Public Limited Companies (Financial Regulation)

– in Westminster Hall at 12:00 am on 13th March 2003.

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[Relevant documents: Sixth report from the Treasury Committee, Session 2001–02, HC 758, and the Government's response thereto, Thirteenth Special Report from the Treasury Committee, Session 2001-02, HC 1219]

Motion made, and Question proposed, That the sitting be now adjourned.—[Mr. Sutcliffe.]

Photo of John McFall John McFall Chair, Treasury Committee 2:30 pm, 13th March 2003

It is a pleasure to open the debate on a report by the Select Committee on the Treasury into the financial regulation of public limited companies, which was published in February last year. I speak on behalf of the Committee, and it is gratifying to know that we were the first to look into such matters and that everything has flowed from that, although my hon. Friend the Financial Secretary to the Treasury may not see it exactly in those terms. We undertook the inquiry because of a remark made by the chairman of the Financial Services Authority in New York at the World Economic Development Forum, when he said that the only honest answer to whether an Enron could happen here was yes.

If an Enron could happen here, it is important that proper procedures are in place for corporate governance, accountancy, auditors and everything related to business. The Committee took oral evidence from the Accounting Standards Board, the Institute of Chartered Accountants in England and Wales, the Department of Trade and Industry, the Treasury and the Financial Services Authority. We are aware that since then the Government have set up various other relevant reviews, which include the co-ordinating group on auditing and accounting issues, which is chaired by my hon. Friend the Financial Secretary and her counterpart at the Department of Trade and Industry, as well as the review of company law that had been under way since 1998, which reported in 2001.

We now have the Government's White Paper, "Modernising Company Law"—published in July 2002—which is concerned with the implementation of the review's proposals, and which, as a result of my Committee looking into the issue, could be best served by pre-legislative scrutiny. If my Committee could play a role in such matters, we would be happy. We need to put such company law on the statute book.

I was encouraged by the Government's response to my Committee's report, and by the Secretary of State for Trade and Industry when she responded in January to the four main reports: the Higgs review, the Robert Smith report, the report of the co-ordinating group and the review of the regulated regime of the accountancy profession. We welcome the fact that the Government's response was mainly positive. One glaring element is that there are 23 regulatory bodies for the accounting profession. If that is not a recipe for chaos, what is? Will the Financial Secretary simplify the procedure as much as possible, because it creates a fog which few people can see their way through?

The Treasury Committee considered the rotation of auditors. At the time, the knee-jerk reaction was that it should be mandatory that auditors should be rotated. My Committee did not advance that argument. We listened carefully to the views expressed and were aware of the good relationship that existed between several auditors and companies. In addition, the complexity of companies prevents an auditor from coming in for a year or two and then departing, because the baton would then have to be picked up by another auditor. We are suggesting auditor rotation and a role for the audit committee. It should look into the issue and make a statement in the annual report, thereby explaining itself to the public. That would be a way forward.

One thing that struck the Treasury Committee about the Enron debacle was that the audit committee was chaired by the professor of accounting at Texas university and one of its members was a British ex-Cabinet Minister who also happened to be an accountant. There is still an awful lot of work to do with regard to audit committees, and the Select Committee considered transparency and publicity a good way forward.

Photo of Nick Palmer Nick Palmer Labour, Broxtowe

Does my hon. Friend agree that although the Select Committee was unanimous it was to some extent putting the auditing profession on notice? If we continue to experience events such as what happened with Enron, the pressure for compulsory rotation may become irresistible.

Photo of John McFall John McFall Chair, Treasury Committee

I entirely agree. Only today, The Times business section carries an article by Chris Quick, the finance and accountancy correspondent, who is also the editor of Accountancy magazine. He states:

"In a recent survey carried out by Accountancy magazine, we found that 53 of the 59 chartered accountant finance directors of the FTSE 100 are alumni of the big four accountancy firms—PricewaterhouseCoopers, Deloitte and Touche, KPMG and Ernst and Young. The survey also found that 18 FTSE 100 companies used the old firm of a chartered accountant director as their auditor."

The notion of old boy networks, as the article calls them, is alive and kicking in spite of the new rules. Those companies have to come up to scratch, and if they do not, legislation should be introduced.

The Committee looked at the big four firms. The chief executive of the Financial Services Authority, Sir Howard Davies, said that certain specialised work is left to one or two of the big firms, the result of which is that there is no competition in the industry. The Minister will note that in our report we ask the Government to refer the big four to the Competition Commission. I fear that that sent a shiver down Ministers' spines, but they should stiffen them. There is insufficient competition in the industry, which does not serve it well.

Sir David Tweedie, who is the president of the International Accounting Standards Board, gave evidence to the Committee. My colleagues and I commend Sir David for his expertise, competence and honesty. He stated that a review of accountancy on the issue of stock options was being held back in the United States by a number of chief executives. He gave us a stark warning: the chief executives of 70 per cent. of the listed companies in America use stock options, largely to inflate share prices so that they, their sons and daughters and their grandchildren can live a life of luxury. Stock options are used at the expense of the company. Those are not my words, but those of Sir David Tweedie—hon. Members can read them in the transcript of the Committee. He suggests that the issue of stock options should be firmly addressed in the United Kingdom. Stock options should be written down as an expense; if they are not, the well-being and long-term future of companies will be at risk. Such a warning to the Minister from someone so eminent is important.

The Select Committee also touched on corporate governance. Sir John Bourn, the Comptroller and Auditor General, suggested that non-executive directors should report on a range of matters relating to the audit. He added that

"the external auditor should know that this discussion with the non-executive directors is an important part of his work, and that his ability to satisfy the non-executive directors is crucial in the determination of whether he stays the external auditor."

Sir John's comments take us into the wider area of corporate governance and the Higgs report. Derek Higgs opens his report by quoting from what Walter Bagehot said in 1867.

"We must not let daylight in upon the magic".

Higgs continues:

"In the corporate boardroom, the importance of non-executive directors should be recognised, but their role, perhaps like that of the monarchy of old, is largely invisible and poorly understood."

That should be the starting point for our Committee. Perhaps the role of non-executive directors is largely invisible and poorly understood.

Warren Buffet, the second richest man in the world, made some critical remarks the other day. During the past 37 years, Warren Buffet's company has delivered an annual return of 22.6 per cent., and its book value has increased by 194,000 per cent., He is someone in the financial markets who knows what he is talking about. He was very scathing about the broad sweep of boardroom behaviour, saying:

"It is almost impossible in a boardroom populated by well-mannered people to raise the question of whether the CEO should be replaced. It's equally awkward to question a proposed acquisition that has been endorsed by the CEO, particularly when his inside staff and outside advisers are present and unanimously support his decision. (They wouldn't be in the room if they didn't.) Finally, when the compensation committee, armed, as always, with support from a high-paid consultant reports on a mega-grant of options to the CEO, it would be like belching at the dinner table for a director to suggest that the committee reconsider."

When Warren Buffet says that directors should be independent, but far too few are business-savvy, interested and shareholder orientated, it is time for reflection, which is where Higgs comes in. He advocates that FTSE 100 executives should not hold more than one additional non-executive position, that chief executives should not step up to being chairman of the same company, that a new post of senior independent director should be established—a non-executive director who would be readily available to meet shareholders—and that more than half of the board should be independent.

Higgs mentions several other areas of concern and asks British business to take this opportunity to change voluntarily. That is the key. His suggestions are not mandatory, but come from an individual who has spent a lifetime in business. Sadly, the business community does not seem to have taken the opportunity. I picked up my copy of The Sunday Telegraph a few weeks ago, and read the headlines: "FTSE 100 chairmen fight back against Higgs" and "The revolting chairmen". A survey in The Sunday Telegraph found that 90 per cent. of chairmen did not want their senior non-executive directors to play an increased role in liaising with shareholders.

I was interested to see a quote by Gerry Robinson, the chairman of Allied Domecq, a whisky company based in my constituency. I have served the company's interests well in my 16 years in Parliament, working alongside its management and workers and the surrounding community. Gerry Robinson is quoted as saying:

"Higgs increases the separation and isolation of non-execs and execs on a board. I don't believe for one moment it stops those people determined to feather their own nests or behave improperly. The whole issue of trying to get corporate governance bolted down is illusory."

That comment comes from the eminent chairman of a FTSE 100 company, so goodness help us. We need corporate governance to be bolted down for the sake of the economy, business and our prosperity. It makes me think that some of these chief executives live in a world of their own. That reminded me of the opposition from business, which echoed previous criticisms of Cadbury, Greenbury and Hampel's reviews of corporate governance. Those reviews led to reforms that are now widely accepted and are in practice. There is no problem with them.

In order to find out Gerry Robinson's full views on the issue, I wrote to him on 17 September. I included a copy of our report and asked for his comments. On 7 March, I asked my secretary whether she had had any reply, and she said no. I told her to telephone him again, so she called the head office in London, and was told that she would have to direct anything through a Mrs. Vivian Kray, the secretary to the chief executive, Philip Bowman. No one would give us a contact number or address for the chairman of the company. Realising that Mr. Robinson was, in his own words, both "separated and isolated", I asked my secretary to give him my London address and my e-mail address, but sadly I have had no response from the FTSE 100 company chairman. I will send him a copy of today's Hansard and see whether that elicits a response. I have here a newspaper article in which FTSE 100 chairmen are being vitriolic about the voluntary system and say that they cannot engage in the debate. That ain't fair play. We need to ensure that they can.

Certainly, Mr. Digby Jones of the Confederation of British Industry tried to engage in the debate; he sent around a questionnaire that involved box-ticking. By the way, he once commented that as the Higgs report was all about box-ticking, he did not want it. However, I have the CBI survey here, and it involves fully coloured box-ticking, as hon. Members can see. Digby sometimes reminds me of something we say in Scotland—sometimes he lets his belly rumble, and then he talks. This is a classic example of that.

Martin Dickson, in the Financial Times, said that the value of the CBI survey was undermined by the fact that Digby Jones was either misreading what Higgs proposed or, God forbid, mischievously twisting it for his own political ammunition. Where does the balance lie with Higgs, and what is it that the CBI and the FTSE 100 directors fear? Martin Dickson says that Mr. Jones thundered that

"only in exceptional circumstances, when normal channels of communication have broken down, should the Sid"— that is, a senior director—

"be available privately for shareholders to voice concerns."

The message for Digby is:

"This is how the governance of modern major companies already operates", and that is how Higgs proposes that it should continue.

The report says that the senior director should be available to shareholders

"if they have reason for concern that contact through the normal channels of chairman or chief executive has failed to resolve".

In other words, the senior director post remains a long stop. Digby Jones says that the senior director

"should not open up a separate and potentially divisive channel of communication with shareholders or have responsibility for reporting back to the other non executives on an exclusive basis" but the Higgs report does not suggest that senior directors should be a separate channel. He merely proposes that they attend enough management meetings with shareholders to understand their concerns. The role is clearly passive and involves listening; that is eminently sensible. That is the point of the senior director, both now and as stated in the Higgs framework.

