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'(1) Section 310 of the Companies Act 1985 (c 6) (provisions exempting officers and auditors from liability) is amended as follows.
(2) In subsection (2) delete "subsection" and insert "subsections".
(3) After subsection (3) insert—
"(4) A company may, in pursuance of such a provision, enter a contract with any such auditor to limit any liability which by virtue of any rule of law would otherwise attach to him in respect of any such negligence, default or breach of duty to an amount equal to the proportion of the total loss or damage suffered which is directly attributable to the negligence, default or breach of duty of the auditor having regard to the contribution to the loss or damage of any other person provided such contract is approved by members in general meeting".'.—[Mr. Andrew Mitchell.]
Brought up, and read the First time.
With this it will be convenient to discuss the following:
'(1) Section 310 of the Companies Act 1985 (c 6) (provisions exempting officers and auditors from liability) is amended as follows.
(2) In subsection (2) delete "subsection" and insert "subsections".
(3) After subsection (3) insert—
"(4) A company may, in pursuance of such a provision, enter a contract with any such auditor to limit any liability which by virtue of any rule of law would otherwise attach to him in respect of any such negligence, default or breach of duty to an amount equal to twenty times the fees paid in respect of the audit of the company, provided such contract is approved by members in general meeting.
(5) Where an act of negligence, default or breach of duty arises in two or more consecutive periods of account, the liability under subsection (5) shall be restricted to twenty times the average of the audit fee for the company for those periods of account".'.
New clause 3—Amendment of Companies Act 1985: limit on auditor's liability (No.3)—
'(1) Section 310 of the Companies Act 1985 (c 6) (provisions exempting officers and auditors from liability) is amended as follows.
(2) In subsection (2) delete "subsection" and insert "subsections".
(3) After subsection (3) insert—
"(4) A company may, in pursuance of such a provision, enter a contract with any such auditor to limit any liability which by virtue of any rule of law would otherwise attach to him in respect of any such negligence, default or breach of duty to the sum of £75 million.
(5) Where the company is a member of a group of companies the sum of £75 million shall be divided between members of the group pro rata to the audit fee charged to each company within the group, provided such contract is approved by members in general meeting.
(6) Where an act of negligence, default or breach of duty arises in two or more consecutive periods of account, the liability under subsection (4) shall be restricted to £75 million for those periods of account".'.
New clause 4—Amendment of Companies Act 1985: limit on auditor's liability (No.4)—
'Section 310(3) of the Companies Act 1985 (c 6) (provisions exempting officers and auditors from liability) is amended, by adding at the end—
"(iii) From entering a contract with its auditors to limit their liability in respect of any negligence, default or breach of duty provided such contract is approved by members in general meeting.".'.
New clause 5—Limit on auditor's liability (No.1)—
'The liability of an auditor which by virtue of any rule of law would otherwise attach to him in respect of negligence, default or breach of duty shall be limited to an amount equal to the proportion of the total loss or damage suffered which is directly attributable to the negligence, default or breach of duty of the auditor, having regard to the contribution to the loss or damage of any other person.'.
New clause 6—Limit on auditor's liability (No.2)—
'(1) The liability of an auditor which by virtue of any rule of law would otherwise attach to him in respect of any negligence, default or breach of duty shall be limited to an amount equal to twenty times the fees paid in respect of the audit of the company.
(2) Where an act of negligence, default or breach of duty arises in two or more consecutive periods of account, liability under subsection (1) shall be restricted to twenty times the average of the audit fee for the company for those periods of account.'.
New clause 7—Limit on auditor's liability (No.3)—
'(1) The liability of an auditor in respect of any liability which by virtue of any rule of law would otherwise attach to him in respect of any negligence, default or breach of duty shall be limited to the sum of £75 million.
(2) Where the company is a member of a group of companies, the sum of £75 million specified in subsection (1)(b) shall be divided between members of the group pro rata to the audit fee charged to each company within the group.'.
New clause 8—Limit on auditor's liability (No.4)—
'(1) The liability of an auditor in respect of any liability which by virtue of any rule of law would otherwise attach to him in respect of any negligence, default or breach of duty shall be limited to the lower of—
(a) an amount equal to the proportion of the total loss or damage suffered which is directly attributable to the negligence, default or breach of duty of the auditor having regard to the contribution to the loss or damage of any other person; and
(b) the sum of £75 million.
(2) Where the company is a member of a group of companies, the sum of £75 million specified in subsection (1)(b) shall be divided between members of the group pro rata to the audit fee charged to each company within the group.'.
New clause 10—Amendment of the Companies Act 1985: Exemption, indemnity and limits on auditor's liability—
'(1) Section 310 of the Companies Act 1985 (c.6) (provisions exempting offices and auditors from liability) is amended as follows.
(2) At the end of subsection (1) add—
"; but before considering any exemption, indemnity or limit on auditor liability, the auditors shall prepare a statement of terms for the approval of shareholders and the information of employees.
(2) A statement prepared in pursuance of subsection (1) shall—
(a) recognise a duty of care owed to each individual who is a shareholder or employee;
(b) recognise the auditor's duty to detect material fraud; and
(c) set out how the audit working papers and files to which any exemptions, indemnity or limit of liability is applied will be made fully available to the listing and regulatory authorities.".'.
I begin by drawing the House's attention to my interests, which are declared in the Register of Members' Interests. This is an interesting, complex and much discussed Bill, and on Second Reading I specified the matters of concern that the Opposition wished to discuss in Standing Committee. The matters that we have not brought back to the House for discussion on Report today include the independent monitoring of major audits, the levy, and the unduly burdensome and onerous obligations that the Bill places on those below board level.
In Committee, we also discussed the nature of disciplinary hearings, the effect on them of the European convention of human rights, and individuals' right to representation. The Committee divided on a number of these matters and in the votes on independent monitoring of major audits and on fair disciplinary hearings the Conservative Opposition had the support of Liberal Democrat Members. Unfortunately, we were not successful in either.
Conservative Members forced a vote on the levy without the support of Liberal Democrat Members. We believe the levy to be very burdensome for business, and the Government have said already that they expect there to be a 400 per cent. increase in the level. I am sorry to say that we were again unsuccessful in persuading the Government to move on that matter.
Many important matters were raised in the two days of Committee sittings, but the Minister showed herself to be unflinching, and she remained unmoved by the arguments that we presented. However, since then I have received a very decent letter from her, in which she accepted that the Opposition had identified one lacuna—as she called it—that will be put right today. Obviously we are grateful to her for that.
Today, we shall bring to the Floor of the House the issue of auditor liability, which is covered by these new clauses. We shall then spend some time on the extremely important question of the investigatory powers available to officials of the Department of Trade and Industry. Also, given that lack of time meant that we were unable fully to discuss part 2 of the Bill in Standing Committee, a probing amendment has been tabled to allow the House to discuss the question of community interest companies, if they so wish.
In general, the Bill is unexceptional and modest, but it does not touch on the really big question of auditor liability, even though the DTI consulted on it. The issue is rather like the elephant in the drawing room, in that the Government seem to want to ignore it.
The Opposition's concerns about liability have nothing to do with the auditing profession, which, as far as I know, is not a specific target for the Conservative party at the next general election. Indeed, I have spoken out on the Floor of the House against various tax schemes invented by auditors that deprive the Exchequer of national insurance and tax funds to which it is entitled. I yield to no one, therefore, in my vigorous distaste for sophisticated avoidance schemes. It is wrong, for example, for a doctor earning £60,000 or £70,000 a year to pay 40 per cent. income tax while a well paid and heavily bonused American banker working in the City does not.
The comments that I make today about auditing are not so much about the position of the auditing profession, but about the good and proper management of the UK corporate system. Apart from auditors, I can think of no other group in commercial life in Britain that can neither limit their liabilities through insurance nor by contract with their customers. Auditors, as far as I know, are the only group stuck in that position. They are in that position because of section 310 of the Companies Act 1985. The measure was first introduced in 1929—some 75 years ago—under a Conservative Government, as the Minister was kind enough to remind us in Committee, and was designed to deal with collusive relationships between companies and their auditors. Those relationships were at the expense of the shareholders and Parliament rightly decided that action should be taken.
