, should be rotated. Various review teams have looked at that matter carefully, because it was raised as an obvious solution to the problem. As with the issue about rotation of audit firms, the problem is about getting the right balance, ensuring that cosy incestuous relationships do not develop—that was part of the problem at Enron—while not destroying the expertise built by an audit team in relation to its client firm. There is evidence that some of the worst problems arise in an audit firm's first year, when the team, by definition, is completely new. Again, there is a balance to be struck, and we have approached it sensibly.

The hon. Gentleman wanted me to say more about non-audit services, including IT services. I draw his attention to the recommendation in the co-ordinating group report that the new regulator should further restrict the circumstances in which auditors supply internal audit services, and ensure that there is a strong presumption against supplying any internal audit services other than in exceptional circumstances. The report suggests that the regulator should review the circumstances in which it is permissible to provide valuation services, actuarial services, litigation support services, taxation services, and services involved in the design and supply of IT and financial information technology systems. A strong case is made for much stronger standards being set for audit firms. They will complement the strengthened provisions in the combined code that result from Sir Robert Smith's recommendations.

The hon. Gentleman also asked about competition in the supply of auditing and accountancy services. Of course that is a matter for concern, although the Office of Fair Trading has looked at it already, at our request, and has agreed to keep it under review. The market for such services is increasingly European and, indeed, global. At a regional level, where smaller companies are concerned, the competition for supply is rather greater.

Several hon. Members:


Photo of Alan Haselhurst Alan Haselhurst Deputy Speaker and Chairman of Ways and Means

Order. I do not promise to call every hon. Member who is seeking to catch my eye, but I will be encouraged to be well disposed if questions have just one part and receive concise answers.

Photo of Fiona Mactaggart Fiona Mactaggart Labour, Slough

My right hon. Friend the Secretary of State will be aware of a serious fraud in my constituency, as I have written to her Department about it. It involves some issues to do with accounting practices. In her statement, she referred only to listed companies. The very large multinational company in which some of the fraud to which I refer originated is privately owned. What protection will be given to third parties such as the small company in my constituency that purchased a company that was formerly a supplier to the multinational? That small company's representatives have told me that audit is merely a tax on firms such as theirs. The audit on the company that it purchased was fine, but completely superficial. How will the new recommendations make such audit less superficial?

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

From what my hon. Friend has said, the company to which she refers would be a suitable candidate for consideration by the financial reporting and review panel. I am aware in outline of the case to which she refers, but it may be sub judice and I therefore do not propose to comment further.

Photo of Mr Archie Norman Mr Archie Norman Conservative, Tunbridge Wells

I thank the Secretary of State for her remarks on payments for failure to departing directors, which is the subject of my private Member's Bill, and I welcome her confirmation that the Department will put the matter out to consultation. However, my Bill has widespread support across the House, especially among Labour Members. It is also supported by Sir Adrian Cadbury, who in a sense is the father of the combined code, and by firms of solicitors in the City. One of those companies is McFarlane's, which was instrumental in preparing a practical and robust solution. What form will the consultation take; how long will it last; who will be consulted; who will be responsible; and will the right hon. Lady take this opportunity to say that she will present the conclusions of the consultation in a statement to the House in a few months' time?

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

I know that many hon. Members of all parties want companies and boards to take action on the matter of big rewards for big failure, and they also want better and proportionate regulation. I do not believe in legislating without sensible consultation and consideration of how proposals would work.

We will publish a consultation document on this issue, I think in March. I certainly want to assess views about the changes that we have made already and which will come into effect for the next round of corporate AGMs. We will put forward the proposal made by the hon. Gentleman and variations on it. We will ask for views about whether further action, over and above what I have taken already, is required. If so, we will ask whether it should be along the lines suggested by him, or whether there are other possible ways forward. Although there is widespread support for the aims of his Bill, there are also widespread doubts about the means that he has chosen—overriding contracts that have been entered into—to achieve those aims. The TUC is one of the bodies concerned about the precedent that would be set.

There are a number of matters that need to be considered. We will have three months of consultation with everyone who has an interest in these matters and who would like to express a view. Of course I shall report the conclusions to the House.