The senior director's other two proposed functions are hardly revolutionary. One function is to chair a meeting of independent directors without the chairman once a year, and the other is to report to other non-executive directors on what shareholders are thinking. Some CBI members fear that that could undermine the chairman, but there is a perfectly respectable view that some chairmen are undermining their own companies because of the present lack of scrutiny. We need not think further back than Marconi. Lord Simpson and John Mayo took nearly £4 million when they left, and both later challenged Marconi for increased pension rights. Those individuals—and Lord Simpson was chief executive of Marconi—went on a spending spree of £4 billion and ended up reducing the value of the company from £34 billion to £66 million, a fall equivalent to a pukka blue-chip company turning into a scrap yard. That is what happened to Marconi, yet its executives left with enhanced pay. That is now a big issue, and perhaps it is what the FTSE 100 directors are afraid of. However, they should express their concerns much more explicitly. The issue of executive pay and fair remuneration is at the heart of the debate.

I have taken a look at the statistics for top executives' pay. In 2001 it rose by 17 per cent., which was six times the national average. That followed increases of 28 per cent. in 2000, and 16.5 per cent. the previous year. Those directors could validly be charged with living in a world of their own, divorced from the rest of society.

That explosion of top pay has social effects. The message that it sends is that one gets handsomely compensated for failing as well as for succeeding, because during the period when top executive pay increased to that extent, the FTSE 100 index lost nearly one third of its value and inflation and earnings growth were running at an all-time low. Earnings growth fell from 5 per cent. in December 2000 to 3.4 per cent. a year later, which was the lowest figure for 35 years.

Photo of Nick Palmer Nick Palmer Labour, Broxtowe

Does my hon. Friend agree that one of the key problems is that the directorships of FTSE 100 companies constitute a very small market and that the salaries involved are a relatively small proportion of the turnover of the companies? For that reason, there is always a temptation for the managing boards to say, "Let's try to outbid our competitors so that we can get this person whom we have heard is good," and that process amounts simply to bidding up demand for a small pool of people who have not been particularly successful. Perhaps companies should recruit talent from a wider pool rather than simply paying more for people whom they already know.

Photo of John McFall John McFall Chair, Treasury Committee

I could not agree more with my hon. Friend, and his contribution leads me on to the next part of my speech. Last year more than 130 FTSE 100 directors were paid more than £1 million. The average chief executive salary was £933,000 in 2001. Chief executives earn 15 to 20 times more than a Member of Parliament and 10 times more than the Prime Minister—and they do not want non-executive directors to talk to their shareholders in case it undermines them. If Members of Parliament could prevent people from talking to us and complaining when we go back to our constituencies, what a lovely life it would be.

When we write to chief executives—as I have done over the past few weeks—we cannot reach them. I said to my secretary, "Could you ask for the Pope's telephone number?"—we might have had a better chance of getting that than the number of a chief executive. They live in fairyland, and they must be taken out of it. We must get them out of "Sesame Street" and into "Westminster Street" and the high street.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster

The hon. Gentleman is confusing the role of the chief executive with that of the chairman. The objection—which in my view is right—is that if there is a problem in a company that is riven by disputes, a senior non-executive director who is in a high profile position involving news in the press could have the opportunity of having a direct link with shareholders. That could undermine the chairman's role, rather than that of the chief executive, as the hon. Gentleman suggested when he compared the large salaries. It is also only fair to draw a distinction between the very high salaries of chief executives and the relatively modest remuneration of many chairmen of FTSE 100 companies.

Photo of John McFall John McFall Chair, Treasury Committee

I would not say that the issue is the remuneration of chairmen. Why should talking to shareholders undermine the chairman's role? I have sought high and low for the answer to that question and cannot find it.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster

In a high-profile, Marconi-type situation—although Marconi is no longer in the FTSE 100—in which the press are keen to find out the exact problems in a company, one quickly sees a massive division between on one side the chairman and executive directors, and on the other the senior non-executive director, who has souped-up, post-Higgs rights and responsibilities. That would not be an ideal battleground on which a company could continue to thrive. In such large companies, tens of thousands of jobs could be at stake if a company's fortunes were undermined in such a way.

Photo of John McFall John McFall Chair, Treasury Committee

I cannot fully understand what the hon. Gentleman is saying, but I shall be happy to listen to him at a later date. His intervention raises this fundamental question: who owns companies? It is not the chairman or the chief executive; thousands of us indirectly own companies through our pension funds and savings.

Many years ago, people were appointed, not elected, to Parliament. They did not fancy having people come in and question them in public. Now questioning is a natural part of our disposition. We are questioned on everything because we are elected by thousands of people who have a link with us. The same is true of companies. Thousands of us indirectly own those companies, and it is correct for chairmen and chief executives to open channels with shareholders.

As for non-executive directors, I would not take such a post unless I had access to independent advice to balance the advice that the chief executive and chairman gave me. The chief executive, the chairman and I would want to arrive at the same end point, but perhaps we would have different starting points. Increased scrutiny and transparency are extremely important.

We need to find more non-executive directors because we have been bad at finding good ones. When I looked up the statistics on non-executive directors, I found that more than half of them never receive a formal appraisal of their work. When they were asked, more than two thirds said that they would want such an appraisal. Half the current non-executives were recruited through friendship rather than assessment, which means that we have not got it right. When only 4 per cent. of them have had a formal interview, there is a long way to go on the other 96 per cent.

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

The hon. Gentleman refers to people being appointed through friendship, which is slightly misleading. In my experience, rather than friendship in the normal sense, the connection is an acquaintance through the industry. You therefore tend to get people being appointed within an industry. There may be an argument for widening those appointments, but at the same time to use the word "friendship" in a derogatory way is misleading.

Photo of Mr John McWilliam Mr John McWilliam Labour, Blaydon

Order. I presume that the hon. Gentleman received the same letter from Mr. Speaker that I did. When he uses the word "you", he is referring to me, and I have done no such thing.

Photo of John McFall John McFall Chair, Treasury Committee

I can use an analogy involving the Conservative party. At the time of Sir Alec Douglas-Home, Macmillan and others, men in grey suits appointed Prime Ministers. When someone left the post, a new man took over when a man in a grey suit said, "Go!" The Conservative party has changed its practice, and I assume that the hon. Gentleman himself would not have been selected without a formal interview. Why can chief executives not have formal interviews? Only 4 per cent. of them have formal interviews. Let us get into the real world. The Conservatives have started to get into the real world—I am not saying that they have fully got there. I say to business, "Get yourselves into reality. Come into the 21st century."

My hon. Friend Dr. Palmer referred to executive pay and efficiency. I shall refer to some of the directors of FTSE 100 companies who were paid more than £1 million last year. Ken Berry was fired from EMI with £6.1 million for failing to find new acts. I would love to fail to find new acts if I could be given £6.1 million. British Sky Broadcasting was the fifth worst performer in the survey to which I referred, but Tony Ball received £7.8 million. Sir Peter Bonfield left BT as a failure and received £3.74 million. The link between executive pay and efficiency is important when considering not only fairness but efficiency, because we want good, well managed companies with better growth and a better standard of living for our citizens. We do not get that because the interests of consumers and society are not best served by the present situation.

I suggest to my hon. Friend the Financial Secretary that what we have done is helpful to the Government. We are asking her and her fellow Ministers to stand firm because the proposals are sensible and voluntary, not mandatory. I am the first to agree that some of the proposals made by Higgs, although sensible, are hardly perfect—for example, the chairman being unable to take part in the nomination committee—but such matters could be reconsidered.

First, non-executive directors could constructively challenge company strategy for the medium and long term. That must be good. Secondly, they could scrutinise performance of the board and the company as a whole. Thirdly, post-Enron and mindful of Sir Howard Davies' rhetorical question, they could ensure accurate financial information. Finally, they could ensure that executives were paid appropriate rewards, which would be good for companies and society.

I finish by referring to the world's second richest man, Warren Buffet. He castigated the boardroom bad apples in his letter a few days ago and stated that those otherwise decent people simply followed the career path of Mae West, who said:

"I used to be Snow White . . . but I drifted."

Let us put down an anchor to ensure that there is no further drift, to improve corporate governance and to make a better City, a better economy and a better future.

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon 3:02 pm, 13th March 2003

I am grateful to have been called to participate in this debate on an important issue for companies, their corporate governance and public confidence in corporate financial regulation.

In general, much of the report is worthy of consideration. It adds to what should be an ongoing review of corporate governance procedures. However, I stress that the process has long been ongoing. It has not been started and it will not end with this report. Therefore, I take issue with the warning in the report against dangerous complacency, and with the Financial Secretary's warning about complacency in her speech to the National Association of Pension Funds yesterday. I have advised boards on corporate governance issues for more than a decade, and I declare an interest as noted in the Register of Members' Interests. I have seen an enormous change in the whole area of corporate reporting, independence and accountability, not least through the Cadbury, Greenbury and Hampel reports and the guidelines of the NAPF, Hermes Pensions Management and the Pensions and Investments Research Consultants. Therefore, I, among others, suggest that the use of the word "complacency" is clearly inappropriate.

Furthermore, I do not wish to rubbish many of the valuable points made in the Smith and Higgs reports, and I acknowledge that we have had no UK Enron, but I have been somewhat surprised at the amount of time spent so far, not only in the House but by the professions and the business community, on the overall question of corporate governance in recent months. Other much more directly relevant issues, such as the weakness of the Government's manufacturing strategy and the impact of tax and regulations on British companies, are hardly ever mentioned. Those issues have much more to do with the success of UK companies than the subject considered in the report.

Why are the Government now being so forthright on corporate governance? Perhaps we could have a debate on that. Is it to keep up with the Joneses in America, who have started from a much weaker position than we have in this country, or is it to divert attention from the Government's failings? Some Members might see the irony when I recall that the Government were recently seen kicking and screaming against Conservative proposals to split the chief executive and chairman roles on the new UK Competition Commission under the Enterprise Act 2002.

In that regard, however, as Mr. McFall made clear, the report made one very important recommendation in paragraphs 42 to 44 in its section on "Other Matters". It highlighted the lack of progress on implementation of the company law review, which was launched as far back as 1998. A thorough rewrite of the Companies Acts is more urgently required than an update of the combined code on corporate governance.

Photo of Nick Palmer Nick Palmer Labour, Broxtowe

I want to establish how much complacency the hon. Gentleman is advocating. Is he saying that there is no need for a change in corporate governance, or that there is a need for change but that it is not very urgent?

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

It is a question of priorities. I did not say that there was no need to examine corporate governance; I specifically said that it has evolved, is evolving and will evolve in the future. It is not something that we need not consider, but I suggest that the Government's priorities are currently wrong. If we look at what is happening in the stock markets in this country and around the world at the moment, we see that chief executives and chairmen have other things on their minds than dealing with corporate governance. The Government are clearly taking the alternative view. They will deal with corporate governance and then start to look at the Companies Acts. They have got it the wrong way round.