It is bizarre that men and women in the auditing profession are asked to take on personal risks that the insurance market, with all its resources, experience and analysis, now says are unacceptable.
My hon. Friend is developing a powerful case. As I recall, the Government undertook a consultation online on the very issue of auditors' liability, which ended in March this year. If so, why have the Government not introduced any provisions in the Bill in that regard? One would have thought that they would have had ample time to have reached a conclusion on the consultation and included some provisions in the Bill, making new clause 1 unnecessary.
My right hon. Friend pre-empts much of my argument. It is at the heart of the Opposition's concerns about this Bill that the Government have yet to take action, which we believe is urgently needed, not in defence of auditors but in defence of the good governance of the British corporate system.
I remind the hon. Gentleman that the 1997 Labour manifesto contained a commitment to introduce limited liability partnerships. Such partnerships go a considerable way towards addressing some of the issues that he raises, and that commitment was put into law in 2000.
The hon. Gentleman is correct on those two points, but as I explained in Committee, they do not resolve the problems.
There are four major auditors left. It is common ground on both sides of the House that we need more auditors to enter the market. The big four audit all of the FTSE 100 companies and not quite all of the FTSE 350. We would like more of those who audit at the bottom end of the FTSE 350 to compete with the big four. The law, as the hon. Gentleman just pointed out, allows audit firms to be limited liability companies or limited liability partnerships. That provides some protection for firms and the capital invested by the partners. However, audit firms are funded entirely by their partners' capital, which has often to be borrowed from banks or through leasing agreements. Those frequently have to be guaranteed by the partners and that is why the legislation, although welcome, is not adequate.
I want to make two other points at this juncture. The first is to do with the law of joint and several liability and the second relates to the fact that only four firms in the world are capable of auditing our largest multinational companies.
The law of joint and several liability means that the audit firm is liable not only for its own negligence but also for that of other parties if it is unable to pay for the loss those other parties have caused. That is what hugely increases the jeopardy facing an audit firm. As there are only four firms, we need to ensure that they survive and prosper and, preferably, that others make the necessary investment, as I have just described.
The hon. Gentleman may be aware that in the United States the Federal Reserve has banned Ernst & Young from practising for six months, which has left only three of the major companies available in the US. As a consequence, that has helped smaller and medium-sized audit firms to expand their business. Is not that the opposite approach to the one he advocates?
Were one of the big four to go under, or be banned, in this country, I have no doubt at all that, within a short period, major public firms, with many shareholders and many pension funds invested, would be unable to secure an audit, so it would be most unwise to draw the hon. Lady's conclusion.
Let me give the House an example of the problem that must be addressed. Let us suppose that a major company is bankrupted because its directors either followed a disastrous strategy or had engaged in fraudulent behaviour, notwithstanding the era of shareholder activism, the work of the auditor and, of course, the new corporate governance codes that have been greatly strengthened by this and the last Government. Let us assume that the liquidator successfully sues the auditors and the directors for £1 billion—by no means the largest amount claimed by liquidators in broadly similar circumstances. Let us further assume that, between them, the directors have some insurance and some limited private assets but that that does no more than cover the legal costs and that the auditors are left with a bill for £1 billion, so they, too, are bankrupted.
It is clear that the directors in that case are to blame; they bear the greatest responsibility for having embarked on a strategy that failed and, in the circumstances I described, for perpetrating a cover-up.
I am trying to follow my hon. Friend's argument. He said that in those circumstances the auditors would be sued, but it would be perfectly possible for them to mount a defence.
It would, but because of the way in which joint and several liability works—the heart of my argument—the auditors would be held responsible in the circumstances I described. A judge might conclude that the directors were 90 per cent. to blame but that the auditors were 10 per cent. to blame, as they were responsible for failing to discover what had been going on. But for the law of joint and several liability, the auditors' liability would be £100 million—a large amount, but one that the big four could probably manage, even bearing in mind that they would also have to pay legal fees, regulatory fines and so on.
Could not the situation be worse than my hon. Friend describes? Under joint and several liability, the plaintiff can choose who to sue; he does not have to sue every person who may share responsibility, so it would be perfectly possible for a liquidator to mount an action against the auditors and not bother with the directors of the company.
I am having some difficulty following the argument about joint and several liability. Unless the auditors and the directors were in some way involved together in the situation that the hon. Gentleman describes, I do not see where joint and several liability would come into it. If, as he suggests, the directors were involved in fraudulent activity, that would be a separate matter from the auditors. Either the auditors would have to be involved in that activity, or—if my understanding is correct—they would be extremely negligent in not discovering an obvious liability. Would not that be the case?
I think that the hon. Gentleman's point was answered by the intervention made by my right hon. Friend Mr. Knight. Although I am reluctant to get involved in a detailed seminar on the workings of joint and several liability, my understanding is that my right hon. Friend is correct.
The Government rightly recognise that there is a real problem relating to stability in the audit profession. More important, there is a significant threat to UK capital markets, which is, I believe, why the Government launched their consultation in December 2003. The Department of Trade and Industry seemed to be conducting that consultation sensibly until the big feet of the Treasury intervened and a compromise deal was done: the Office of Fair Trading was to produce a report, and if it said that the result of the measures that the DTI was considering would promote competition—I argue that that is the case—all would be well, but if not, the DTI proposal could not proceed.
The OFT produced a report that was not one of its best, which commentators rightly branded suboptimal and which has led to an embarrassing stand-off between Treasury Ministers and DTI Ministers, who are red-faced and doubtless extremely irritated. The Opposition offered to go with the Minister for Industry and the Regions to a meeting with the Chancellor of the Exchequer during the Committee stage, to try to persuade him to listen to his DTI colleagues. The right hon. Lady has yet to take up that offer, but it remains on the table.
It is the duty of the Opposition to help out. It is bad government not to proceed; it will let down the business community, which could have serious consequences for business, savers and pensioners. We face the real prospect that the big four could become the big three and that a major company would be unable to obtain an audit. The Government are behaving like a rabbit caught in the headlights and it is time that they took action. That is why we have offered every possible way out of the problem that we can think of; we tabled amendments in Committee and have re-tabled today no fewer than eight new clauses and amendments. The Minister thus has a galaxy of choice and opportunity; she can choose which measure she wants to adopt. I hope that she will either make it clear that the Government will legislate with one of our proposals as soon as possible, or that she is moving towards a conclusion and will soon be able to announce to the House a programme for action.
New clause 1 would accommodate the Government's recent but much welcomed conversion to the concept of limiting auditors' liability on a proportionate basis by contract. Until recently, according to last December's DTI consultative document on director and auditor liability, the Government believed that the adoption of proportionate liability would need to be part of major reform of the law of negligence. As a result, the document concentrated on forms of monetary capping rather than examining proportionate liability. Although the document explicitly ruled out reform permitting proportionality, a large number of respondents volunteered the view that it was the solution that they most favoured. Indeed, it may be the widespread support for proportionality evident in the responses to the consultative document, which the Minister has most helpfully placed in the Library, that has led to the Government's new-found enthusiasm for proportionality. Whatever the reason for their conversion, it is extremely welcome.
The current system of joint and several liability, which I have set out, allows a claimant to sue any party who has contributed to their loss for the full amount of that loss, regardless of the extent to which that party was directly responsible. It is, of course, open to that party to sue all the other people who may have contributed to the loss, but if they have no money the first party has no redress.
To illustrate that point, I shall consider another example—the case between Equitable Life and Ernst & Young. I stress that I have no direct knowledge of the case, but I understand that the board of Equitable Life is suing Ernst & Young for £2.4 billion. I do not know whether those at Ernst & Young were negligent in their work, but, even if they were, it is inconceivable that they and they alone are responsible for the total loss suffered by the poor policyholders at Equitable Life. However, quite properly under current law, the board is suing those at Ernst & Young as though they were the only people involved. The board is doing so, I imagine, because it perceives that Ernst & Young has deep pockets.
