Memorandum submitted by the Department
of Trade and Industry and HM Treasury
1. This memorandum is submitted jointly
by the Department of Trade and Industry (DTI) and HM Treasury
to inform the Treasury Committee's inquiry into the arrangements
for financial regulation of public limited companies in the United
Kingdom, in the light of the Enron collapse.
2. This memorandum describes:
The respective roles and responsibilities
of the DTI, the Treasury and other organisations with an involvement
in the regulation of public limited companies;
The current framework of regulation;
The work the Government and relevant
regulators have put in train to assess the implications of recent
corporate failures for the regime in the UK and what lessons can
3. The DTI has overall responsibility for
company law in Great Britain,
which includes company reporting requirements, corporate governance,
and the regulation of auditors. In Northern Ireland this is the
responsibility of the devolved Administration. A number of specific
areas are the responsibility of independent regulatory bodies,
The Accounting Standards Board (ASB)this
is independent body responsible for the setting of accounting
standards, which apply to companies' individual and consolidated
financial statements intended to show a "true and fair"
view. It is a subsidiary body of the Financial Reporting Council
(FRC), whose role is to promote and secure good financial reporting.
The Secretary of State for Trade and Industry and the Governor
of the Bank of England jointly appoint the Chairman of the FRC.
Another subsidiary body of the FRC, the Financial Reporting Review
Panel (FRRP) is responsible for the enforcement of financial reporting
by listed and large companies. The FRC and its subsidiaries are
funded jointly by the accountancy profession, business and the
The professional accountancy bodies
impose their own rules and standards on their members, in relation
for example to qualifications, monitoring, complaints and discipline.
Although the best known are the six chartered bodies of the Consultative
Committee of Accountancy Bodies (CCAB), a range of other bodies
represent accountants. The DTI gives delegated authority for regulating
company auditors to those accountancy bodies,
which meet the legislative requirements, ie they are recognised
under the Companies Act 1989 as a supervisory body;
The Accountancy Foundationthis
has been established recently to provide independent oversight
of the regulatory activities of the principal accountancy bodies;
The Foundation has a number of associated bodies which have specific
The Review Boardwhich
has the role of reviewing the regulatory activities of the participating
accountancy bodies and monitoring the operation of the system
to ensure that it serves the public interest;
The Auditing Practices Board
(APB)which is responsible for setting and developing auditing
The Ethics Standards Board (ESB)which
has the role of securing the development of ethical standards
by the principal accounting bodies;
The Investigation and Discipline
Board (IDB)which will investigate disciplinary cases of
4. The DTI also has powers to appoint inspectors
to investigate companies and their affairs, and to requisition
5. HM Treasury has responsibility for maintaining
a stable macroeconomic environment and for securing an efficient
market in financial services, including the overall institutional
structure of regulation for financial services, and the legislation
that governs it. The Treasury also has an interest in the stability
of financial markets and the general environment for business.
6. The Financial Services Authority (FSA)
has responsibilities for both the regulation of the financial
services sector and the UK Listing Authority. The FSA was established
as an independent non-governmental body, given statutory powers
by the Financial Services and Markets Act (FSMA) 2000. The FSA
regulates the financial services industry in the UK. There are
four main aims;
Maintaining confidence in the UK
Securing the appropriate degree of
protection for consumers;
Promoting public understanding of
the financial system; and
Reduction of financial crime.
7. The FSA has responsibility for the UK
Listing Authority (UKLA)
and the maintenance of the Listing Rules. Through this process
of vetting firms at entry, the FSA aims to allow only those firms
and individuals satisfying the necessary criteria (including honesty,
competence and financial soundness) to engage in regulated activity.
Once authorised, firms and individuals must maintain the standards
set out in the Listing Rules. Performance is monitored. Breaches
are investigated and, if appropriate, those responsible are disciplined
8. In considering the current framework
of regulation, it is necessary to bear in mind that there have
been a number of major developments over the past decade or so
which have greatly changed the framework within which business
operates. Previous problems and failures have led to changes in
the regulatory regime, with the aim of strengthening the regime
and making it more effective. For example, the setting up of FRC
and ASB was a response to the accounting abuses of the 1980s.