Photo of Mr Alan Howarth Mr Alan Howarth Labour, Newport East

Will my right hon. Friend explain further why she has stopped short of proposing a ban on the provision by auditors of non-audit services such as consultancy services, which may be much more profitable than audit? Following the events at Enron and elsewhere, does she accept that confidence in the integrity of audit is undermined where there is evident conflict of interest? Does she accept that investor confidence is also undermined, with all the damage that that causes?

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

This is a matter of enormous interest, and one on which I have elaborated already. It has been looked at carefully by the various reviews. Clearly, as the co-ordinating group concluded, there are situations in which a ban would be appropriate. Those circumstances depend on the relationship between the client company and the audit firm, and the particular non-audit services that it is proposed will be bought. In some cases, a company will not be able to buy those non-audit services from its external auditor. In other cases, however, as Sir Robert Smith makes clear, there is no conflict of interest and so no risk of jeopardising the independence of the audit. In those cases, the expertise built up in the external audit may be valuable to the company and therefore help to strengthen its governance and its competitive success. That is why I do not think that the proper way forward is to write into the regulations a blanket ban. Instead, we must ensure—through the role of the audit committee on the company's side, and through the audit standards on the auditor's side—that we have the right balance. We must also ensure that the non-audit services are banned in those cases where that is required.

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

The pool of people qualified for non-executive positions is relatively small at present. If the role of non-executives is to become more onerous and demanding as a result of these recommendations, that pool could become even smaller. However, Mr. Higgs has also suggested that the boards will have to have more than 50 per cent. non-executive content. That could mean that boards will get larger. How will the Secretary of State tackle the significant concerns being raised by business that those possibly conflicting aims could lead to weaker, if not larger, boards?

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

There is a real problem with non-executive directors, especially in the larger companies, being drawn from such a small pool. The hon. Gentleman is right to say that the burden on any director of a firm is becoming increasingly difficult. We therefore need to widen the recruitment pool. It is pretty implausible to suggest that only the very small number of already existing non-executives are capable of carrying out that role.

We can widen the pool in two ways. First, a growing number of large and medium-sized companies regard a non-executive directorship as an important contribution to the professional and career development of younger executives. That means that the corporate governance of the smaller firms on which those younger executives cut their teeth will be strengthened, and also that the pool of people with the commercial experience needed by good non-executives of major companies in future will grow.

The other step that we are taking, as I have indicated, is to encourage firms appointing non-executive directors to look to the non-commercial sector. In the public services and the not-for-profit sector, there are large organisations such as NHS trusts that are responsible for very large sums of money. Their non-executive directors tend to be drawn from a rather more diverse community than their counterparts in FTSE 100 companies, and to have built up exactly the sort of expertise need by the boards of large listed companies.

Photo of Ms Linda Perham Ms Linda Perham Labour, Ilford North

As my right hon. Friend knows, I am interested in the issue of corporate governance and, with 20 or so other colleagues, made a submission on the White Paper. How will the measures that she has announced today fit in with the rest of the agenda for the reform of company law? Is it not a rather piecemeal approach if some reforms are introduced now, while others have to wait for the introduction of a new company law Bill?

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

I am grateful to my hon. Friend and the other hon. Members for their very detailed submission. I think that my hon. Friend is in part referring to the proposals for the operating and financial report that we made in the company law reform report. It is important that that enormous rewriting of the whole of our company law is all taken forward together, as we intend it will be, so that we can deal with the problem of 150 years' accumulation of company law, both statute and case law—and that is what we are doing, building on last year's White Paper. However, the package that I have announced today can in large part be taken forward by the actions that we have described in reorganising the Financial Reporting Council and the other bodies, and through the combined code and the audit standards that I have mentioned. They will complement and provide a solid foundation for the much larger reform of company law that is also coming.

Photo of Michael Weir Michael Weir Scottish National Party, Angus

The Secretary of State says that the provisions to reveal levels of dependency on single clients will at this stage be voluntary, but that she will consider legislation if necessary. Can she tell us more about how that will be reviewed? Obviously, it is important that any problems are revealed at an early stage. It would be a tragedy if we had to wait for another Enron-style debacle before new rules were brought in.