Let us consider what would happen if Ernst & Young were bankrupted. First, Equitable Life policyholders would probably end up with far less than they would if Ernst & Young continued in business, simply because there would be many other creditors and no future income from which to pay them. Secondly, the 7,000 people employed by Ernst & Young in the UK would lose their jobs, and its 400 partners would lose their jobs and their capital as well. No doubt, some of those people would obtain employment, but many others would not.
The hon. Gentleman raises some interesting issues about one case—I certainly do not want to dwell on the case—but, surely, those are issues for the courts, not for the House of Commons. It is not for the House to ring-fence and protect some of the actors involved with special legislation.
The hon. Gentleman is entirely wrong on that point. The House determines the law and the courts interpret it. It is very much a matter for the House to consider whether the laws that we pass and the regulations that we make are in the best interests of the good governance of the British corporate system.
I am grateful to the hon. Gentleman for giving way to me again, but let me make the point clear. The new clauses that he proposes would entrench protection for one of the actors in such an action. How can it be right for the House of Commons to do that?
The hon. Gentleman's point is a matter for debate. If he catches your eye, Mr. Speaker, he will be able to progress that argument, but I do not agree with him.
Of greater significance—in no way do I ignore the current consequences for Equitable Life policyholders or the possible consequences for employees and partners at Ernst & Young—the bankruptcy of Ernst & Young would be a disaster for UK plc. The big four would become the big three, further restricting the choice of auditor available to our largest global companies. Ernst & Young's clients would have to find a new auditor, but it cannot be assumed that the remaining big three or the next tier of audit firms would necessarily wish to take on all Ernst & Young's clients. The shock waves from the collapse of a firm of Ernst & Young's size and stature would make the remaining firms even more risk adverse. It seems almost inevitable that some companies in the riskier segments of the marketplace would end up without an auditor. That would be a crisis for UK plc, and the Government would have the task of trying to find a solution.
It would not be possible to create a new global firm either by dividing the remaining big three in half or by forcing some of the mid-tier firms to merge. Neither route would create a new global auditor firm, with the global reach, specialist skills and ability to invest in new technology necessary to audit the largest multinational companies that make up the FTSE 100. The Government would, however, have to introduce liability reform if there were to be any hope that the remaining big three and the mid-tier firms would take on those audits that they would otherwise reject. It is never easy or sensible to legislate in a hurry. Rather than introducing reform in the midst of a crisis, it would be far better to do so now, before the crisis erupts.
Will my hon. Friend clarify a matter that may indicate whether Mr. Cousins made a valid point in his intervention? If my hon. Friend is arguing that we should accept new clause 1 and the associated new clauses, that is a perfectly legitimate point to make, but if he is urging us to accept new clause 1 and is saying that its operation should be retrospective, the hon. Gentleman's point might have some merit.
I reassure my right hon. Friend that I am certainly not suggesting that new clause 1 should apply retrospectively. I am trying to propose a range of different opportunities to resolve the problem. New clause 1 contains the solution that the Government will eventually reach—it is certainly my preferred solution—but it is not the only way to resolve the problem, as I shall attempt to persuade the House.
Permitting auditors to limit their liability by reference to proportionality does not remove financial risks from audit firms. Furthermore, proportionate liability does not guarantee the survival of an audit firm. In an extreme case, the loss caused by a firm's negligence could be greater than its financial resources. However, such liability would reduce significantly the likelihood of a catastrophic corporate failure bankrupting an audit firm, while making it far more attractive for some of the mid-tier firms to compete more vigorously to audit companies in the FTSE 350, and perhaps later, in the FTSE 100. For all those reasons, new clause 1, which would permit auditors to limit their liability by reference to proportionality, has a great deal to commend it, and I hope that the Government will at least accept the principle today if not the new clause.
I offer new clause 2 as an alternative approach. Although the Secretary of State for Trade and Industry has ruled out the introduction of a cap, she had concluded in favour of doing so until she learned of the Chancellor's strong opposition. The OFT confirms in its report, to which I referred a moment ago, that a cap set appropriately would not be anti-competitive, so clearly, any cap would have to be set by the Secretary of State or by someone else with delegated authority, such as the Financial Reporting Council. That would be necessary to ensure that the cap was set appropriately.
New clause 2 proposes to set the limit at twenty times the UK audit fees. I am not wedded to a multiple of twenty. Some have argued that it is too high and others have suggested that it is too low, but it represents an appropriate level, high enough to provide proper redress when something goes wrong and low enough to reduce significantly the possibility of a large claim bankrupting the auditors. There are not many providers of services and goods in the UK that face a penalty of twenty times.
Sometimes, a single failure at a certain moment gives rise to the audit failure. More often, however, the problem has arisen over several months or occasionally years, and it is necessary for that purpose to regard the failure as what the insurance industry calls a single event. In other words, if the auditors fail to detect a fraud that begins in one accounting period and it is detected in a later period, the auditor's liability would be limited to twenty times the average fees paid to it in those years. That is an important principle if we are to avoid double counting, and it forms the substance of new clause 2.
New clause 3 is similar to new clause 2, except that a single monetary sum—£75 million—would be imposed on all companies. PricewaterhouseCoopers suggested that sum in its response to the Government's consultative document. I am persuaded by its logic that £75 million is not an unreasonable figure. In its submission to the Department, it says:
"For all but the very largest companies, losses arising from an auditor's negligence are very unlikely to exceed this amount, so such claims would effectively not be capped. For the very largest companies, which give rise to risks of loss greater than £75 million, it is appropriate that they should carry the excess risk themselves. We further believe that a statutory cap at this level will improve the likelihood of mid-tier firms taking on larger audit engagements, thereby increasing choice in the marketplace."
The Government have made it clear that they expect any form of limitation of auditors' liability to be such that it promotes competition. I can certainly understand that a cap of more than £75 million would be so far in excess of the ability of mid-tier firms to meet an award of damages against them that it would do nothing to encourage them to compete for larger audits. Indeed, even for the big four, a settlement of damages much above that figure could be met only by the firm mortgaging its future, with the inevitable consequence that the firm would become unattractive to possible new partners and, indeed, many of its existing partners. Inevitably, therefore, in the long term, such a settlement would lead to terminal decline. Such a firm's ability to invest in new technology and in the development of the people whom it was able to retain would be severely damaged. That would not be in the interests of either competition or preserving high-quality audits, which are dependent on the involvement of high-quality people as audit partners and audit managers.
New clause 4 is both the simplest and most deregulatory measure in the group. It would permit a company to enter into any contract to limit liability with its auditors provided that shareholders approved such a contract in a general meeting. The requirement for any contract to limit auditors' liability to be approved by shareholders in such a meeting would address the abuse that gave rise to the provision in the Companies Act 1929 that I cited at the start of my speech, which eventually became section 310 of the Companies Act 1985. The measure was required because of directors and auditors who conspired to enter into cosy contracts to limit their liability that became known to shareholders only after a loss had been suffered and an action had been launched against the directors or auditors. No doubt some would argue that the 1929 Act would have been better if it had simply required such contracts to be approved by shareholders. In any event, 75 years later, in a radically different and more litigious and transparent age, we can ensure that any contract would be effective only if it were visible to, and approved by, shareholders.
Before my hon. Friend moves on from new clause 4, does he accept that there could be an alternative danger? A big four auditor could put huge pressure on a company by saying that it would withdraw its services unless the company approved such a contract in a general meeting.
My hon. Friend might be on to a good point, but once a new system were set up—albeit not necessarily that outlined in new clause 4—the risk of such an event would be less than he suggests.
New clauses 5, 6 and 7 effectively mirror new clauses 1, 2 and 3. However, they would impose a limitation by statute, whereas new clauses 1, 2 and 3 are permissive and would allow companies to limit auditors' liability by contract if shareholders so wished. New clause 8 combines the benefits of proportionality with those of a cap. It would provide for a belt-and-braces approach that would combine the equity of proportionality with the safety net of a cap to guard against a catastrophic claim.