I note that the Government's response to the report says that the precise timing of Companies Acts legislation will depend on the parliamentary timetable. I suggest to the Financial Secretary that that is not an acceptable response to every company in this country that is affected by those Acts and that, for the most part, will be assisted by new legislation. I ask her again: when will we have the Bill?

Paragraph 31 of the report states that the Committee is

"generally opposed to the use of share options as a significant source of remuneration in public companies."

However, I was somewhat bemused that the hon. Member for Dumbarton equated stock options with a life of luxury, because the rate of remuneration is dependent on the success or otherwise of the company concerned. I note that the Government response did not address that point.

Photo of John McFall John McFall Chair, Treasury Committee

On stock options, I used the words of Sir David Tweedie, the president of the International Accounting Standards Board. They were not my words. He said that stock options were used by executives, who get a cheap price, inflate the share option and profit themselves while the health and welfare of the company is disadvantaged in the medium and longer term. He warned us that that practice is widespread in the United States, and that we should not have it in the United Kingdom. I quoted an eminent authority.

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

Sir David may well have said that, but I doubt that he meant it to apply to every single company that issues stock options. Of course, like any other aspect of corporate governance, share options can be abused, and I admit that they have been abused in certain cases. That does not mean that stock options are, per se, the wrong means of remuneration. I note, however, that the Government did not respond to the report's point about that.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster

Does my hon. Friend accept that there is a very important role for stock options, both to incentivise staff at all levels—not just directors—and as a means of growing a business? The small and medium-sized business sector will be the main vehicle for jobs growth in the decades ahead. In such companies, stock options can be a very good way of keeping valuable and innovative young employees on board for the long term.

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

My hon. Friend makes an important point, with which I totally agree. There have been many surveys over the years on alternatives to stock options. None came up with a scheme as flexible or as consistently useful as the issuing of stock options.

The only evidence in the report for the position that stock options are a bad idea is the statement that in the United States "people could get most of their remuneration in share payments 'and even pay suppliers in share options'". However, those points simply do not follow. Paying directors in shares is an established practice in this country. It is completely different from issuing stock options to directors and has even been recommended as good practice in previous corporate governance reviews.

Existing statutes ban directors from buying tradeable options in their own companies, and existing corporate governance rules disapprove of non-executive directors holding stock options in their own companies. Will the Financial Secretary tell us whether there are any proposals to change current practice as a result of the report? I have not heard of any such proposals, but I would be interested to know whether there are any.

It is important to keep in mind that the size of companies may be very relevant. My hon. Friend alluded to that in his intervention. As a non-executive in an alternative investment market company—I accept that such companies are not subject to the combined code on corporate governance—you can be issued with stock options, as they are often offered as part of the overall reward for becoming involved in what may be a much riskier type of company.

Photo of Mr John McWilliam Mr John McWilliam Labour, Blaydon

Order. I have never in my life been offered stock options. The hon. Member is again using the word "you".

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

I apologise, Mr. Deputy Speaker.

In that instance, the company may prefer to promise future shares rather than give up its cash. Finally, there is sometimes an assumption that share options are some sort of cheap giveaway. The hon. Member for Dumbarton alluded to that in his contribution.

Photo of John McFall John McFall Chair, Treasury Committee

Stock options are part of aggressive earnings management and must be stamped out, although I take the hon. Gentleman's point that they may be useful for some companies. I quote Sir David Tweedie:

"The whole question of aggressive earnings management is one of the big problems we are facing. If you can hold the share price for three or four years so you will be so rich that your family will be taken care of for generations to come, you can see what the temptations are going to be of just ramping the profit figures. That is why we are absolutely convinced that the way to deal with this sort of situation is to be pretty brutal . . . share options should be charged, if you control a special purpose entity you should consolidate it. Let us forget the exceptions, that is it. We will hear special pleading, 'We're different' but you soon learn that the world is a special case after a while in this job."

We must knock down such aggressive management and charge stock options as expenses.

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

With the greatest respect, I must point out to the hon. Gentleman that Sir David Tweedie was referring to the tax treatment of share options. He was not discussing whether they should be issued. Indeed, their tax position is being addressed.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury

May I put it to my hon. Friend that the problem with Sir David Tweedie's proposals is that they are intended to stop the abuse of share option schemes such as no doubt occurred in the United States? The tragedy is that the proposals would also kill off the highly beneficial and widely spread employee share schemes, which have been a great success in this country in spreading wealth, encouraging employee participation and improving productivity. Companies issue shares at a discount under the employee share schemes introduced by previous Governments and this Government. The companies would be forced to account for them in the profit and loss statement, and that would be wholly inappropriate in principle. The main objection to the proposal is that it has taken a draconian stance towards abuse and forgotten about the good things that it would also kill off.

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

I thank my hon. Friend for that helpful contribution, with which I absolutely agree. It is also important to make the point that, historically, stock options in America have been issued in a very different way from those in the United Kingdom—most specifically in relation to the time for which such options can be exercised, and the conditions of issue. I shall finish my remarks on stock options on that point.

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

Let me return to the quotation from Sir David Tweedie cited by my hon. Friend Mr. McFall. Sir David Tweedie was talking about the perverse financial incentives that can be obtained. He was not talking about tax, but about the corruption of the purposes of people who receive such stock options. I heard Mr. Flight say that they were used widely for ordinary employees. Employee share schemes are used widely, but not stock options. Those are a different kettle of fish altogether.

Photo of Mr John McWilliam Mr John McWilliam Labour, Blaydon

Order. We have had some interventions that are bordering on becoming mini-speeches. Can we keep interventions short?

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

Thank you, Mr. Deputy Speaker. I have to say that I welcome interventions. They make for an interesting debate.

Photo of Mr John McWilliam Mr John McWilliam Labour, Blaydon

Order. So do I, but they should be interventions.

Photo of John McFall John McFall Chair, Treasury Committee

I shall be very brief, and this is my last word on the subject. Sir David Tweedie was speaking about the accounting treatment of stock options. That is the issue. In reference to the point made by Mr. Flight, it is interesting to note that many US companies, including those with all-employee schemes, such as Wal-Mart, are moving to expense share options. That is the trend that Sir David Tweedie was considering when saying that there are lessons for the UK.

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

Indeed, that is so, and this country is moving in that direction. I have no problem with that point, but it is very different from saying that issuing share options is wrong.

The other key issue regarding share options is the conditions which they are issued. That process can be carried out responsibly or irresponsibly. An effective remuneration committee will carefully consider the conditions under which share options are to be issued, which will normally be directly related to the future success of the company, the individual's performance, or indeed, a combination of the two. As with the other issues that we are discussing, that process can be handled in a responsible or an irresponsible manner.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster

Although I take on board the concerns raised by Mr. McFall, there is a risk that if we berate stock options—the press would inevitably make that into a big issue—we would encourage the short-termism that would blight smaller, growing companies. Although I recognise the abuses, I hope that my hon. Friend will agree that we need to encourage stock options in the general sense, particularly for relatively low-paid employees and middle management staff who aspire to a long-term career with a company.

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

I thank my hon. Friend for that contribution, and I absolutely agree with him. Stock options will be used in different companies for different purposes. Larger companies will be concerned that executives do not have as large a financial stake in the company as in the capital. The companies will therefore want to incentivise their managers and make them feel part of the future success of the company. On the other hand, smaller companies may not be able to afford to pay the significant salaries that will enable them to recruit competitive staff, who will otherwise go to large companies. The use of stock options can be an effective way of binding such people in. It is difficult to say that one size fits all, and that is the beauty of the use of stock options. As things stand, stock options are probably the most adaptable way of incentivising staff.

Paragraphs 38 to 41 of the Select Committee's report deal with the implications for directors. I was somewhat surprised at how little time the report gave to that issue, even though the hon. Member for Dumbarton made it the centrepiece of his speech. Unfortunately, the report to some extent justified the Government's response by saying little about the implications for directors. Following the Higgs report, more will come out and I have a feeling that we will discuss the subject again. I will not dwell too much on that issue at present; instead, I will address the content of the report and particularly recommendation (q), which states:

"there is a good case for an audit committee composed of non-executive directors, rather than the board as a whole, to be responsible, in the case of quoted companies"—

I assume that that means fully listed quoted companies—

"for selecting the firm of auditors...and for fixing the auditors' remuneration."

The Government did not respond to that part of the report and I would be interested to hear the Financial Secretary's views on the matter.

The proposals should be treated with caution. They tie in directly with one of the main problems that has been identified with the Higgs report, which the hon. Member for Dumbarton addressed. Taken together, the proposals will create a split between executives and non-executives on a board. Not only does the Higgs report say that non-executives should not sit on an audit committee, but it says that the chairman should not sit on it either because, by way of that appointment, he is deemed to be non-independent. I see good reason for audit committees to review who is the right auditor and how much the auditor is to be paid, and to question boards' decisions if they feel that those decisions are wrong. However, the final decision should be a full board decision, with the board acting and answerable as one.

As with several other proposed measures coming out of Higgs and Smith, there are serious implications for non-executives. They will bear a greater responsibility and there could be negative implications, which could go against Higgs's desire to encourage people and to have a wider pool of non-executives. There could also be higher cost implications for the companies, which may have to pay more to those who are prepared to take on the extra responsibilities.

Finally, I support the Select Committee's findings that considerable improvements in the governance of companies can be brought about by greater shareholder interest in their affairs. More to the point, much more emphasis should be placed on that issue, which relates to matters such as how information is disseminated to the market, how brokers' reports are produced, how banks market their client shares and how institutions vote their shares and involve themselves in the corporate governance of the companies in which they have invested. That issue has been much more thoroughly reviewed in the Untied States, and we could usefully take a closer look at it in the UK. However, since the report was produced, the institutional shareholders committee has produced welcome new guidelines on institutional activism. That is a move in the right direction, but it is a matter on which we should concentrate further.

Photo of Mr Nigel Beard Mr Nigel Beard Labour, Bexleyheath and Crayford 3:24 pm, 13th March 2003

The failure of Enron and WorldCom has been a disaster, and not only for their shareholders and employees. Such dramatic examples of malfeasance have triggered a crisis of confidence among all investors in equity shares in all public limited companies. They have contributed to an avalanche fall in share prices over the past two years, with baleful consequences for people's pensions, life insurance and savings. We heard evidence in the Treasury Select Committee that Enron and WorldCom were operating to American standards and practices, and that the same could not happen in Britain. I completely reject that—it has happened here. The reports of the Select Committee on the crisis in Equitable Life and on split capital investment trusts demonstrate that.