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

I think that the hon. Gentleman is referring to how we monitor the comply-or-explain provisions. The combined code on corporate governance is, of course, attached to the listing rules, so for large listed companies—that is what we are talking about here—the Financial Services Authority has responsibility in its role as the listing authority.

Photo of Jim Cousins Jim Cousins Labour, Newcastle upon Tyne Central

I congratulate my right hon. Friend on what she has said about the move away from self-regulation, but I want to return to the point about possible conflicts between audit and non-audit services, which is now being raised by hon. Members on both sides of the House. Does she not see that in sending out rather confusing signals about what may or may not be acceptable in future, she has lost the opportunity to make a clear-cut separation between external audit services, internal audit and consultancy? That distinction could help to create more competition, and to prevent the dangerous possibility of regulatory conflict for listed companies in Britain that also list in the United States.

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

I entirely agree with my hon. Friend about the importance of that point, but I do not think that we are sending out confusing signals. The report from the combined group is absolutely clear about that, and I have no doubt that the FRC will respond positively to the recommendations. I also stress to my hon. Friend the fact that the steps that we propose should be taken to ensure that there is much greater transparency in relation to where the audit firms get their income from.

All the recommendations about an annual report, about the disclosure of the fees received from a client where those exceed 5 per cent. of a firm's total fees, and about audit firms publishing information on how they manage auditor independence within the firm, together with relevant management and reward structures, will shine a bright spotlight on the practices of audit firms. They will also, I think, ensure that the separation of functions and the preservation of the independence and integrity of the audit, which is at the heart of both my hon. Friend's concerns and my own, will be delivered.

Photo of John Greenway John Greenway Conservative, Ryedale

Will the Secretary of State monitor the growing practice of the qualification of audit certificates, which is having adverse consequences for small businesses? I learned only this week that the Civil Aviation Authority is refusing to accept for the purposes of ATOL—air travel organisers' licensing—bonding accounts that have had a qualified audit statement. We understand why the auditors are doing that, but what is the small business supposed to do when its own auditor says, "I can only give a qualified statement, because that's what my professional body says I must do"? That is very difficult, and I would like the Secretary of State to look into the problem

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

The hon. Gentleman raises an important point. There is no doubt that since Enron, auditors have, not surprisingly, been much more cautious, so there is a much greater readiness to qualify accounts. I have not come across the particular problem that the hon. Gentleman raises concerning small firms that need ATOL bonding; of course I will look into that and also draw it to the attention of my right hon. Friend the Secretary of State for Transport.

Photo of Angela Eagle Angela Eagle Labour, Wallasey

I congratulate my right hon. Friend on her determination to bring forward quickly these sensible changes in the aftermath of the financial scandals that became apparent in the United States. Will she undertake to keep the new regulatory system under constant review, because ways of getting round regulations often demonstrate much more innovation among the rogues than we would like to see. If my right hon. Friend keeps such matters under constant review, we shall know that we have the best possible protection in this country, and that shareholders and investors can proceed with confidence.

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

I am grateful to my hon. Friend for her comments. I hope that the new structures that we are putting in place, especially the merger of the Accountancy Foundation and the FRC, will simply be able to settle down and get on with the job. It would be a great pity if we had to change those structures again in just a year or two. Within that framework, however, I agree that we must monitor the impact of the changes that we are making. The new unified regulator and the overarching council that we are establishing will be well placed to ensure that they are constantly monitoring and reporting on the impact of the strengthened ethics and the independent standards that are being put in place, as well as the strengthened and much more proactive enforcement and monitoring system involved.

Photo of Michael Moore Michael Moore Shadow Minister (Foreign and Commonwealth Affairs)

As a member of the Institute of Chartered Accountants of Scotland, I believe that the Secretary of State's proposals for audit and accountancy deserve strong support. In the current climate, however, does she not agree that public confidence in the reforms, particularly in the capital markets, will depend on their having an early statutory underpinning, and a funding basis independent of the accounting profession that is to be subject to the revised regulations?