We have tabled the eight new clauses to help the Government. Conservative Members have no vanity of authorship, so we are happy to be corrected by the many skilled officials and draftsmen who serve the Minister.
Several events have taken place since Committee. It was said in Committee that the Government would amend section 310 of the 1985 Act to permit auditors to limit their liability by contract with reference to proportionality if it were made clear that the audit profession, the business community and investor organisations supported it, and that such an amendment would enhance competition in the audit market and improve the quality of auditing. I understand that all those conditions have been satisfied—I shall deal with each in turn—yet the Government have failed to table an amendment to address the matter.
The Institute of Chartered Accountants in England and Wales, which represents the auditors of almost every listed company in the United Kingdom, supports proportionality by contract and has said that the big four and mid-tier audit firms, which are the actual auditors of the listed companies, support such reform. Other accounting bodies, especially the Institute of Chartered Accountants of Scotland, also support the reform. It is thus clear beyond doubt that the Government's first requirement that the audit profession supports the reform has been met. The CBI, which represents larger quoted companies, and the Quoted Companies Alliance, which represents smaller quoted companies, support the concept of auditors being permitted to limit their liability by reference to proportionality.
Would there not be a further benefit if liability could be limited by entering into free contractual negotiations because there would be no need to alter the law on negligence, which is a tort?
My right hon. Friend makes an extremely good point.
The Government's third requirement was support from the investment community. The Association of British Insurers, the National Association of Pension Funds and a substantial number of individual investment houses have made it clear that they support the principle of auditors being able to limit their liability by proportionality. However, they have said that they would need to see the fine detail of how such a proposal would work before finally committing themselves to it. That is perfectly reasonable, yet it provides absolutely no excuse for the Minister's failure to amend section 310 of the 1985 Act.
It had always been envisaged that the Financial Reporting Council, on which investors, businesses, the audit profession, the Financial Services Authority and the Government are represented, would oversee the detailed terms of clauses in an audit contract to limit liability, so there would be no question of anyone signing up to the proposition before seeing the detail. Furthermore, given that the appointment of auditors is subject to a shareholder vote at an annual general meeting, investors would always have the last word on the matter, so, as I say, the legitimate requirement of investors and others to see the fine detail before making a commitment should not be used as an excuse for failing to introduce enabling measures today.
I have always found it rather strange that the Government thought that enhancing competition in the audit market was a prerequisite for auditor liability reform. We need the UK's capital markets to be competitive and highly regarded. Sound financial reporting, backed by high-quality auditing, is a prerequisite for that, and it is clear that liability reform would improve the work of auditors. Contrary to the assertions of the Office of Fair Trading, it is clear that competition in the audit market would improve if liability reform were embraced. It would improve the chances of the existing big four avoiding catastrophic litigation, which could ultimately destroy them, and increase the likelihood of mid-tier firms being prepared to take on audits about which they had specialist knowledge and for which they had global reach, if necessary.
The final condition laid down by the Government was that liability reform should improve the quality of auditing. I understand that several useful discussions have taken place between the Institute of Chartered Accountants and the users of accounts on how there could be more innovation in audit reports, how further assurance could be provided and how better information for capital markets could be given within an appropriate liability regime. However, audit quality fundamentally depends on the quality of people in the auditing profession. There is no doubt that the risk of catastrophic litigation is a deterrent for high-quality people, so it is possible that quality will reduce if we do not have liability reform.
All the conditions that the Government laid down have been met, so if they prevaricate there is a risk that great damage could be caused to not only auditors— I accept that that might not worry every hon. Member—but financial stability, which should worry each and every one of us. Immensely damaging consequences would arise from the collapse of one of the big four or if a company were unable to find an auditor simply because the perceived risks associated with undertaking its audit were too great. Permitting auditors to limit their liabilities would not avoid those risks completely, but would significantly reduce their likelihood. The Government's failure to legislate is thus as irresponsible as it is disappointing.
It has reached my attention over the past few days that the situation might be getting even worse. I understand that the European Union transparency obligations directive will make the position and liability of auditors and directors more uncertain. It is arguable that the directive might make them liable to investors in general rather than just to existing shareholders, as is the case under current English law. Auditors can cap their liabilities in other states of the European Union. The Minister will know that in Germany the cap is set at €4 million per audit, which is £2.5 million. In Austria, it is a lesser sum of €350,000. In Greece, the cap is set at five times the salary of the president of the Supreme Court.
Auditors are liable to existing shareholders if they are negligent in their audit, but the transparency directive means that there is a risk that auditors could be liable to an investor who was not a shareholder when the audit certificate was given, but who became one subsequently on the basis of those accounts. In other words, a far bigger group of people could join in an action against the auditors.
These are dry but extremely serious matters. We have tried to help the Minister in Committee and today. We did not vote on the subject in Committee and are shocked at the way in which she and her colleagues have been treated by the Chancellor of the Exchequer and Treasury Ministers. If she can give a copper-bottomed assurance of action, with a time scale that satisfies us, that will suffice, but if she cannot, we shall put new clause 1 to the vote.
The debate is remarkable in that the Conservative party seeks to entrench the powers of a cartel by embedding new principles in legislation. To pray in aid the company laws of Greece to allow that to happen is a double conversion to more badness of an extraordinary kind.
I shall be frank. I see little requirement or necessity to consider the idea of limiting auditor liability. None the less, having regard to the debate on Second Reading and some of the discussions in Committee, it is clear that the Government are at least willing to consider the principle of limiting auditor liability in some form.
I am about to do so.
That limit on auditor liability could be achieved by one of the three methods outlined by the hon. Gentleman: proportionate liability, a cap on the sum or a system of contract between the company and its auditors. I remind him of the intervention by Mr. Fallon, who explained to him some of the risks and dangers in a system of limiting liability in a contract between a company and its auditors which could give the company's auditors an even greater control of its workings and their activities within it. That is a new and unfortunate principle. To entrench a cartel is one thing, but to entrench a cartel by giving it new rights over companies to enforce its will is wrong.
It is clear that the Government are considering the matter. We all know the way in which debates work. I thought that it might assist the Government, who are coming under intense pressure from one side of the argument, to consider opposite views and the factors that might be relevant were they minded to consider proportionate liability in the future. I have set out some of those factors in new clause 10 as a contribution to the debate.
I referred to a cartel, which is perhaps unkind but not untrue. The hon. Member for Sutton Coldfield said that the FTSE 100 companies are audited by the big four auditors. I am informed that all but eight of the FTSE 250 companies are audited by the big four. That looks like an embedded, entrenched and powerful cartel that has a stranglehold on the current marketplace, effectively barring access to smaller companies, many of which are not small by any normal judgment but small by comparison with the big four.
If limited liability were in place, might not the auditing work be more attractive to the smaller companies, which would enter the market?
Not if the limit on liability was carried out in the form of a contractual relationship between the auditor and company. That method of limiting liability gives the mechanism to entrench the existing cartel.
As for the financial cap, the Opposition's new clauses set a cap that would be way too high for most medium-sized firms to enter into if money were a consideration. So that is not a powerful argument. We are talking about a fundamental principle of British company law since at least 1948. In that year, the Government of the day—a Labour Government—agreed to the requirement that audits would be acceptable only if they were carried out by a limited range of firms. In effect, that gave the auditor firms a professional monopoly over such work.
The other part of that understanding, however, was that the moral hazard that was thereby created would be dealt with by exposing those auditor firms to the full test of absolute liability. That principle has guided the House in its discussions of the issues and through the company legislation of the 1980s steered by the Conservative party. That approach recognises that once we remove the fact of moral hazard, and if we are also prepared legally to entrench a cartel, we are moving in a profoundly wrong direction.
