Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 240-256)

MR ANDREW SIMMS AND MS DEBORAH DOANE

TUESDAY 25 JUNE 2002

  240. My point is, would we not be coming at it from the other side, not your side, that you would be presenting to the global business community very, very tough and strict rules of audit and accounting, big hurdles to cross; is there not a risk that they would say, "Right, we won't base ourselves in the United Kingdom, we'll get out"?
  (Mr Simms) Can I make just a couple of comments on that. Just going back to some fundamentals about how markets operate, one of the things which classically underpins market failure is a lack of information; what we are talking about doing is making more information available. What we would hope is that, with these better reporting requirements, you would have more trust in the market-place, you would have less volatility and less instability. And, just in case it sounds like it is coming from way out of left field, as a proposal, we dug around and discovered that, in the 1920s, the Chairman of General Electric, Owen Young, was pushing the idea of stakeholder boards, as a fundamentally different model for corporate governance. These are ideas that perhaps do the rounds, depending upon the levels of instability; and I do believe that instability, market instability, is a major issue at the moment.

  Chairman: We mentioned Company Law Review, so maybe Jim Cousins could go into that one.

Mr Cousins

  241. In a sense, you have already covered this ground, but just to reiterate it, your view of the proposal in the Company Law Review for an Operating and Financial Review that looks forward is that it will not prove adequate; and it will be helpful if you just set out the reasons why you do not think it will be adequate?
  (Ms Doane) Right now, the OFR, in its proposed format, recommends that directors consider reporting on social and environmental issues, not on financial issues, where it is deemed to be relevant to a company's operations, I believe "material" is the legalistic term there. Why does that fail; well, it is up to directors' judgement. We already know now that companies fail to report and consider these issues, and they do not necessarily perceive them as being relevant till it is too late. If we go back several years, you can look at Shell as being one example. We only have less than a third of the FTSE 350 reporting on the social and environmental impact, only 16 of the 79 companies that are actually issuing reports put any relevant, measurable, social indicators whatsoever, in spite of the fact that there is a very full set of guidelines, the Global Reporting Initiative, out there. The OFR will not make things any different; companies do not want to put their head above the parapet, if there is no need to, because it is a risk to the company, it is a risk to shareholders, it is a risk to society, and it may reduce their share price. So, the OFR, if it is not deemed to be relevant, and it leaves it up to directors' judgements, there are no considerations on wider stakeholder issues, it is up to directors.

  242. Now one of the ways this issue is tackled in the United States is through listing requirements on the New York Stock Exchange, the 20F statement, which is, in effect, an Operating and Financial Review. Because the responsibility for listing now lies with the Financial Services Authority, have you approached the Financial Services Authority to see what work they are doing on listing requirements, because, if listing requirements covering the ground you want to cover were imposed, that would completely bypass the need for parliamentary legislation?
  (Ms Doane) I have to say, one of the concerns we have is, and I face this every day, trying to muddle my way through these things, there is a great deal of confusion, these things are embedded in company law, they are in the OFR, and the OFR should be covering that, but yet, if you are saying we should look at the FSA and their rules, these should be compatible, what is in company law should be absolutely compatible with what is in listing rules. The problem with looking solely at listing rules is, you are dealing only with London-based companies; we are looking at extraterritorial issues as well, in respect of company law.
  (Mr Simms) Maybe, just as a brief post-script to the previous question, as well, going back to first principles, what are the values that we hold good for the operation of good markets, and increasingly we hear, coming from the G7, from Gordon Brown and his equivalents, in the G7, that the fundamentals are about accountability and transparency and these are essential to stable market-places, and yet we still have the situation where Britain gets brought to book for having the highest number of its multinationals not living up to the OECD guidelines on bribery and corruption. So we feel there is kind of an awful long way to go.

Mr Beard

  243. The emphasis of today's conversation has been on accountancy, but before you get to the accountancy the directors of different companies have their own responsibilities, and they take the primary responsibility for some of the things that have gone wrong. We have had, in this country, several different looks at corporate governance, Cadbury, Hampel, Greenbury; how do you see some of these problems being corrected by changes in corporate governance?
  (Ms Doane) I am not sure I quite follow the question.