The companies involved here are not exact replicas of Enron and WorldCom, but they operate in the same culture of concealing rather than revealing their true financial state; they display irresponsible recklessness in not adequately assessing the risks to which others' savings are exposed. Those trusted by investors focused their attention on extravagant personal rewards that immunised them from the risks to which they exposed others. It amounted to contempt for the investing public who had trusted those responsible.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster

Does the hon. Gentleman not recognise that there is an inevitable element of risk involved in buying shares, whether in a pension fund or individually? Does he believe that it is the role of Government to ensure a risk-free environment for every investor?

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

Of course I do not believe that. There is a reasonable risk involved in the market. However, in the two cases to which I have referred there was reckless risk taking far beyond what would normally be expected. That is the issue that I raise. The hon. Gentleman trivialises it by suggesting that I believe that people can have a risk-free existence. I am surprised that he felt his intervention to be worth while.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster

The simple point is that the matter has been extremely problematic. It is entirely different from the fraud allegations about Enron and WorldCom. However, the proposals are wide-reaching and apply to all companies, not only to companies that are guilty of fraud or near-fraud. It is of great concern to many in large companies, particularly in FTSE 100 companies, that this one-size-fits-all approach is not an appropriate way of ensuring good corporate governance for the protection of investors.

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

I have already given a list of the issues that arose from the two crises that I mentioned in Britain. Those issues are very similar to those that arose in Enron and WorldCom. I do not suggest for one moment that all joint-stock companies are subject to them; however, they can be found in several of them.

This is not only a matter of deficiencies in accounting standards and auditing practice. Those technical issues are important; they are the main theme of the Treasury Committee's report. I wholly support the report's recommendations and I am pleased to see that in the main the Government have endorsed them. However, the fault does not lie solely with the financial maintenance of public companies. There is a deeper malaise in the culture of some public companies—I emphasise the word "some"—that has led to these deficiencies. I do not wish to tar the boards and management of all public companies with those strictures. However, such observations have parallels and echoes in the wider policies of some public companies. The ever increasing rewards of chief executives and directors do not establish a fair differential between themselves and other managers and staff; they accelerate increases in the differential year after year after year without apparent justification.

There are rewards through share option schemes that create perverse incentives in financial reporting. There is a contrast between all that and the way in which occupational pension schemes have been closed or diminished recently, even where the company took pension provision holidays in good years. There is accumulating evidence of people at board level in major companies behaving as if they were a caste apart, which does not need to abide by the same rules of fairness and ethics that apply to everyone else. Much of the evidence that we received concentrates on the deficiencies in accounting and auditing procedures. That, however, does not excuse the responsibilities of executive and non-executive directors, who are actually responsible for preparing the accounts. Theirs is the responsibility for ensuring that a true and fair picture of the state of a company is presented to shareholders. Accountants are advisers. Auditors give a final objective check. If accounting rules are weak and auditors inattentive, the defects need to be remedied, but the fault begins with the members of a board in whose name the accounts are presented.

The question of the ethical behaviour of directors is inescapable when reviewing the question of the financial control of public limited companies, but the ethics become disguised and laundered by some of the language used. Off-balance-sheet accounting too often means keeping relevant information from public scrutiny and so giving a distorted picture of a company's profits and liabilities. Aggressive accounting means sailing as near to the legal limits as possible without actually being illegal.

What is missing from all this cunning is the concept that all commerce—every commercial deal—depends on trust. That is why many of the great merchant families in Britain in the 19th century were Quakers or Methodists; because of their strict ethics, they could be trusted and so their businesses grew. In simple terms, it is trust that lies behind the issues that have given rise to the Treasury Select Committee's inquiry. The root of the problem is the breakdown of trust and the routine acceptance of a culture of institutionalised deception.

There are three dimensions to dealing with the problem, and our report is one of them. It deals with various ways of ensuring good accounting practice and the independence of auditors. The other two dimensions are the modernisation of company law, as mentioned in paragraph 44 of our report, and corporate governance, which is referred to in paragraphs 38 to 41. The chairman of the Financial Services Authority has also drawn attention to the need to modernise company law in the light of the prospective European Union directive. According to its response to our report, it is disappointing that the Government will not be able to introduce a draft companies Bill in this Session. It would be highly desirable for one to be included in the next Queen's Speech. Such a Bill would seem to be a good candidate for pre-legislative scrutiny by the Treasury Select Committee and the Trade and Industry Select Committee. Alternatively, it might be scrutinised by a Joint Committee, a procedure that proved successful in dealing with the complexities of the Financial Services and Markets Act 2000.

Corporate governance has been the subject of a review by Mr. Derek Higgs, whose excellent report, which complements the recommendations of the Treasury Select Committee, was published since our inquiry. It presents a radical but reasoned approach, which is what is needed. It sets out the role and responsibilities of the board and chairman, from which flow ethical guidelines. The emphasis on the board having at least 50 per cent. of non-executive directors is an evolutionary way of ensuring that issues are lifted from the internal concerns of executive directors and dealt with objectively and transparently. The formation of an audit committee from among the non-executive directors will ensure independence in the appointment of and subsequent dealings with auditors, and will promote objectivity in the auditing process and in the presentation of information.

It is also much to be commended that non-executive directors should be responsible for non-executive appointments to the board, so that the chance of the chairman appointing cronies or the 'quiet and persuadable' is eliminated. The idea of one senior non-executive director having a special relationship with shareholders seems to be less obviously beneficial. It may cut across the role of the chairman and create a high risk of unproductive friction. The proposal to limit the number of non-executive directorships to be held by one person is a way of concentrating attention on duties in the company. The days of the non-executive sinecure, with one person holding half a dozen or more directorships, should be over, and quite rightly.

All these sound proposals and others go a long way towards addressing the introspective malaise which can become a conspiracy against the outside world, and it is sad that the vast majority of the chairmen of the FTSE 100 companies, and the Institute of Directors, object to the proposals. The objections are perhaps a confirmation that introspective and cosy arrangements have become too much of a habit. It is as though those chairmen do not recognise the issues that the proposals address. Theirs is not the first—and no doubt will not be the last—vested interest that needs to be overruled for its own good.

In conclusion, I urge the Secretary of State for Trade and Industry to implement the proposals of the Higgs review as soon as possible and to take such steps as are necessary to implement the recommendations of the Treasury Committee report. Company law reform complements those measures and should be dealt with expeditiously. Let us not hear from sections of business or from the CBI the ritualised parrot cry that all this is another imposition of red tape. What is proposed will underpin and enhance public trust in business enterprises, which are a vital part of our society and must act within it, not be detached from it. Nobody gains if business enterprise is widely considered to be a conspiracy against everybody else. Without public trust and understanding of business activities, business will be the poorer and so shall we all.

Photo of Mr John McWilliam Mr John McWilliam Labour, Blaydon

Order. I cannot prevent the hon. Gentleman from speaking, but given that he has missed a third of the debate, I have to tell him that it is a matter that is deplored by the Chair.

Photo of David Ruffley David Ruffley Conservative, Bury St Edmunds

I apologise to you, Mr. Deputy Speaker. I put in to speak and have since been unavoidably detained, but I take your strictures on board.

I congratulate Mr. McFall, the Chairman of the Treasury Committee, on helping to secure this important debate. He leads a Committee that, for the most part, avoids and eschews party political debate and concentrates on scrutiny. All its members are to be congratulated on raising in a Committee for the first time in the aftermath of Enron issues relating to accounting, auditing and, more generally, corporate governance. We announced our inquiry on 5 February, and much has flowed since we began. We took a great deal of evidence, and that in the documents in front of us should give a large measure of reassurance to the British public, whom we all know are not awfully enamoured of financial services at present, especially in terms of split capital trusts, the collapse of Equitable Life, and so on.

I am more concerned about the response from the Government, particularly to the Higgs report. Our inquiries envisioned the report as an important contribution to the corporate governance debate. The Financial Secretary has made some comments about the Higgs report, and I want to turn to those in the latter part of my speech.

On the reassurance of which I spoke, I believe that we have been able to show in the report that it was the shortcomings of US accounting practice that led directly to the Enron collapse—principally the inability properly to account for special purpose vehicles. That could not really happen in this country, because we have a principles-based approach to auditing. An auditor signing off must be satisfied that the accounts represent a true and fair view. The US system is much more narrow and makes it much easier to evade a general judgment. The box ticking and rules-based approach in the US were direct contributors to the problems that Enron and WorldCom experienced. That should be a source of reassurance to those in this country who legitimately ask whether an Enron could happen here. The answer is that that is unlikely.

We considered various aspects of the auditor's role, particularly in relation to that old chestnut of audit firm rotation. Lord Sharman, who gave evidence on the matter, could find no evidence that a regime of enforced statutory audit firm rotation—five years, seven years or whatever the period was—was helpful or worked. However, we considered the proposition that audit partners should be rotated, although not on the industry standard of a seven-year basis, but rather on a five-year basis. We went further than that though, and considered the suggestion—I think that this is the central proposal of the report—that there be a requirement on a board to consider both the retendering of audit work and the audit rotation of partners rather than rotating firms on a five-year, rather than a seven-year, basis. These are sensible suggestions. Why are they needed? Quite simply, the answer is that there is always the concern that there will be too much cosiness between corporate management and an audit firm.

We also examined how audit work has been used in a low-balling way—using loss-leading audit work to secure much more lucrative consultancy. I did not share the view that that was a huge problem. We must be careful, not least because there are definitional problems with regard to what pure audit work is on the one hand, and what consultancy work done by the consultancy arm of an audit firm is on the other. It is difficult to delineate which is which. The report flags up that difficulty and asks the Government to examine more closely that definitional problem. That is a sensible proposition and is evidence based, which is the great strength of the report.

The issue of corporate governance was touched on tangentially in the report. We argued that it was important for audit committees to be much more alive to the role of audit firms and the work that they do. That was a direct lesson from Enron that we can apply to this country. Audit committees are much more important than we perhaps thought they were before. That has alerted us to a problem, and is one way in which the Higgs proposals support what the Committee flagged up. However, that is where my support for Higgs ends. So that you are absolutely sure that I am in order, Mr. Deputy Speaker, I point out that although the central proposals of Higgs are not referred to in the report because the report came out before Higgs, nevertheless we were acutely aware of the issues that Higgs would raise. Now that the Financial Secretary, who is responsible for responding to Higgs, is in front of us, it is apposite to address some of the concerns that have been set out.

Mr. Ken Rushton, who is the head of the UK listing authority in the Financial Services Authority and not a man known to rush into rash judgments, responded by remarking that the Higgs proposals on corporate governance could lead to a "one size fits all" rule book if wrongly enforced. He went on to say:

"It has the look and the feel of a more prescriptive framework. If intelligently applied by all parties this would be okay, but some companies are concerned that they might be shoe-horned into an orthodoxy that could not and should not be applied to them."

He said that there was a danger that companies who did not subscribe to all the requirements of the Higgs review, even though it is meant to be a voluntary set of proposals, might be considered "heretics".