If the Government were tempted to limit liability a wide range of market actors should be able to contribute to that decision. Also underlying new clause 10 is the principle that the auditors owe a duty of care to people concerned with the company that they are auditing. I shall discuss the duty of care later, as it is a legally contested principle with a bearing on our debate. Finally, if we wish to limit liability, new clause 10 would give the regulator full and automatic right of access to all the documents and working papers of both the company and the audit firm. If, therefore, we go down the route of limited liability there must be an exchange—there must an increase in both the regulator's power and the ability of other market actors to contribute to the debate, and the duty of care that ought to guide the new relationships that are created should be much clearer.
Among the motives that underpin new clause 10 is a recognition of auditors' duty of care. Auditors' responsibility has been eroded by case law. Under the Caparo Industries judgment of 1990, auditors generally owe a duty of care to the company only as a legal person rather than to individual shareholders. The Law Lords further decided that the audit report was prepared to enable shareholders to exercise their rights as members of the company, and not to enable them to make any investment decisions. That reversal of the principle of the duty of care has had some unfortunate effects. It is doubtful whether we can always rely on audit reports to provide public actors, market participants, investors in the market and shareholders with a guide to what is going on in a company. Another legal judgment in 1996 held that auditors may be liable to third parties beyond the company and the auditor where
"the purpose of audit work has been widened so that it is no longer confined to the statutory one . . . and the auditor in all the circumstances ought to have regarded himself as carrying out the audit for the plaintiff's purpose as well as the company's."
Such circumstances, however, are rare, which is why I have sought to revisit the auditor's duty of care in new clause 10. If the Government wish to limit auditor liability, in exchange we should at least be able to re-establish the broad principle of the duty of care that existed before the Caparo judgment.
The Law Commission reviewed those issues in 1993 and 1996, and rejected the call for a cap on auditor liability. It concluded that
"we can find no principled arguments for a 'capping' system . . . that . . . cuts across a principle that a wrongdoer should compensate the plaintiff for loss caused by its tort or breach of contract".
It also said that a capping system would
"put the plaintiff at a disadvantage, since the cap would represent the upper limit in negotiations for a limit".
That demonstrates the unfortunate implications of the new clauses tabled by the hon. Member for Sutton Coldfield. The sum of £75 million in new clause 3, for example, would be significant in discussions and negotiations between companies and auditors. The Law Commission regarded
"the policy objections to joint and several liability to be at worst unproven and, at best, insufficiently convincing to merit a departure from the principle".
It responded to propaganda from the big four accountancy firms by arguing that it was
"misleading to say that defendants can currently be called on 'to provide 100 per cent. of the damages even though they are only 1 per cent. at fault' since the principle of joint and several liability is . . . relative to the plaintiff".
I made that point in an intervention on the hon. Gentleman.
The Limited Liability Partnerships Act 2000 passed by the Government increases the concessions and protection given to accountants. We have already moved a long way from the 1948 bargain, but very few of the concessions made in the intervening period have been accompanied by a compensating quid pro quo to increase the rights of companies, shareholders, employees and other market actors. If the Government embrace limited liability, new clause 10 would create a clear quid pro quo so that powers and rights are given to participants other than the big four accountancy firms.
I am listening carefully to the hon. Gentleman's argument, but what is the rationale in new clause 10 for extending the duty of care to existing shareholders, but not future shareholders who may rely on a previous auditor's report?
That point was covered backhandedly in the speech of the hon. Member for Sutton Coldfield, who rightly drew a distinction between the liabilities of auditors in mainland Europe and those of their British counterparts. In Europe, there are shallow financial penalties, but auditors can cast a wide net. The UK has evolved a different principle—auditors' rights and obligations are narrow but deep. I have therefore framed new clause 10 in a way that respects the traditional narrowness of obligation at the heart of the British approach. I do not want to move towards a mainland European system in which obligations are shallow but responsibilities are much wider. I want to maintain the traditional British principle of a network of narrow auditing obligations that are specific to a limited range of actors but have a deep application. I hope that that is helpful to the right hon. Gentleman.
Some of the mainland European principles that guide the connection between auditors and companies were prayed in aid by the hon. Gentleman to support his new clauses. However, they are full of bad consequences and under future legislation could allow all sorts of people to pursue action on various grounds against company auditors. My purpose, however, is to defend the traditional British principle of maintaining a pattern of narrow but deep obligations.
I do not want to detain the House too long. I have sought to put a contrary view to that being expressed by Conservative Members, and I have sought to introduce into the debate some discussion of issues that might be helpful to the Government when they consider their next moves on these matters. We should all bear in mind as legislators that major accountancy firms are sometimes fairly adept at non-co-operation with regulators. In the case of Parmalat, an Italian company, we heard recently that the UK parts of Parmalat were audited by a firm called Grant Thornton, but the firm says that the real auditor was Grant Thornton International, an Italian firm, and that the UK firm would not share its working papers and files with the regulators. That illustrates some of the mechanisms that auditors currently use to defend their position, without the House being motivated to entrench their powers still further.
I could go on at length, discussing some of the disciplinary schemes and some of the issues of Enron that have guided American legislation. I will not do so. Suffice it to say that when the hon. Gentleman says that the Institute of Chartered Accountants in England and Wales supports the principle of Parliament adding to the entrenchments of limits on auditor liability, it is difficult to avoid the conclusion that they would say that, wouldn't they?
If the House is minded to consider moving in the direction of further entrenching the powers of a cartel, it must also consider what additional rights it gives other actors in the situation to defend themselves and their interests. It must also make sure that we do not accidentally contrive a situation in which we agree to limitation by a contract between a company and an auditor that could result in new forms of blackmail being applied to companies in order to secure an audit. That would be wholly wrong. The House should never engage lightly in the entrenchment of cartels. When it does so, it should seek new rights and obligations in exchange.
Mr. Cousins mentioned Parmalat. I would have cited Parmalat as one of the special reasons why the Government should reform the present arrangements and support my hon. Friend Mr. Mitchell on new clause 1.
The hon. Member for Newcastle upon Tyne, Central also said that all our new clauses would strengthen what he described as the cartel of the big four companies. If that were the case, why would the organisations on the other side of the fence—the Federation of Small Businesses, the Institute of Directors and the CBI—be enthusiasts for reform of the law in this area? They would surely not campaign for a change if they thought it would be disadvantageous to them and strengthen the monopoly that the four major players had in the market.
The hon. Gentleman should also consider the comments of the hon. Member for Sutton Coldfield that some of the support given by those trade organisations to the idea of further limiting auditor liability is accompanied by all sorts of caveats about the need to consider the details. What will probably not commend itself to them is the principle of limiting auditor liability by a contract with the company.
I agree that the trade organisations will want to see the small print of the Government's proposals, but that does not affect the broad principle that all the organisations on the business side of the fence are keen on a change in the law. The hon. Gentleman cited the 1993 Law Commission report. The world has moved on considerably since 1993. Equitable Life, Enron and Parmalat are all major events that have happened since the Law Commission reported in 1993, and it must be right for us to look again at the issue. I cannot say whether the Government will go for new clause 1, 2, 3, 4 or any other of my hon. Friend's new clauses, but it is a matter of considerable urgency.
Much of the debate so far has revolved around the big four companies, the FTSE 100 and the FTSE 350 companies. However, the issue has an impact on many other companies in the wider market, particularly small and medium-sized business, organisations and charities, all of which must have their accounts audited. The additional costs of the risks involved flow down the chain to the prices that are charged by the medium-sized and even small firms of auditors. As we heard earlier, many partners in the large audit companies are required to borrow large sums in order to take up their partnerships. Because of the higher risk involved, the cost of borrowing that money is greater. The costs of auditing therefore rise, not just for the big firms, but for firms down the line.
For those reasons the Government should consider urgently the reform of the law. The Minister will know what businesses are saying to the Government. Every small and medium-sized business is complaining about additional cost and additional regulation. This year has been a vintage year for that, with the costs of meeting the requirements of the disability regulations, the costs of all the new employment regulations that have been heaped on businesses and the soaring costs of audits. Many medium-sized businesses are paying thousands of pounds a year in auditors' fees. That unnecessary burden should be addressed, which is why I support my hon. Friend's new clauses. For the benefit of the health of the smaller companies in our economy, reform is urgently needed.