  244. The issues we are addressing are that companies have gone wrong, they have misstated their financial position, and that has not necessarily been discovered by auditors; but the initial target ought to be the directors. How can these circumstances be avoided by changes in corporate governance?
  (Ms Doane) By widening out accountability, by adding extra levers of control through stakeholders, I think it would place a great deal of potential impetus on change and transparency. Let me give you one example, that I was speaking to some people at a conference in Oxford last weekend, and when they said, "How would you actually implement stakeholder accountability, it's unwieldy, it's ridiculous, we can't have that, we have to keep things narrowly with directors?" Let us look at an environmental example. Company X is polluting in the river, it does consult with their stakeholders closely, the provincial boundaries, or the regulation is national; what good does it do, what happens to company Y, who is beyond the boundaries of where they are accountable to, is having to pay for the effects of the clean-up, in effect, so that their factory can operate. As soon as you widen accountability to stakeholders, regulation happens at a civil level, that company raises the issue to company X and they in turn deal with the issue, or the barrier. What that does is it makes the problem more open and transparent.

  245. If I might interrupt, I do not think you are really addressing the question I am raising. I am raising the question of the company, a board, or a company, structured presently with executive and non-executive directors, with various precepts as to what the directors' responsibilities are; how can that arrangement, if it can, be reorganised to ensure that we do not get the Enrons, we do not get the Equitables, we do not get people who are, deceptively, presenting false accounts of the company's behaviour?
  (Ms Doane) And what I am saying is that you need a board structure that is not just executives and non-executives getting information from inside the company, that you need a wider board structure, that has stakeholder representation first, and you need them to get information from outside the company and ensure that that is fed into the system; it cannot only come from within.

  246. Why cannot it come from within; directors read newspapers and they are members of society too?
  (Ms Doane) The impacts of companies and what is happening outside of companies, but, at the moment, they are only concerned with the financial impact; if that is their only concern, that will be a myopic view and where you end up at the end of the day, if you do not take into these wider considerations information. There is also, if you look at the case of employees who are getting, they are all part of the system, they are getting share options, it is in their interests to make sure the financial bottom line wins at the end of the day. You have to have people who do not have a financial stake in the company.
  (Mr Simms) We are basically arguing that the whole governance structure should be opened up, to resemble not a shareholder arrangement but a stakeholder arrangement; so that, as Deborah says, everyone from the local community, where a particular firm might be based, through to its staff, everybody who is directly or significantly indirectly impacted by the business should begin to have a stake in the decisions that are made.

Kali Mountford

  247. Can I suggest that it is not easy to define such stakeholders, is it?
  (Mr Simms) It is not, and it will be different, depending upon which sector, which kind of company you are looking at. What we can say is that we have outlined some proposals about how such stakeholder boards would work, and we can certainly send that through to the Committee for consideration.

Mr Beard

  248. Can I move on from there, because another central element of the criticism of the Big Five is that they are providing audit services with other services, and they are cross-subsidising the two. Do you support a complete prohibition on auditors doing other work for companies?
  (Mr Simms) I have to say that we came to the conclusion that a basic measure that was necessary, which I do not think we are alone in thinking, this, is that there should be a complete separation between the function of auditing and the provision of other services. We have looked at some of the academic surveys that have questioned people in the profession; we think, even within the profession, there is an awareness that there are compromises, there are conflicts of interest, which automatically emerge as soon as the value of the ancillary services you are providing gets close to or overtakes, as they have, the value of your basic auditing function.

  249. Have you looked at the possible impact on the cost of accounting services of doing that?
  (Mr Simms) We do not have sufficiently sophisticated economic models to be able to guess what the outcome of that would be, no; so we cannot answer that now, no.

  250. Could it not mean also that you would have some very narrow auditors who have no experience outside their sphere?
  (Mr Simms) One of the problems that we do have at the moment, in terms of the proposals that we are making, is from where would you draw your new generation auditors who are going to be aware of and sensitive to other issues, such as social and environmental issues. And one of the criticisms that we do have, even though this is obviously not a mandatory requirement and not part of the formal audit, is that, as the more progressive companies have started to report voluntarily on their social and environmental performance, they are going to auditors who basically lack the skill set to be able to provide intelligent and detailed reports of that nature. Some of the early attempts by the Big Five, as they have moved into that market, have been embarrassingly poor in quality, and we mention a couple of those in the report. So it is certainly the case that we believe, as public expectations of corporate performance change, and as these conflicts of interest continue, that there will need to be a new generation of auditor, significantly more independent than the ones that exist at the moment, significantly more sensitive to a wider range of concerns than just the bottom line.