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

I am grateful to the hon. Gentleman, with his expertise in such matters, for the welcome that he gives the proposals. Confidence in the system is crucial, and I think that we will achieve that. There is enormous consensus, especially with the regulators—the independent bodies—about what needs to be done, and that this package is the right one. He makes a strong case, as does the combined group, for a statutory underpinning for the new package, and the combined group has sketched out what that might look like. As he will know, there are very different views about which bits of the system should be underpinned by statute. I am sure that the House will groan if I announce yet another consultation—but we do need to take views on the details of what that statutory underpinning should concentrate on; we do not want to legislate unnecessarily. We will consult on that, and if we decide that it is necessary, we shall make proposals as quickly as we can.

Photo of Mr Nigel Beard Mr Nigel Beard Labour, Bexleyheath and Crayford

I congratulate my right hon. Friend on the statement, which I think will make a major contribution to securing the integrity of corporate finance. In the light of what happened with Equitable Life, and other difficulties in the insurance industry, will she consider whether the special risks of insurance require special treatment, both in accounting and in auditing?

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

That, of course, is a matter for the Financial Services Authority and I understand that it is looking at it already.

Photo of John Bercow John Bercow Conservative, Buckingham

Given that more than 100 companies with a full listing have a market capitalisation of less than £10 million, how does the right hon. Lady expect those businesses to comply with the Higgs requirements on non-executive directors?

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

As I said earlier, in some cases those companies will not comply with every aspect of the Higgs recommendations, and Derek Higgs makes it very clear that that is what he expects. His recommendations are drafted with proper regard for the fact that they will not fit those smaller listed companies, and the comply-or-explain provision works very well in enabling companies to say, "This particular recommendation"—on the number of independent directors, perhaps—"does not fit our circumstances, for this reason, and this is what we have done to ensure that we still have very strong corporate governance," which of course is what our shareholders expect.

Photo of Professor Ross Cranston Professor Ross Cranston Labour, Dudley North

I very much welcome the package that my right hon. Friend has announced. It is a sensible and measured approach. However, may I press her on the progress of the company law review? Although one always starts with self-regulation and the improvement of professional standards, at the end of the day one needs a modern legal framework to underpin directors' duties and to ensure that auditors' conflicts of interest are properly addressed.

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

I entirely agree with my hon. and learned Friend about the need for complete reform of our archaic company law, but it is of course a huge undertaking. It is very complicated. I am glad to say that the whole process of drafting the legislation is making very good progress and, as my hon. and learned Friend will be aware, we are consulting on many different aspects of the company law reform package at the moment. I hope that we shall be able to legislate on it just as quickly as possible.

Photo of Mark Hoban Mark Hoban Opposition Whip (Commons)

I have a declaration to make in that I am a non-practising chartered accountant. What estimate has the Secretary of State made of the additional costs that companies and auditors will have to bear as a consequence of the proposals? It strikes me that these, in addition to some of the proposals in the company law White Paper, will actually increase the costs of compliance to many businesses, and perhaps the extent to which those costs are disproportionate to the benefit that they bring.

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

The initial reaction that we have had, particularly from the large companies that are most affected, is that in most cases they are already in compliance with the bulk of, for instance, the Derek Higgs recommendations. I do not believe that the additional compliance costs will be substantial in most cases, if indeed there are additional compliance costs at all, but of course the FRC will be undertaking a proper regulatory impact assessment of the changes that it will be bringing forward.

Photo of Mr John Burnett Mr John Burnett Liberal Democrat, Torridge and West Devon

In the light of her statement, will the Secretary of State explain her Government's policies towards multidisciplinary professional practices, and does she believe that the description of an individual or a firm as an accountant or accountants should be reserved for those who have achieved professional qualifications, are subject to rigorous rules of practice and have adequate insurance?

Photo of Patricia Hewitt Patricia Hewitt Secretary of State, Department of Trade and Industry

As I think the hon. Gentleman knows, there is nothing in law at the moment that prescribes the use of the term "accountant" in the way that I think he is suggesting. This is really a matter for the professional bodies to take forward.