I remind the House of my business interests recorded in the register.
Like Mr. Cousins, I initially found the new clauses somewhat unappetising. My hon. Friend Mr. Mitchell is vulnerable to the charge of entrenchment. No Member of the Opposition likes to be in the business of reinforcing cartels, and the hon. Member for Newcastle upon Tyne, Central was right to draw our attention to that.
It is dangerous to legislate because of a particular case: that of Equitable Life, which is before the courts. We should not legislate in advance of the case—my hon. Friend the Member for Sutton Coldfield assured us that the measure would not come into effect in time—and we should not legislate alongside it. If we did, we might well be asked why liability should be limited for auditors, rather than for the unfortunate shareholders in the event of the sort of catastrophic business failure to which he referred. However, I do not disparage my hon. Friend's motives. Clearly, if the big four were reduced to the big three, that in itself would reduce competition and choice for the large companies. There may well be other work that needs to be done to improve the audit marketplace, and the banks, insurance companies and lawyers may need to be better educated as to the merits of the mid-cap firms.
My hon. Friend the Member for Sutton Coldfield is in that position because we are not where we would like to be. Her Majesty's Government have, of course, reneged on their commitment, have not followed through on the consultation and, although we have yet to hear from the Minister, do not appear to be in a position to legislate. If the Department of Trade and Industry has failed to win its battle with the Treasury, and if the Government, who have a massive majority, cannot make up their mind on auditors' liability, my hon. Friend the Member for Sutton Coldfield is right to step into the breach and offer the House a range of alternatives.
I sympathise with new clause 10, which was tabled by the hon. Member for Newcastle upon Tyne, Central. However, the definition of the recognition of the duty of care is unclear, so I cannot support it without further detail as to how it would work, although I certainly applaud the motivation behind it.
On the alternatives—we are being offered a menu of hot and cold food—I do not set much store by new clause 4, which is naive. Perhaps my hon. Friend the Member for Sutton Coldfield has spent too long in merchant banking rather than the business world. In the real world, auditors would simply to say to firms, "This new companies legislation has come in, and unless you sign this kind of contract, you will lose us as your auditors." New clause 4 would put auditors in the driving seat.
The flaw in my hon. Friend's argument is that if new clause 4 became law, a thrusting, up and coming firm might say, "We will offer better contractual terms than the four auditors in the cartel." That would weaken the cartel, rather than strengthen it, and more big players would enter the arena.
My right hon. Friend and I share the objective of widening the audit marketplace for companies that are outside the FTSE 100, so I hope that that scenario would occur. Because firms do not change their auditors that often, however, the equal and opposite danger is that the auditor who holds the contract with a particular firm would simply go to the directors and say, "We are offering you this new contract because the new companies legislation has come in. We want you to put it to the general meeting in these terms; otherwise we will no longer be your auditor." My hon. Friend the Member for Sutton Coldfield has clearly toiled hard in the kitchen over his menu of options, but new clause 4 is not his best offering.
I say to my hon. Friend what I said to the Minister: it does not matter which of my new clauses you do not like, so long as you like one of them. We have tried to lay every possible option before the Commons today, so that hon. Members can make a decision. Saying nothing, a policy to which the Minister has been getting perilously close, is not an option, and that is the lacuna that we seek to address today.
I applaud my hon. Friend's hard work, but I want to comment on the individual options. We must choose one of the options, but new clause 4 is not the strongest.
I am not particularly attracted by new clauses 2 and 3, because a cash-terms cap is vulnerable to changing circumstances and nobody knows exactly how the mid-market audit firms will evolve. I am always suspicious when PricewaterhouseCoopers or any of the other large firms proposes a cash ceiling, and handling matters on a fee-related basis would not work either.
If the Minister does not come up with a solution, which she has promised and to which the Government were initially committed, the House must choose one of the options. As my hon. Friend Mr. Atkinson said, new clause 1, which is based on proportionality, has received support from not only PricewaterhouseCoopers, but across the business community and is therefore the least worst option. If my hon. Friend the Member for Sutton Coldfield were to press new clause 1, I would support him.
In a moment, I hope to congratulate the Minister on making a clear commitment to a solution along the lines of new clause 1, which, as Mr. Fallon said, is supported by much of the business world. I hope that the Minister will make such a commitment, because, as she knows, we need such a solution, which is why it is incumbent on her to accept new clause 1 or to make a precise commitment on when and how the solution will be produced.
We are all taken by the galaxy of choices offered by the hon. Member for Sutton Coldfield, who, like Father Christmas, has many tempting trinkets that glitter in front of our eyes, but a solution based on new clause 1 is the prize that we want. I hope that the Minister will respond positively; she knows that she should respond positively and that everybody is calling for such a response.
The debate has been interesting. I congratulate my hon. Friend Mr. Mitchell on having done his homework. I trust that the Minister has done her homework too, although Conservative Members fear that it has been retained on the desk of the Chancellor of the Exchequer. Mr. Cousins also made an interesting and thoughtful speech. If the Minister has other things to do this afternoon, she could rise to the Dispatch Box and indicate that she is minded in principle to accept one of the new clauses tabled my hon. Friend the Member for Sutton Coldfield, and we could all get away earlier.
It is odd that the DTI conducted a consultation on auditors' liability. The consultation commenced in December 2003 and specifically covered that issue. Responses were requested by
A full overhaul of company law is required and provisions such as the new clauses tabled by my hon. Friend the Member for Sutton Coldfield should be encompassed in wider company law legislation. I am therefore disappointed that the Government are seeking to proceed in one area, while we await whatever proposals they may have to change company law in the future.
My hon. Friend Mr. Fallon said that he was attracted to new clause 1, which I, too, find the most attractive of those tabled by my hon. Friend the Member for Sutton Coldfield. However, I do not share his concern about new clause 4, which could have the opposite effect to that which he suggests; that is, it could lead to mid-market firms entering the marketplace, thereby weakening the cartel that was mentioned by the hon. Member for Newcastle upon Tyne, Central. New clause 4 is not as bad as my hon. Friend suggests, because it seeks to allow free contractual relations to take place. The benefit of proceeding in that way is that the law on negligence does not need to be reviewed because free contracting parties are allowed to build into their agreements a scope on the limit of liability.
The hon. Member for Newcastle upon Tyne, Central spoke eloquently to his new clause 10. Looking at its precise wording, I see nothing that is incompatible with new clause 1; indeed, it could be a supplement to the provisions of new clauses 1 or 4. There is no conflict between taking a twin-track approach in allowing free contractual relations and imposing the duty, as would new clause 10, that before any exemption or contractual limitation is agreed, the shareholders and employees must have a statement. That would be a belt and braces approach. In supporting new clause 1, I am also somewhat attracted to new clause 10, which is in no way incompatible with the argument advanced by my hon. Friend the Member for Sutton Coldfield.
I am attracted to a duty of care provided that it is circumscribed and well defined so as to avoid court actions of the sort that take place all too often in the United States.
I hope that the Minister will be prepared to respond positively to the constructive suggestions that have been made, particularly by my hon. Friend the Member for Sutton Coldfield, and that she will tell us what action the Government intend to take.
In response to the opening remarks of Mr. Knight, I can think of nothing more rewarding or enjoyable to do this afternoon than to take part in the Report and Third Reading debates on this Bill. Having said that, I do not intend massively to extend the proceedings, because, as Mr. Mitchell said, we had a relatively short but good-natured and well-informed Committee stage in which we dealt with many important issues. That followed considerable scrutiny, and changes that the Government were willing to make, in the House of Lords.
With these new clauses, we return to the aspect of the Bill—auditor liability— that has given rise to the most significant debates, not least because the eight new clauses that the hon. Member for Sutton Coldfield has tabled for consideration today are those that we also debated at some length in Committee.