Mr Cousins

  251. In your paper, at one point, and you have referred to it again this morning, you do refer to this issue of intangibles; and this is a point that I put to the representatives of the institutes when they were in front of the Committee, and they did not demur from a ballpark figure of 70 per cent of the value of British listed companies being represented by intangibles. Do you think that, with such a high percentage of the value of British listed companies being focused on things which are inherently very problematic to measure, we do have, in fact, the potential for real crises of confidence in the returns of British companies?
  (Ms Doane) What is interesting is, right after September 11, BA, one of the top performing companies in the UK, fell off the FTSE 100, simply because of that sense of its intangible asset base rather than its real asset base. One of the interesting things we found was, when we looked into this issue, each accountancy firm has their own way of measuring that intangible asset base, it is not transparent and they will not share it with you and they will not speak to each other. And one of the things we would certainly like to see is, there is human capital, there is social capital, there is a lot in that intangible asset base that we need to draw out and we need to find relevant measures, but they need to be transparent to the shareholder and to the wider public, so that we can trust in what that measure really means, rather than it simply being listed as one line on the balance-book, and then seeing share prices of BA, and people's pensions, fall like that.

Mr Laws

  252. In your paper, on page 37, you have got these various proposals that you make to tackle the problems in the auditing sphere; and one of the proposals is that there should be a cooling-off period that should apply when people are moving from the auditing world into the companies that they audit. And you suggested that it should be a minimum of three years, which seems quite a long period of time; why so long, and would that be consistent with human rights obligations, in respect of employment?
  (Mr Simms) Technically, whether or not it would fit, I would have to look into the human rights law to see where there are any potential clashes on that, but we think it is a realistic period of time. It is flexible how long people think it is now respectable to stay in a particular company for a period of time, but, in our experience, two to three years is a job cycle, and that is why we went for that figure, we thought it was not too long but not too short, and it was a reasonable cool-off period for somebody not to be able to take employment on the promise of having a particular set of contacts and insider knowledge that could give them an inappropriate advantage in the work-place. Two to three years is what we were thinking about; we put three years, we think, actually, that is a realistic cool-off period.

  253. Are there any precedents for having a period of cooling-off that is that long?
  (Mr Simms) That I do not know.

Kali Mountford

  254. In one of your recommendations, you speak about donations to political parties, and I am assuming you have Enron in mind here. How widespread is the problem, and how much do you think needs to be done about it?
  (Mr Simms) One of the quotes that we have in the report is from Senator John McCain, who pointed out that, where Enron was concerned, they were all stained by the process, and I believe, talking about the US situation here, but of the various committees which feed into the regulatory process in the US, a good two-thirds of its representatives had been touched either by political donations by Andersen or Enron.
  (Ms Doane) I do not know if Andrew has pointed this out; we actually drafted the first draft of this report long before the Enron scandal hit the press, so you could say that this is quite widespread. In the UK, it is a very interesting scenario. I do not know if you saw the FT, a number of weeks ago; it was encouraged by PR firms for companies to engage in voluntary CSR programmes, as a way of gaining political access. It is a different type of lobbying that is going on here than is happening in the UK, either than is happening in the US; so that is something that is extremely widespread, certainly in the US, it is slightly below the surface here, as far as I can see, from where I sit.
  (Mr Simms) And just as a peculiar example of the bizarre contradictions that can be thrown up, I would draw the Committee's attention to the fact the Department for International Development employed KPMG to look at the tax system in Belize, questioning whether or not, if the Government was haemorrhaging resources through having too lax a tax system, it should be either given debt relief or receive aid. Now perhaps it was not pointed out to the Secretary of State at the time that KPMG were also, simultaneously, advertising their services through their Belize office for the tax advantages of being established in Belize; so there are certainly a number of problems.

  255. So are you alleging an actual corruption, or are you simply saying there is a perceived problem?
  (Mr Simms) There is certainly a lot a collusion. I would say that it is almost inevitable that corruption is taking place, and I would pass on one comment, that was said in confidence to me by a director of one of the Big Five accountancy firms, when asked about the issue of bribery and corruption, and of a number of issues that we raised with them this certainly was the issue that they fear most, in terms of being exposed. The question was asked in a fairly direct way about what happens in your associated offices around the world, and the reply was that "It is just a guess as to whether bribery, corruption and a range of illegal practices are occurring in 30, 40 or 50 countries where we have offices around the world." There is a major issue about the consistency of standards throughout the families of the Big Five, Big Four.

Chairman

  256. Can I thank you for your appearance this morning, and also your publication, which will be very helpful to us in formulating our report. Thank you very much.
  (Mr Simms) Thank you for inviting us. We will send on some of the supporting information that has come out of your questions. [7] Thank you.

  Chairman: Thank you.





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