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.