It is worthwhile returning to first principles. There is widespread agreement that audit plays a crucial role in our market and in ensuring trust and confidence in our businesses. It is therefore important, as Mr. Atkinson observed, that all those who need and want to access high-quality audit services are able to do so. We need to maintain a complete market in which the principles of competition ensure that completeness and help to drive quality through the system. In addition, we need to maintain, and preferably to improve, the quality of the audit process and of the information that is available to those who need it.
Those are the criteria by which we should judge any reforms that we make, and I shall use them to judge the eight different dishes that the hon. Member for Sutton Coldfield has served up to us.
I shall start with new clause 4 because it is the most straightforward. It would remove auditors from section 310 of the Companies Act 1985 and allow them to negotiate limited liability with their clients, free of statutory constraints and subject only to shareholder agreement to any proposed limitation of liability. The Government consultation considered a similar option and found that just over half of respondents were opposed to the proposal, partly for reasons that hon. Members rehearsed today.
Under that system, the market would set the level of any limit. That was a key fear of some of the respondents to the consultation. One major company commented:
"if the cap is left to individual negotiation, lack of competition would probably mean that the audit profession will push liability caps down over time".
Other respondents were concerned about the client's ability to negotiate an appropriate limit. There was concern that companies could find themselves in a weak bargaining position, particularly in situations where only a very few firms are capable of conducting the audit or where there have been past issues arising out of the audit. It is obviously important that the Government take note of those concerns and of the fact that more than half the respondents did not see this option as the way forward.
Furthermore—I hope that this is music to the ears of my hon. Friend the Member for Newcastle upon Tyne, Central, although I cannot promise to provide that all afternoon—we are conscious that the current rules were introduced in the late 1920s in the light of difficulties whereby directors and auditors had, in effect, colluded to the detriment of shareholders. We certainly do not want to see the return of those scandals.
New Clauses 2 and 6 would restrict, or permit restriction of, any liability to a figure of 20 times the audit fee, or—when the auditor has committed the same act of default in two or more consecutive audits—the average of the audit fee paid by the company in those periods. An upper ceiling set as a multiple of the audit fee has the merit of making the limit proportionate to the audit fee. However, it does not in any way reflect the loss caused to the company. To that extent, it is an entirely arbitrary figure in relation to any actual loss, and it will have arbitrary results.
At one extreme—where there are very high audit fees, for example—that approach could result in liability at levels that auditors suggest they cannot afford, thereby not solving the problem that hon. Members set out in the first place. At the other extreme, where there are low audit fees, it could mean investors being compensated for only a small proportion of the loss that they suffered through the auditor's negligence.
That dichotomy and problem cannot simply be addressed by changing the multiple from, for example, 20 to 10 or 20 to 40, because what improves the position at one end of the scale makes it worse at the other. That is a fundamental problem with the idea of a cap that reflects a multiple of the audit fee. It is of further concern that any limit that is based on a multiple of the audit fee would create a potential incentive for auditors to keep the fee as low as possible. At first sight, that might appear to be a good thing, but it is not in shareholders' interests for auditors to take short cuts. Indeed, under the regime set out in the new clauses, they have a positive interest in paying a high fee so that they can claim more back if things go wrong. It is therefore ironic that the new clauses could create a position whereby, because of the potential for claiming back in the case of a problem, the purchaser wishes to pay more than the supplier wants to charge.
The Government have considered the options in new clauses 2 and 6 carefully and concluded, again with the majority of the respondents to the consultation, that they are wrong in principle and in operation.
Let us consider new clauses 3 and 7, which, in some ways, are even more arbitrary in their effects. Under the proposals, the auditor's liability could or would be limited to £75 million. We have serious concerns that the approach would be anti-competitive. Some alternative arguments have been put today, but a major difference already exists between the big four audit firms and the next group, the so-called tier A firms, on the proposal. The Government have been told that a simple limit, which is fixed at a figure such as £75 million, would benefit the biggest firms but do little or nothing for some of the smaller and medium-sized firms, which risk being wiped out by such a sum. That approach could therefore entrench the current position and do nothing to aid our objective of enhancing competition in the audit market.The option clearly does not have the unanimous support of auditors, let alone investors. It is seriously flawed and the Government cannot accept it.
Let us consider new clauses 1 and 5, which, as hon. Members have said, are based on proportionality. New clause 8 mixes that idea with the sort of numerical cap against which I have just argued. New clauses 1, 5 and 8 raise more questions than they answer in running together contract and tort, and contribution between two or more liable people and that between company and auditor. However, despite the comments of the hon. Member for Sutton Coldfield on the disadvantages of the system of joint and several liability, I welcome his apparent agreement that any solution such as a proposal to limit liability proportionately by contract should be placed in the context of the current law on joint and several liability.
One of the attractions of a proposal to limit liability proportionately by contract is that it would not involve some of the much wider implications and unintended consequences of a full-scale reform of the law on joint and several liability but could enable the introduction of elements of proportionality.
The response to the proposals, especially in new clause 1, is that there may be scope in the system of joint and several liability for the auditors to limit their liability in some way to an amount that, in lay terms, is proportionate to their responsibility. That idea emerged in the course of our consultation. The Government did not present such a proposal for consultation but, as happens in good consultations, it emerged during the process and has rightly received serious consideration. It has come to be known as proportionate liability by contract.
It is relatively easy to understand how a system of proportionate liability by contract could work between professional advisers, albeit with shareholders or the liquidator bearing the risk that one or more of those who had been negligent are unable to pay their share of the sum involved. As I have made clear, the Government certainly does not rule out that approach. However, it raises many questions that we need to work through with companies, auditors and investors before reaching a conclusion and a way forward.
For example, what should happen when directors have been dishonest, the auditors have been negligent in not detecting the dishonesty, and the company has suffered further loss? It is possible to argue that the company would not have suffered such losses if the auditors had done their job. According to that logic, auditors should be responsible for all the loss that their negligence caused the company. However, that would not do much to reduce auditor liability.
Alternatively, one could argue that the shareholders were responsible for choosing the directors and ensuring the maintenance of proper systems of corporate governance and hence should bear the risk of the possible dishonesty of the people whom they choose for the job. Accordingly, the auditors should not be held responsible for any loss. I hasten to add that that is not an argument that the auditors wish to advance; it would deprive the audit of purpose. However, I hope that it demonstrates some of the difficulties.
There are key questions, such as: should auditor's liability vary according to how much money a negligent or fraudulent director can pay back, assuming that he can be found and has assets? How different is that from the current position? Should the auditor's maximum liability vary in some way according to the negligence of the conduct of the audit? Some recent cases show that simple slips can play a key part in leading to huge losses. Do the simple slips matter, or should we ask the courts to consider the whole question of how the audit was planned and conducted? What guidance can we give them to distinguish between an audit that was 10 per cent. flawed and one that was 5 per cent. flawed? Is it possible to have degrees of audit failure?
Those are not easy questions but that does not mean that they have no answers. However, new clauses 1, 5 and 8 propose no answers. The Government have therefore concluded that there are too many unanswered questions currently to ask hon. Members to approve any reform. Moreover, stakeholders have stressed that it is important that changes to the liability regime take place only as part of a package of reform in which both the audit's quality and competition in the audit market are enhanced. Indeed, there is no reason why work to improve further the quality of the audit should not proceed immediately, in parallel with consideration of the rules of liability. I am pleased about the proposals from the Institute of Chartered Accountants in England and Wales to which the hon. Member for Sutton Coldfield referred. That is a good sign of action to deal with quality of audit.
The Minister has explained at some length and helpfully some of the prevailing arguments about the difficulty of following the route of new clause 1. However, we are considering a companies audit measure. Is she genuinely claiming that it is not possible to propose such a package before the Government's Bill, which deals with audit, is passed?
I have pointed out some of the problems involved, and I am now going to talk about some of the possible solutions. While I cannot support any of the amendments that are before the House today, I am personally determined to make progress on these issues, not least because of the importance of maintaining confidence in the operation of our capital markets.