The level of consultation on the Higgs review carried out by the Financial Reporting Council was also criticised by Mr. Rushton. The consultations, which are due to be completed by 14 April are an unconscionably short period of time for a full consultation on such critically important corporate governance changes. It is a matter of regret that the FRC will be consulting only on what it considers "fatal flaws" in the Higgs review.

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

Does the hon. Gentleman not agree that some of the complaints fulfil George Bernard Shaw's aphorism that there is nothing more indignant than a vested interest masquerading as a moral principle?

Photo of David Ruffley David Ruffley Conservative, Bury St Edmunds

I always enjoy that quotation when I hear it, but I am not entirely sure that it is appropriate to my point. This is not some self-interested defence by a company chairman; we will get to that in a minute. It is from the head of the UK listings authority, a paid official from the FSA who polices the listing requirements of public limited listed companies. I quoted him for the reason that he is likely to be more dispassionate than the average company chairman.

There is a point with which I am sure that the hon. Member for Bexleyheath and Crayford will agree. Miss Farnish of the National Association of Pension Funds expressed a countervailing view that the Higgs review will be seen to be pretty much like the Cadbury, Greenbury and Hampel reports—in other words, they will be seen as a bit controversial at the time but will soon effortlessly become an orthodoxy and down the road we will wonder what all the fuss was about. However, I am not so sure about that, for reasons that I will describe.

Sir Nigel Rudd, chairman of Pilkington plc and a very experienced industrialist, described the proposals as "absolutely barmy". An interesting survey conducted by the CBI reported that 82 per cent. of FTSE 100 chairmen believe that one of the key proposals in Higgs, that a senior independent director—or SID—would undercut the authority of the chairman, was not to be welcomed and could lead to confusion. For that reason Mr. Digby Jones, director general of the CBI, said that a

"one-size-fits-all approach will not be good for British business or British wealth creation."

Mr. Jones went on to say that the proposed code was too prescriptive and that there was a danger that the "explain" element of Higgs would be forgotten over time. That is that the benchmarking of corporate governance relating to SIDs and their ability to head nominations committees for the appointment of new members to boards would, although voluntary at the outset, lead to a "comply or else" philosophy rather than, as Higgs now asserts, a "comply and explain if you do not comply" philosophy.

These views of the CBI should be taken seriously. The CBI's approach is not a headbangers' approach. It talks about the fear of the application of the law of unintended consequences. Higgs is not trying to do in British business, but is acting from the best motives. However, the problem, in the words of the CBI, is that it could

"stifle the creativity and drive that characterises so much of what is good about UK business".

Photo of Nick Palmer Nick Palmer Labour, Broxtowe

I understand that the hon. Gentleman favours the relatively moderate changes in corporate governance that we proposed, but he resists some of the further-reaching ones suggested by Higgs. Does he agree that our recommendations should be a reasonably high priority for the Government?

Photo of David Ruffley David Ruffley Conservative, Bury St Edmunds

The proposals about which I spoke in my opening remarks are sensible and should be taken on board. I agree with the hon. Gentleman, who spoke about the necessity for clear indications from the Government about the next companies Bill, the primary legislation that will flow from it, and in which Session it will be introduced. I therefore agree with the hon. Gentleman to that extent. However, I have a problem with Higgs. As Mr. Jones of the CBI says:

"Chairmen have got to be able to run an effective, unified board. The senior independent director should not open up a separate and potentially divisive channel of communication with shareholders or have responsibility for reporting back to the other non-executives on an exclusive basis."

That is the crux of the issue. These proposals seem to have caused the most difficulty in corporate Britain.

The first part of the proposal is that the senior independent director should have an exclusive channel of communication with shareholders. That is not too offensive. In a sense, he would not differ much from the investor relations office: reporting to the chairman of the board and having a chat with the shareholders and the institutional investors. There is no great difference between that and an SID talking to institutional shareholders.

The problem arises in the second part of the proposal. According to Higgs, the non-executives will be able to get into a huddle and chew over what the shareholders are saying and thinking. They should have regular meetings—a claque, as it were—of non-executives. That seems to be a recipe for disaster and for the disunity that the CBI hinted at in its analysis. Even if one accepts, as one will probably have to, that chairman and chief executive roles should be split as a matter of course, there appear to be at least two competing centres of authority already in Higgs's proposal. If one were to add a third centre of authority—the SID—one can imagine him corralling a group of his fellow non-executives. Incidentally, Higgs suggests that half the board should comprise non-executives. That could be a third fount of power, which would not make for especially efficient management decisions. In that sense, corporate Britain has a legitimate gripe in saying that it is not happy with that proposal.

Let me say one or two things about Higgs, which the Financial Reporting Council can address. Before mid-April, the FRC is allowed to tweak the Higgs proposal in some ways. I hope that it will take some of my points on board. First, Higgs believes that the advantages of introducing the proposal that a non-executive director should head the nominations committee were marginal. He did not think that it was a deal-break; he did not think that it was make or break. The overwhelming body of opinion, and the responses, suggest that it is odd for a non-executive who is unfamiliar with the sector to decide what the shape and architecture of a board should be. That person would have the power of life and death over nominees to the board, which is more properly the province of somebody other than a non-executive director. If what I read in the press is accurate, it would be useful if the FRC were to take that criticism on board and not implement the proposal. It was the most unpopular measure in the CBI survey. Nearly 90 per cent. said that it was bad news, or words to that effect.

Higgs should not promise too much. There is a danger that that will happen, because Higgs has asked Laura Tyson, the dean of The London business school, to provide a list of 100 top-notch non-executives, drawn from the public sector, charities and professional services. I fear that we are in danger of political correctness creep. I am not convinced—marvellously qualified in charities law and dedicated to the public services for which they work so diligently though they might be—that some of those individuals can necessarily read a balance sheet very well or go in to bat with some slick city auditor who is trying to pull the wool over their eyes. I urge Higgs and the FRC, when they are putting together the combined code, not to be seduced by the idea that the quality of non-executives in corporate Britain can be improved by such tinkering. A pool of 100 drawn from the public sector is a start, but it is not going to prevent Enrons from happening.

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

Does the hon. Gentleman not recognise the nature of the problem that Higgs addresses? That is that far too narrow and inbred a group of people occupy the posts of non-executive directors, many of them enjoying as many as eight such positions. They cannot possibly be giving adequate scrutiny to any one of them. The proposal to put the matter in the hands of a non-executive director has been made in order to prevent it from going to cronies and to broaden the pool. Nobody can pretend that there are not enough wise, sensible people in Britain beyond the 1,600 whose names appear—

Photo of Mr John McWilliam Mr John McWilliam Labour, Blaydon

Order. I suggested earlier that interventions should be just that. That was going on a bit.

Photo of David Ruffley David Ruffley Conservative, Bury St Edmunds

There is a certain amount of truth in what the hon. Gentleman says. We agree that the quality of non-executive directors in corporate Britain should be improved. I see from research done by Deloitte and Touche that if Higgs's proposal that half of each board should be non-executives were applied to the top 350 FTSE companies, 500 new non-executives would be needed quickly. Like the hon. Member for Bexleyheath and Crayford, I should have thought that there were enough clever, financially literate and tough-minded men and women in the country to fill those posts. However, it is not clear that those people exist or want to come forward. I agree that chumminess and cosiness in boardrooms does not help public confidence.

The Committee's inquiry into split capital trusts demonstrated that there was a great deal not only of cross-share holding but of cross-directorship holding. We wait with interest to learn whether any impropriety arose as a result of the arrangements for people to sit on several boards of split capital investment trust companies, but the hon. Gentleman makes a fair point.

I wonder, however, whether Higgs goes far enough in addressing the problem of the quality of non-executive directors. I do not believe that the main proposition that Higgs puts forward—to get the dean of the London business school to trawl round the voluntary, non-corporate part of Britain—is the answer to our problems. Nor do I believe that that is likely to secure the greater confidence in the way in which companies are run that the British public needs.

I again thank you, Mr. Deputy Speaker, for your indulgence in allowing me the time to contribute to the debate, notwithstanding my delay in getting to the Chamber. I will make one point to the Minister, to which I hope that she will respond.

The piece of work undertaken by Higgs is substantial. If even half of it is implemented—I am sure that more than that will be implemented—it will have a great effect on corporate Britain. I bet my bottom dollar that the combined code, which will be modified as a result of what the Financial Reporting Council says, will be a document that says, "Comply or else" rather than "Comply or explain."

Why is that important, and why does it worry me? Every working day since 1997, 15 new pieces of red tape have been imposed on British business. As a result, management people need to be lighter on their feet, more nimble and more flexible. There should be less need for them to look over their shoulders—they should be able to make decisions unburdened by regulatory clutter. Will the Minister tell us whether, in the consultation period that remains between now and 14 April, she will give any thought to cutting back on the more prescriptive parts of Higgs? Does she believe that the remaining consultation period is long enough? The Financial Services Authority appears to believe that it should be longer.

I wonder why the consultation seems to be taking place in haste. I hope that that is not because the Treasury wants a good headline. I have the utmost respect for the Minister, and I know that she would not try to get cheap headlines and follow the principle of, "Let's show the public that we are doing something." The issue should be taken more seriously than that. Will the Minister address my concerns about the over-prescriptive nature of Higgs and the speed with which that over-prescription will be applied?

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

On the last point that my hon. Friend made about complying or explaining, does he agree that the problem is that even if companies explain, the institutional shareholder committees will often put a cross in the box? That means that there will be a vote against at the general meeting. Even under the current system, "comply or explain" often does not work. It has led to box-ticking, and that will get worse under the Higgs proposals.

Photo of David Ruffley David Ruffley Conservative, Bury St Edmunds

My hon. Friend makes an excellent point for my peroration. He is right to say that the combined code already leads to a certain amount of box-ticking. It has been argued that Higgs, if fully implemented—the Government seem to be bent on that—will be a box-tickers' charter. It will be box-tickers' heaven, because any advisers going through the process will go down the box-ticking route, as a back-stop against negligence and as a way of showing that they have done everything right. If in doubt, such advisers will not look at the specific circumstances of a particular company and why that company might, for perfectly good reasons, have deviated from the combined code. For a simple life and as a back-stop against negligence, they will say that the company does not fulfil the requirements of the combined code in its corporate governance regime, will not tick the appropriate box, and, as my hon. Friend pointed out, cause trouble for that company. We are opening ourselves up to such a rules-based approach, which will make a growing problem significantly worse.

Photo of Norman Lamb Norman Lamb Shadow Spokesperson (Treasury), Liberal Democrat Spokesperson (Treasury) 4:04 pm, 13th March 2003

I congratulate Mr. McFall on securing the debate. Unlike other members of the Treasury Committee, I can be objective in saying how good the report is, because I was not on the Select Committee when it was produced. The report makes a valuable contribution to kick-starting the post-Enron debate. As Mr. Ruffley said, the fact that it is based on evidence heard by the Committee makes the report a particularly strong document.