Since the House last debated this issue, in Committee on
In particular, it is crucial that we should be able to address the issues of competition as well as some of the issues raised in report of the Office of Fair Trading. It is only right, when we set up an independent competition authority, to take seriously the issues raised in such a report. The job now is to move from the principle that the approach involving proportionality by contract could well be the appropriate way forward, as the Government believe—I acknowledge that there is agreement in this regard—to the detail of how that will work, and the consequences that will ensue. To ensure that that happens, following further discussions involving officials, I plan to meet the key players personally soon, and I hope to gain an agreement that meets all their concerns. Urgent though the issue is, it is also important that we get this right.
If an appropriate package of reforms can be constructed in time—I reiterate my concern to ensure that that happens—the Government will aim to consult further next year on the details of proposals to be included in the forthcoming companies Bill. We have the opportunity to legislate at that time, and I will certainly work hard to ensure that we move from the principles on which there is agreement to the details that will enable us to take this issue forward.
I want to turn to the points raised by my hon. Friend the Member for Newcastle upon Tyne, Central. He has made clear his objectives. While he opposes caps on auditor liability, he believes that the law may be changed to permit auditors to limit their liability at some point in the future, and he is seeking to establish a framework within which any such limitation would operate. I agree with his desire to protect the interests of groups other than auditors, and I hope that I made that clear when I described the process that we have undertaken and will undertake as we go forward on these issues. He is not alone in having concerns in this regard. I have also explained that the Government are determined to protect the interests of all key stakeholders, including shareholders, in this work. The representatives of investing groups will also be fully involved and consulted.
My hon. Friend expressed his concern that proposals to limit auditor liability could lead to the entrenchment of cartels. I have made it clear on every occasion on which I have talked about this issue that the reason that we have already ruled out many of the more simple, unsophisticated limits and caps is that they would not help to improve competition and would therefore not fulfil our objective in that regard. I can assure my hon. Friend that the proposals that we introduce will ensure that competition is sustained and improved. The whole point of an approach involving a contract that limits liability proportionately with respect to responsibility is that it would not introduce a crude limit that would entrench or over-protect the position of auditors. Instead, it would enable liability to be more effectively divided in proportion to responsibility. That seems to be a reasonable way of going forward.
I am also grateful to my hon. Friend for raising the issue of audit working papers and files. He rightly said that, in order to maintain the quality and regulation of audit that we need, it is important that such documents should be available to the regulatory authorities. The work of all audit firms and individual auditors is subject to monitoring by their supervisory body, and part of the monitoring process consists of the review of audit working papers and files.
Clauses 1 and 2 of the Bill will ensure that the monitoring of the audits of listed companies, and other companies in whose financial condition there is a major public interest, is carried out independently of the supervisory bodies. We expect that this independent monitoring will be carried out by the audit inspection unit which will report to the professional oversight board for accountancy of the Financial Reporting Council. Clause 1 specifically requires supervisory bodies to have rules to ensure that the auditors registered with them
"take such steps as may be reasonably required of them" to enable their performance as auditors to be monitored. This will include making available audit working papers and files where these are required by the audit inspection unit.
The new power contained in clause 12 of the Bill will give the financial reporting review panel—the body authorised to investigate departures from the accounting requirements of the Companies Act 1985—the power to obtain information and explanations from, among others, the auditor of a company. I can confirm that auditors could be required to disclose audit working papers to the panel if those papers are reasonably required by the panel to carry out its statutory functions.
I thank the Minister for many of the things that she has said. May I press her, however, on whether the provision of a framework for the auditors' duty of care will form part of the debate that she expects to take place before the next companies Bill is introduced to address these issues?
I was just coming to that point. My hon. Friend has raised some important issues about the duty of care, but it is not the case that they have not already been considered in some detail by the company law review, which gave detailed consideration to the arguments—some of which my hon. Friend made—for extending the duty of care. The review consulted twice on possible ways of resolving the issues identified. Some of those were highlighted today by the right hon. Member for East Yorkshire, who said that he could see benefits in extending the duty of care but instantly provided caveats involving how broadly it should be extended and whom it should apply to.
Those are precisely the difficulties that resulted in the company law review—despite having consulted twice on ways of resolving these issues—concluding that it did not believe that the case had been made for the statutory extension of the duty of care of auditors. That is why the Government's own consultation sought further views on this matter—the majority of respondents were opposed to any change—and why my right hon. Friend the Secretary of State therefore announced to the House on
To conclude, I hope that hon. Members feel that we have given serious consideration to the issues raised during this debate. We have made considerable progress. I am committed to ensuring that that progress continues, and we have the ability, and I hope that we will have the wherewithal, to legislate in the draft companies Bill next year on the basis of an agreement not only on the principles but on the detail as to how we can make the proposals work.
This has been a most interesting debate on an important matter. It is important that those outside the House see that such issues are properly addressed in this place.
Mr. Cousins, who has a longstanding interest in these matters, mentioned the issue of duty of care. The suggestion that the auditor's duty of care should be extended has been subject to much discussion and was one of the matters on which the Department of Trade and Industry consulted. The overwhelming response, not just from the auditing profession but from business and investor organisations, was that the present system had much to commend it, and that widening the duty of care would not, overall, bring benefit to investors. As far as employees are concerned, their remedy, of course, is related to the company, and I am pleased that the Minister has wisely said that she does not intend to alter the duty of care of an auditor. On that point, I am happy to support the DTI.
The hon. Member for Newcastle upon Tyne, Central spoke about the dangers of entrenching a cartel, which was also a point made by my hon. Friend Mr. Fallon. I assure both of them that that is not my intention. I want to widen competition, and there is nothing between the Opposition and the Government on that point. My hon. Friend Mr. Atkinson signalled widespread support for the reforms but warned against the costs and burdens imposed all too readily, sadly, by this Government on business.
My hon. Friend the Member for Sevenoaks made several other points: he went through the menu that I put before the House this afternoon, and selected new clause 1. The concern about one of the big four going bust is that major public companies will not get an audit as a result. That has significant implications for pensioners, the work force, customers and dependants. That is at the heart of our argument.
Brian Cotter who spoke for the Liberal Democrats and whom I thank for his kind comments, urged the Minister to give in to my advances and also selected new clause 1. My right hon. Friend Mr. Knight spoke up for good government, and showed that not only does he have the eye of an extremely able lawyer but, as a distinguished former Government Deputy Chief Whip and DTI Minister, that he understands the importance of the provisions that we are debating today. He said that he awaits the wider Bill, subject to the company law review, and in that respect he joins almost everyone else in the House.
The Minister came tantalisingly close to agreeing with the view put by the Opposition and the Liberal Democrats. She undertook a tour d'horizon of the argument. She went through the new clauses, which we tabled today, and gave the House a dissertation on the choice. I fully accept that she and her colleagues have seriously examined the arguments and the new clauses, and I agree with much of what she said. I accept her point that the £75 million cap might be anti-competitive—this is a case of trying to examine all the possible options in a clear-sighted way. She, like many others in the debate, came down on the side of limiting liability proportionately and by contract. But having come tantalisingly close, she then proceeded—to use what I believe is the military metaphor—to lay down smoke, and started talking about the number of important and fringe issues affecting the debate, and the issue of how to measure the degree of audit failure. She teased me with the fact that while in this Bill she could not come forward with a new clause, she was absolutely committed to a package of reforms for another Bill later in the Parliament.
Clearly, the House feels that new clause 1 is the best way of resolving this matter. Certainly, the business community, those who speak for the investor community and investors themselves feel that. The regulatory and professional bodies feel that. In fact, everyone apart from the hon. Member for Newcastle upon Tyne, Central feels that. If I have read the comments of the Secretary of State aright, and if I have interpreted the Minister's body language correctly, it is new clause 1 that basically takes her fancy. To strengthen her position in her negotiations with the Treasury, I hope that she and her colleagues will remonstrate vigorously with the Chancellor over the embarrassment that he is causing to the Department of Trade and Industry team and the irritation of the business community, as she knows well that the blame for the embarrassment that she is about to be caused rests fairly and squarely with him. Even so, it is right that we should test this matter out and put new clause 1 to the vote.