Other hon. Members have spoken about the impact across the world of Enron's collapse and of the shock waves that it caused on global financial markets. It produced—not just in the United States, but throughout the world—a collapse of confidence in corporate governance and in the role of accountants and auditors, so we should devote our attention to rebuilding confidence in them.

As Mr. Beard explained, the implications of a collapse of a company such as Enron are widespread and affect, both directly and indirectly, the livelihoods of many people. It is an issue of supreme importance, but I noticed an element of complacency from Conservative Members, particularly in the speech of Mr. Djanogly. It reminded me of my views on nuclear power: everything is fine as long as power stations operate without difficulty, but as soon as something goes wrong, it is rather disastrous. We saw that with Enron, and it could happen again. The hon. Member for Bury St. Edmunds argued that it was probably less likely to happen in this country, but it could. Sir Howard Davies made that very point to the Select Committee, so we must approach the subject with urgency and accord it the priority that it deserves.

In shaping our response to the implications of Enron, key points must be recognised.

Photo of Jonathan Djanogly Jonathan Djanogly Conservative, Huntingdon

Does the hon. Gentleman appreciate that fraud, criminal activity and so forth present quite distinct problems and are unlikely, other than in non-extreme cases, to be dealt with through best practice corporate governance? Whatever corporate governance practices had been in place, it is unlikely that Enron would have been stopped.

Photo of Norman Lamb Norman Lamb Shadow Spokesperson (Treasury), Liberal Democrat Spokesperson (Treasury)

I accept that, but I shall explain in a few moments that a loose framework can be responsible for things going wrong.

I was arguing that the traditional regulatory framework in this country is clearly different from that in the United States. We should acknowledge much that is good in this country, both in respect of corporate governance and the principles-based approach of auditors to which the hon. Member for Bury St. Edmunds referred. We need evolution, not revolution: we should build on the framework already in place, not destroy it. We must not, however, be led into complacency: reform is clearly needed. As the Government have acknowledged in their responses to various reports, the world does not stand still. There is a need to recognise and understand the rapidly developing global economy and its implications.

In shaping reform, the UK cannot act in isolation. There is a real need to try to develop common and consistent standards without that resulting in an acceptance of the lowest common denominator. We must never allow a dumbing down of standards, but the aim to achieve common consistent standards across financial markets is a massive challenge. With the benefit of hindsight, many have seen the Sarbanes-Oxley legislation in America as an ill-considered, knee-jerk reaction to the Enron collapse. I applaud the Government for having adopted a deliberative approach in this country. They have listened to plenty of evidence and taken their time in shaping proposals. We must also take into account the EU proposals to be put in place by 2005. All those elements could go in radically different directions, and we must try to achieve uniformity.

Reform must be based on the following principles. The first is transparency and openness in the way in which companies and boardrooms operate. Secondly, it is important to avoid conflicts of interest, particularly in auditing. Thirdly, we must achieve the highest possible standards of financial reporting, accountancy and auditing. Fourthly, we must tackle a boardroom culture that is too often—although not always—cosy, incestuous and lacking in independence.

I turn to some specific issues. On corporate governance, we welcome the Higgs report. As the hon. Member for Dumbarton and others have already made clear, the response of the FTSE 100 chairmen is disturbing, disappointing and complacent. The heading of the leading article of the Financial Times on Monday this week was, "Higgs' critics have failed to grasp why change is needed". The response of the Financial Times, in criticising the chairmen of the FTSE 100 companies, seems very sound.

In contrast to what seems to be a very head-in-the-sand, ostrich-like response from those chairmen, Warren Buffet, the United States investor to whom the hon. Member for Dumbarton has already referred, takes a very different view. He thinks that US reforms have not gone far enough and specifically refers to the cosy boardroom atmosphere that in his view has caused the lax supervision of US companies.

On moves to strengthen independence by enhancing the roles of non-executive directors, a divide is clearly developing between those who argue for unified boards—which Digby Jones argued for this week in response to the CBI survey—and those who see the case for, and the value of, dissent and independence on the board. Surely, the latter must be the way forward. Dissent can shake up and tackle complacency, whereas unity can lead to complacency and weakness.

Buffet also argues that independent directors must be supported by active owners. Institutional investors need to play a much more active, engaged role than they have played hitherto. Too often, there is a tendency for them to stand by and do nothing, but then complain after the event. It is also important that the culture of the non-executive director is effectively challenged. Non-executive directors have too often been appointed because of friendships. The hon. Member for Huntingdon referred to that instead as "acquaintances" and people within the industry, but there is no doubt that the old boy network is alive and kicking. There is no transparency in the appointment of non-executive directors.

The hon. Member for Bury St. Edmunds suggested that tightening up and improving the transparency of the appointment of non-executive directors and increasing the independence of the board of directors could affect the competitiveness of British industry. It could, however, have an opposite effect. If we improve the transparency and openness of the system of appointing non-executive directors and widen the pool of people who could be appointed, we might improve their quality and their input into the boards and companies that they represent.

Too many non-executive directors are on good little earners. They are on too many boards of directors and are unable to focus on the professional supervision that a company needs. The Government must ensure that effective steps are taken to widen the pool of non-executive directors. I should welcome the Financial Secretary's comments on how they intend to achieve that.

On auditing, the danger of conflict of interest has been clearly demonstrated by the development of a culture in which large accountancy firms carry out a wide range of consultancy functions in addition to auditing—it is bound to end in tears. The independence of the auditor is inevitably compromised if their accountancy firm earns substantial income by undertaking other work for their clients, because there is a risk that punches will be pulled. Apart from regulatory reform, market pressure has already had a dramatic effect. Inside the big four accountancy firms, marketing for new work for consultancy services has shifted away from the companies for which they carry out audits and has been directed at companies for which they do not provide audit services. However, we must recognise that that process needs to go further and should be enshrined in regulatory controls.

From their marketing shift, those companies have clearly recognised that it is no longer acceptable to continue in that way and that they could be destroyed, as happened to Arthur Andersen, by conflict of interest. That is encouraging, but they have not gone far enough. There needs to be an effective regulatory framework to stop a slippage back into the old ways.

Another encouraging trend, which is continuing at some pace, involves floating off the consultancy arms of accountancy firms. I favour enshrining a clear divide in regulation between audit work and other work. Lord Sharman, the former chairman of KPMG, made it clear that auditors are watchdogs:

"they are supposed to be the ones who exemplify independence, objectivity and probity".

It cannot be right that those firms are touting for other business from the same company, which potentially compromises their position in their primary role as auditors.

On the rotation of audit firms, several expert analysts have highlighted the potential problems with the compulsory rotation of firms. For example, problems can often occur in the first year of a new appointment because the people involved are all new to a company and have no knowledge of its background. I am not sure whether the Government's recommendations go far enough. The Select Committee took the view that requiring the audit committee to look at possible rotation every five years was appropriate.

In its report, the Committee drew an analogy with the re-tendering exercise in public sector appointments. The old law firm in which I was a partner before my election to Parliament provided legal services to a number of local authorities. We had to be involved in a re-tendering exercise after a specified number of years. It focused the mind and improved performance, because one knew that the tendering had to be gone through again at the end of the contract period. Forcing the audit committee to consider re-tendering and whether it should change, rather than requiring it to change, seems a wholly sensible recommendation. The Treasury Committee made the point that it was presented with no evidence that re-tendering of public sector contracts caused a problem. We support the model proposed by the Committee.

The rotation of personnel involved in an audit has been tightened, as the Government made clear. The lead partner must now be rotated every five rather than every seven years. However, there is a risk of incestuous relationships going much further than just the lead partner; others can also do damage. The principle of rotation needs to apply to other partners and senior employees involved in the audit process. I am pleased with the Government's recommendation to prohibit for two years an auditor's being employed by a company that they have audited. The Government go further than the Committee, which I think recommended one year, so that is good news.

I have not dealt with the whole range of reforms dealt with in the report and envisaged by the Government. The agenda is substantial. We broadly welcome the deliberative approach that the Government have taken. It seems measured and avoids a knee-jerk reaction, but none the less it attaches to the subject the priority and importance that it deserves.

I welcome the suggestion by the Chairman of the Select Committee of pre-legislative scrutiny of the company law reform proposals. I hope that the Minister will confirm that she will want that when the proposals are introduced. Clearly, the Committee would perform a central role in any such scrutiny. It is important to modernise the regulatory framework to rebuild trust and confidence, to ensure openness and to drive up standards, while not undermining competitiveness.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury 4:22 pm, 13th March 2003

I congratulate the Treasury Committee and its Chairman, Mr. McFall, on its report. I have read it in full and very little of it cannot be agreed with by a broad cross-section of hon. Members—and, indeed, of the nation as a whole. It was particularly important that the Committee recognised the changes and improvements that had been made to the accounting profession in the United Kingdom since the Maxwell scandal. The Committee also recognised that rules are not the answer—indeed, rules were very much the cause of the problems in the United States of America—and that principles are of acute importance.

The only territory where I express some dissent, and to which I have referred, is Sir David Tweedie's proposal about how to deal with the excessive use of share options in the US. There is no doubt that that occurred and was often quite ridiculous. Shares were given out like confetti. Students would suddenly find themselves worth $1 million because a high-tech company had boomed, and then it would disappear. Sir David Tweedie recommends in respect of all granting of options or shares at a discount to market value that that difference should be charged to the profit and loss account. That is undesirable as it will create great volatility in the profit and loss and a charge to it—in a cash sense, it is not a charge. When times are good in respect of options and discounts, there will be large charges, and when times are bad and options are out of the money, there will not be charges. That will provide a further complication in understanding accounts.

It has always been clear that shares at a discount dilute earnings per share, and as a shareholder I want to know what the earnings-per-share dilution is and what is the effect of the dilution of my equity. Just having a charge to the profit and loss will not tell me that. For starters, the most important thing is to require the fullest description of the earnings-per-share dilution impact in the notes to the accounts.

Secondly, Proshare is the main campaigner for widespread employee share schemes, which will be affected. As the Minister told the hon. Member for Dumbarton in a note, the only way around that will be for companies not to apply any discount to shares that they issue under widespread employee share schemes.

The big corporate problem is disappearing profitability. It is pretty likely, if companies are faced with this accounting problem, that the result will be a major contraction in broadly based employee share schemes. Indeed, that is precisely what Proshare found from its soundings of the FTSE 100 companies. It would be a mistake to think that this change to accounting standards, international and domestic, will not carry a very heavy price in terms of restricting, if not stopping, broadly based employee share schemes, and I think we all agree that their impact has been excellent. They improve productivity and bring communal effort to businesses. There are famous examples such as John Lewis, and measurements of company performance show that those with widespread employee share schemes have a significant impact: they outperform others by a factor of 40 per cent.

It would be a great economic loss to this country if the likely change in the accounting standard ended widely based employee share schemes, as I and many others, including Proshare and many Members of Parliament, fear will happen.

There was pretty widespread agreement with what was contained in the reports of the co-ordinating groups on accounting and auditing issues, and on 29 January, the Secretary of State for Trade and Industry announced a review of the regulatory structures for the accountancy profession. As others have said, the UK would undoubtedly benefit from a companies Bill to introduce the modern company law framework outlined in the company law review, and the sooner the better. It is a little disappointing that more progress has not been made in that respect.

The company law review contained two other important measures—the introduction of a mandatory operating and financial review to provide, in narrative form, an outline of the company's business strategy and the risks and opportunities inherent therein, and secondly, the removal of statutory provisions preventing auditors from limiting their liability, together with a proposal to establish an informal framework for liability capping.

Some hon. Members have suggested that the proposals to date do not go far enough. I think that they are measured and appropriate. If anything, the danger is going too far as a gut reaction to the problems that have occurred in the United States. No one wants to be complacent, but to date there have not been problems of the same magnitude on the accountancy front here.

The Select Committee report drew attention to the warnings that Sir Howard Davies, the head of the Financial Services Authority, has given about the impact of increasing European Union financial regulation, which appears not to have received the same consideration as was given to the Financial Services and Markets Act 2000, and which could be a major threat to what is left of the financial services industry in this country. The report particularly referred to the listing directive.

Let me now turn to Higgs. As others have pointed out, time has passed. Higgs represents the Government's response to further proposals on corporate governance. I felt that the hon. Members for Dumbarton and for Bexleyheath and Crayford (Mr. Beard) were somewhat unfair in attributing the reason for their criticisms of the CBI, the Institute of Directors and the overwhelming majority of chairmen purely to self-interest. I accept that what I have always called the great and the good of the 100 FTSE companies are too narrow a group of people and that they are often motivated to vote generous pay increases for each other. That is a perfectly fair point. I am concerned that Higgs may not necessarily address that.

The concerns that have been raised about Higgs are genuine, and the Government should listen to them before proceeding with implementation of the proposals. There have been three general complaints, which have largely been referred to by my hon. Friend Mr. Ruffley. First, the report is misguided, in that the proposals could make boards less rather than more effective and could undermine the position of the chairman by reintroducing the senior independent director, whose powers seem to run parallel with, and compete with, what many would consider the proper role of an independent chairman.

Secondly, there is a view that the proposals are too prescriptive and rule-based. Although they are supposed to be voluntary, there is a probability that they will be institutionalised in code and that trying to explain why a company has not followed them will be seen as a not particularly pukka or proper position. At the least, there will be a very strong, if not regulatory, pressure to fit into the code.

The third general criticism is the lack of time for consultation before implementation. I do not know whether it is true, but I have heard that the Government are giving consideration to extending the consultation. I hope that the Financial Secretary will be able to confirm that.

There have also been specific criticisms. The first, which I think is fairly valid, is that while such an overly prescriptive regime may not be a huge burden for very large companies, there is the question of those that are not FTSE 100 companies. The regime is too expensive and is not particularly suitable for them. Where do they stand? I should initially have declared an interest, incidentally, in that I am a non-executive director of a company. It has decided to follow Higgs, although it is manifestly inappropriate for what is actually a small company. The decision was based on exactly the type of mentality to which I have referred. A good case can be made for the argument that the success of smaller businesses depends on powerful leadership.

Warren Buffet speaks with two voices because in his companies he pays little regard to the rest of the board and thrives on being able to dominate a weak board. His perspective as an investor in other companies reflects what he says, but that is not so in his practice, nor is it the reason for his considerable success, which has been the robust, individual, all-powerful leadership of a business. It is strange that even large boards will be controlled by non-executive directors. As with the other proposals, their ability to know and understand a large company is perhaps not as great as many may think.

Photo of Nick Palmer Nick Palmer Labour, Broxtowe

Mr. Djanogly referred to Marconi, which operates in my constituency. I understand that its share price collapsed by 99 per cent. as a result of the current arrangements. Does he believe that the outcome would have been worse if it had been subject to challenge by independent non-executive directors?

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury

I was a shareholder in Marconi and know the history well. I would say the reverse—a compliant board broadly agreed with unrealistic and over-ambitious schemes. The previous leader of the old GEC company—hon. Members will remember that he died not long after Marconi's collapse and was almost heartbroken about the demise of the business that he had built up over 30 years—had run that business with a rod of iron, taking little notice of the rest of his board. I would say that it was more of a Higgs board that led to the Marconi collapse than an old-fashioned type of business led by a strong character.

That leads to another major point. It is dangerous to lead the public to think that Higgs would be a solution for companies that are badly run and making bad decisions. It has been a great mistake to lead the public to believe that regulation means that they need not take responsibility for their own investment decisions, and there are dangers in theoretical panaceas to address problems that cannot be effective in practice.

I see no logic for suggesting that a chief executive cannot mature to become chairman. A company that I would have thought was greatly admired and liked by the Government—Unilever—has thrived on that principle for many years. It is useful and important that the chairman knows and understands such a large business, and I see no impropriety in principle in that. Indeed, there has often been a problem for companies when chairmen and chief executives have come in from outside without knowing the business and one has presided over the other making a mess of it.

I want to pose a question. What happens if a retiring chief executive becomes chairman of a rival company? It is a serious practical risk that if someone retires at 55 and knows an industry well but cannot naturally become chairman of his old company, he will be an attractive recruit to a rival company.

The suggestion that non-executive directors should serve only six years is a mistake. It may make sense for boards to be able to get rid of them, but that can be arranged contractually. Many non-executive directors will not have got to grips with a company for two or three years, and I do not see the logic of a six-year term.

Finally, I support the principle that the posts of chief executive and chairman should be split. That is a long-standing recommendation, but I note that the Competition Commission did not want to do it, and Sir Howard Davies of the FSA was determined not to do it. However, the Bank of England is set up so that the two roles are effectively combined in the governorship. The public sector should follow the same rules, and I repeat that although I broadly support it, it does not always make sense, certainly for a small business, for the two rules to be combined. What are the Government's proposals for those other than FTSE companies? There have been suggestions that the costly and cumbersome structure would not apply to listed companies, but from a practical point of view, large FTSE companies could probably cope with it. That could be positively damaging for smaller companies.

My worry, and something that I have seen happen here and in other parts of the world, is that a board controlled by non-executives would end up going through the motions rather than running the business. The business would instead be run by an informal committee of the senior management, and the net effect of the proposals would be contrary to the intention. That results in what I call an unofficial running of the business, not a transparent system recorded in the minutes, and that is one of the biggest dangers. It is a practice that occurs a lot outside the United Kingdom, and it is a mistake to require a majority of non-executives because it tends to tip the balance that way.

Although the report is about public limited companies and the private sector, the highest standards of accounting and propriety in management should also exist in the public sector. The hon. Member for Bexleyheath and Crayford rightly referred to improper practices of off-balance-sheet financing that have taken place in the United States and, to some extent, here, and I draw the Chamber's attention to the continuing disagreement of principle between Sir John Bourn and the Chancellor.

Sir John Bourn is adamant that the Strategic Rail Authority and Network Rail, under accounting standard FRS 2, should be consolidated into Department for Transport accounts when we move to whole of Government accounting. The result will be, in the words of the National Audit Office, to blow out of the water the mythology that control rests with the business's directors. Sir John is clear that equity control rests with the Government, and each organisation should appear in the Red Book and national accounts with its debt as part of the public borrowings and public borrowing ratios. As hon. Members will have seen, he went as far as to say that he would not sign off the accounts unless that happened. We have the present nonsense that the Treasury has accepted that the SRA and Network Rail will be consolidated into whole of Government accounts, but not into the Department for Transport accounts, which is the key issue in whether the debt is included in the Red Book figure.

I urge the Chancellor to abide by the high standards of accountancy by which we are urging the private sector to abide, and to cut back on off-balance-sheet accounting. The Government have moved to consult not just two accountants, but, as the Minister will undoubtedly confirm, the Treasury is now in discussions with Allen and Overy, which is known to be the sharpest law firm in structuring private sector off-balance-sheet accounting. Let us not have one rule for the public sector and another for the private sector.

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

The situation, which we on the Treasury Committee looked into, is not exactly as the hon. Gentleman represents it. Sir John Bourn believes that the Railtrack debt should be a contingent liability. It should not therefore be added to normal Government debt, or be considered against the golden rule or national debt. That is quite different from off-balance-sheet accounting.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury

With the greatest of respect, I do not think that the hon. Member for Bexleyheath and Crayford is up to date. It is quite correct that, as far as this year's accounts are concerned, Sir John Bourn has ruled that, as non-departmental public bodies are not consolidated, Network Rail should be consolidated into the Strategic Rail Authority, although there is no need to consolidate the SRA into the Department for Transport's accounts. The Department should have full notes of the contingent liability. That is the position for this year.

However, when we move to the whole of Government accounts—I confirmed the details with the National Audit Office just two days ago—the position changes. The rule then is that non-departmental public bodies should, in principle, be consolidated, particularly if they meet the FRS 2 test. That test is about equity control in relation to subsidiaries. On that basis, Sir John Bourn has made it quite clear that the debt should be consolidated into the Department for Transport's accounts. As he pointed out, if that is so, the ruling of FRS 2 is that the Government have equity control. That blows out of the window the mythology that the Government do not have that control and that it rests with the directors.

It is on the basis of that mythology that the national statistician has sought to argue that, for EUROSTAT purposes, the liability does not have to be included in the Red Book borrowings. We are dealing with obscure but classic examples of the sort of clever stuff that people have got up to with off-balance-sheet accounting in the private sector.

Photo of Nick Palmer Nick Palmer Labour, Broxtowe

Is the hon. Gentleman aware that his simulacrum—it could not possibly have been him—said earlier that the off-balance-sheet accounting of share options was quite satisfactorily covered by a note in the accounts? That speaker did not think that it was important to include it in the balance sheet.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury

I am surprised that a Member of Parliament of the hon. Gentleman's intelligence should not have heard what I said. My point was that dealing with the issuing of shares or options for discount in the profit and loss account creates a false profit figure, because profits go up and down inversely to share prices. That is unhelpful to a general shareholder because it distorts the profit record. What a shareholder needs to know, resulting from option schemes and even employee-wide share schemes, is how much his shareholding will be diluted if that option is exercised and when the general employees take up their share options. The task of explaining and setting out the dilution factor requires some space; indeed, that explanation can only be set out as a note to the accounts. That is a pretty straightforward common-sense issue, and the matter is entirely different from the accounting principles, for which Sir John Bourn is responsible, that apply to how public sector bodies' debts should be treated within the national accounts.

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury 4:48 pm, 13th March 2003

I start by congratulating the Treasury Select Committee on its report, and its Chairman, my hon. Friend Mr. McFall, on the way he which he introduced this important debate—and, indeed, on securing it. He asked whether we would stand firm on our proposals, and I assure hon. Members that we will. There is no room for complacency on this issue.

I certainly take issue with the comments of Mr. Djanogly, which I thought were extraordinary. The United Kingdom must remain at the forefront of international best practice in auditing and accounting standards and corporate governance. Indeed, our commitment to those issues is widely recognised internationally. It is also widely seen as one of the strengths of the United Kingdom system—one that enhances the efficiency of capital markets.

I welcome the commitment that my hon. Friend Mr. Beard and Norman Lamb have shown on this issue. We must give it priority, which is why my right hon. Friends the Chancellor of the Exchequer and the Secretary of State for Trade and Industry set up the co-ordinating group on audit and accounting issues, which I chaired with the Under-Secretary of State for Trade and Industry, my hon. Friend Miss Johnson, who has responsibility for competition, consumers and markets. Our final report was published on 29 January, and we had valuable input from a wide range of sources, including the Treasury Committee report on the financial regulation of plcs.

Good systems of financial reporting and audit regulation are vital to underpinning confidence in the efficient and effective operation of capital markets. Establishing those conditions requires us to have timely, true and fair financial reporting, underpinned by high accounting and audit standards; effective arrangements for the enforcement of those standards; the independent audit of financial statements; effective corporate governance arrangements; and independent and transparent regulation of the accountancy profession.

As Mr. Flight noted, standards and regulation, although important, can never be a complete defence against individuals who are determined to do wrong. Nor can they wholly protect us against a culture of corporate greed and loose ethics. A zero-failure regime is not a desirable option, but we owe it to savers, investors, employees and all the honest business people whose reputations have been tarnished by these scandals to ensure that our defences are as robust as they can sensibly be.

The package of reforms announced on 29 January will raise standards of corporate governance for listed companies, strengthen our accountancy and audit professions and provide for a more effective system to regulate the profession. Taken together, those reforms are comprehensive and mutually reinforcing. The package is tough where it must be, but measured and proportionate throughout. We have sought to achieve better regulation, not just more regulation. Our approach will ensure that our corporate governance structures remain among the best in the world, and that must be in the interests of the millions of pensioners, savers and businesses that depend on them.

Let me turn now to some of the specific points that were raised. I should probably start with the Higgs report, because that is where the interest of most hon. Members seemed to lie. The first line of responsibility for ensuring honesty and probity must rest with companies and their boards of directors. In the light of the report's proposals on the role and effectiveness of non-executive directors, the combined code on corporate governance will be strengthened to provide that at least half the board, including the chairman, should be independent. Similarly, all the members of the audit and remuneration committees, and a majority of the nomination committee, should be independent. Furthermore, the definition of an independent director should be strengthened and clarified, the separation of the roles of chairman and chief executive should be reinforced, and new descriptions should be given to the roles of the board, the chairman and non-executives.

Derek Higgs's report also contains proposals to improve the way in which top-level appointments are handled. They should promote meritocracy through an open, fair and rigorous appointments process, rather than encourage appointment through personal contacts and friendships. As part of the follow-up, a group led by Laura Tyson of the London business school will study ways of bringing candidates from the non-commercial sector to greater prominence. It will report to my right hon. Friend the Secretary of State for Trade and Industry in May.

There has been a good deal of comment about the Higgs proposals. The Financial Reporting Council is currently consulting on revisions to the combined code. It has stated that the consultation is intended not to reopen debate about the substance of the recommended changes but to get the detail right and to examine the best way of implementing the changes.

I note the comments of the hon. Members for Bury St. Edmunds (Mr. Ruffley) and for Arundel and South Downs about the consultation process, but I urge Members to remember that Derek Higgs consulted extensively. He undertook a great many interviews and a great deal of research, all of which has been published on the web. He sounded out the main representative organisations, including the CBI, about his proposals. His recommendations on the combined code are not drawn out of thin air.

I am confident that the Financial Reporting Council will still consider all responses received from business, investors and others, but the issues should be considered carefully rather than through megaphone diplomacy. That is exactly what the FRC will do. The consultation runs through until mid-April and the FRC, as an independent body, is fully responsible for that consultation.

I completely agree with the comments of my hon. Friend the Member for Dumbarton, the Chairman of the Treasury Committee, who said that the proposals represent the opportunity to change voluntarily. The Higgs proposals are intended to be a statement of best practice, based on the principle of comply or explain. They are not rigid rules. Indeed, they are specifically designed to leave room for judgment, and we believe that such judgment is best exercised by shareholders. In laying out his approach, he has deliberately avoided the rule-based approach of the United States. I believe that that is a great merit of our current system, and one that will continue. We may not have seen an Enron in the United Kingdom, but we have not been immune to numerous home-grown cases of corporate scandal or destruction either. There is no ground for complacency in that regard.

Certain myths have sprung up in relation to the Higgs proposals. One is that somehow the role of senior non-executive director is a new role, but that is not the case at all. The role of senior non-executive director is embedded in the current combined code. It works very well already in many large companies. The intention of the proposals is not to undermine in any way the spirit of a unitary board. The role of chairman rightly remains central, both in managing the board and in the relations with shareholders. Derek Higgs's proposals would complement that role with better communication to the non-executive directors of shareholder views. That opinion was forcefully expressed by shareholders to the Government, and to Derek Higgs when he carried out his review.

The hon. Member for Arundel and South Downs asked how the proposals should apply to smaller companies. In his review, Derek Higgs specifically considered whether there should be a difference in best practice rules between large and small companies. The view that came loud and clear from small companies was that they did not wish that to be the case. They did not wish to be considered in any way as having a second-tier system of corporate governance.

All publicly listed companies have responsibilities to their shareholders. As a matter of principle, Higgs was wary of promoting different sets of standards. That does not mean that he assumed that in all cases all principles would necessarily be appropriate. In fact, he specifically recognised that many small companies may wish to explain rather than to comply. There are no deadlines for the implementation of his proposals; it is up to the individual company to explain to its shareholders the principles that it decides to follow. That comment was reflected in the debate on Higgs that took place after the statement by my right hon. Friend the Secretary of State for Trade and Industry earlier this year. She said:

"Let me stress and develop . . . the need to avoid one size fits all."

She explained that the proposals did not apply to alternative investment market listed companies. She added 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 explain why we rely on comply or explain."—[Hansard, 29 January 2003; Vol. 398, c. 887.]

The report of the co-ordinating group on auditing and accounting emphasised the importance of the audit committee in overseeing the financial reporting of the audit processes of listed companies. We believe that effective audit committees are central to restoring confidence in capital markets and that their role and membership need to be strengthened. In that respect, we welcome the work of the FRC group, chaired by Sir Robert Smith. The group has developed the existing combined code guidance for audit committees.

The Financial Reporting Council's proposed revisions to the combined code will also implement the recommendations of the Smith group that the audit committee should consist of entirely independent members, at least one of which should have 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 those provisions or to explain to their shareholders why they are not doing so. The comply or explain approach is one of the great strengths of the UK system.

A second major aspect of the reforms concerns tougher measures to underpin auditor independence. Following the recommendations of the co-ordinating group, the Government have announced that, as well as an enhanced role for audit committees and a tightening of the provision of non-audit services by auditors, the professional bodies have already changed their regulations so that the lead audit partner must be rotated within five years, and partners and senior employees of audit firms will not be able to take up employment with the company that they audit within two years of leaving the audit firm.

Photo of Norman Lamb Norman Lamb Shadow Spokesperson (Treasury), Liberal Democrat Spokesperson (Treasury)

Will the Minister respond specifically to the Treasury Committee's recommendation relating to a compulsory re-tendering exercise—not a requirement to change audit firms, but to examine the possibility? The Minister said that a change every five years for the lead audit partner would be required, but what about the others? I note that the final report of the co-ordinating group refers to change for other key audit partners every seven years. Is that still part of the Government's recommendations?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

Yes. We will consider those issues further as these proposals are developed. The issue of mandatory rotation is raised time and again. It was considered in great depth by the co-ordinating group, which concluded that the balance of advantage was against such a mandatory requirement. That is partly because we accepted the view that there were sensible and workable alternatives and that mandatory rotation itself had not been proven as an effective way of ensuring auditor independence.

Indeed, the key elements of the package of measures that we announced as an alternative to mandatory rotation include an enhanced role for the audit committee in the appointment and oversight of the relationship between the company and its auditor, the audit partner rotation requirements, greater transparency by audit firms, and a greater emphasis on independence when monitoring auditors with long-standing relationships with client companies.

The co-ordinating group also considered the Treasury Committee's proposal to set a precise periodic requirement for audit committees to consider the relationship, and decided that that would cut across the enhanced role for the audit committee envisaged by the report. The proposal was influenced by the fact that the enhanced role and the role for judgment should be made as coherent as possible throughout the report. That would provide the effective check that the hon. Gentleman is seeking.

The Chairman of the Treasury Committee, my hon. Friend the Member for Dumbarton, also asked why we were not referring auditors to the Competition Commission. The co-ordinating group also examined that matter. Indeed, the Office of Fair Trading considered the question in detail and announced in November that it did not consider there to be a case for referral. Although the market was dominated by four large companies, it did not show evidence of being uncompetitive. The Office of Fair Trading concluded that it should keep the market under review, particularly in light of Andersen's demise.

My hon. Friend also raised the importance of streamlining the regulation of the accountancy profession. Following a DTI review of regulation, the whole package of measures will be underpinned by a much more streamlined process and a better structure for regulating the accountancy profession. The FRC will assume the functions of the Accountancy Foundation, creating a unified independent UK regulator with three clear roles: setting accounting and auditing standards; proactively enforcing and monitoring them; and overseeing the self-regulatory professional bodies. All those steps will be taken forward alongside the Government's long-standing programme of company law reform.

I could not fail to note the interest in the publication of a Bill for pre-legislative scrutiny. The Government fully accept that such a Bill would benefit from pre-legislative scrutiny. The Government have shown evidence of their commitment to consultation with the publication of 225 draft clauses, but ultimately—I shall inject a caveat here—the decision depends on the parliamentary timetable, the views of the Select Committee on Trade and Industry, and the evidence given to it during the company law review by the Department of Trade and Industry. However, we accept that a Bill on this issue would benefit from a pre-legislative process.

In conclusion, the debate has been valuable and well informed. Members are right to take a close interest in accounting, auditing and corporate governance. I congratulate the Treasury Select Committee on being the first off the mark in considering in depth the issues contained in its report. It is absolutely right that we should give those issues our full attention. The approach that the Government have taken will ensure that our corporate governance structures remain among the best in the world, and that must be in the interests of the millions of pensioners, savers and businesses that depend on them.

Question put and agreed to.

Adjourned accordingly at seven minutes past Five o'clock.