Similarly, after the collapse of Barings, the Bank of England
commissioned the independent Tiner review, which made a number
of recommendations, including highlighting the importance of a
risk-based approach to regulation. This lies at the heart of the
FSA's approach to regulation.
9. In a free market economy, corporate failure
is an inevitable fact of business life. For example, some businesses
will fail because the business model was unsustainable, or tastes
or technology change. But a number of corporate failures have
raised issues or concerns about regulatory or public policy. The
Government has taken, and continues to take, such issues and concerns
seriously, but in responding, has always been mindful that there
is a trade-off to consider between the burden of regulation and
the encouragement of wealth-creation and innovation. The current
regulatory regime seeks to strike the right balance.
10. All companies are subject to the same
broad framework of company law. The main piece of legislation
is the Companies Act 1985, which consolidated earlier legislation,
and also incorporates subsequent changes. In addition the Companies
Act 1989 sets the framework for the regulation of auditors by
recognised accountancy bodies (see also paragraphs 24 to 27 below).
Company Law Review
11. In 1998, the Government launched a fundamental
review of the framework of core company law: the Company Law Review
(CLR). Its objective was to create a framework of company law
that promoted the competitiveness of British companies, struck
the proper balance between the interests of the different parties
concerned with companies in the context of straightforward, cost-effective
and fair regulation, and promoted consistency, predictability
and transparency in the law. The review was managed by an independent
Steering Group and the final report was published in July 2001.
The CLR proceeded on the basis of wide consultation and was able
to build a wide consensus around many of the recommendations contained
in the Final Report, which was generally warmly welcomed. It looked
at the framework of core company law and corporate governance
and made wide-ranging recommendations. Amongst these the CLR recommended
that there should be a statutory statement of directors' duties
to set out clearly the duties and responsibilities of all directors.
The Review also made a number of important recommendations relating
to transparency in corporate governance, ranging from a requirement
for an Operating and Financial Review (OFR) for economically significant
companies, to improved arrangements for company disclosure and
12. The Government is committed to modernising
the framework of company law in the UK to ensure that it is up-to-date
and fit for the 21st Century. It has made clear that it warmly
welcomes the broad thrust of the CLR proposals. The Government
is developing legislation in response to the recommendations,
which it willin due coursepublish in draft for consultation.
This is a task of great scale and complexity.
13. This legislation will include measures
to modernise the powers available to the DTI to investigate companies
and their affairs and to requisition company documents.
14. The Companies Act 1989 introduced the
current relationship between accounting standards and the law,
giving effect to the recommendations of a committee chaired by
Sir Ron Dearing. The legislative changes at that time also paved
the way for the establishment of a new Accounting Standards Board,
separate from the accountancy bodies; it also introduced the concept
of control into the definition of those entities to be brought
within consolidated accountsin essence, that an entity
controlled by the parent should be brought within the consolidation,
regardless of the legal form.
15. These changes were a response by the
DTI and the accountancy profession to standards of financial reporting
in the UK in the 1980's that were increasingly seen as inadequate.
Changes were also necessary to give effect to EU company law directives.
16. By requiring companies to state in their
accounts whether their financial statements had been prepared
in accordance with standards set by the Accounting Standards Board,
the legislation gave effective backing to accounting standards.
Standards are established as the authoritative means of giving
a true and fair view in most circumstances. The early 1990s, following
the establishment of the ASB, saw the rapid improvement of accounting
standards. For example the ASB built on the Companies Act structure,
attacking the use of off balance sheet vehicles by requiring the
consolidated accounts to reflect the economic substance of a group.
17. In more recent years the setting of
accounting standards has been increasingly influenced by the desire
to converge on international accounting standards. In the EU,
a Regulation is likely to be agreed shortly requiring the use
by listed companies of international standards from 2005. The
International Accounting Standards Board (IASB) is committed to
a set of high quality global standards, which will not require
a country with "advanced" standards, such as the UK,
to settle for second best in order to gain the benefits of a global
standard. The UK is pressing hard within the international standards
setting process to ensure that this aspiration is achieved in
18. A related reform introduced by the 1989
Act addressed the enforcement of accounting requirements and the
revision of defective accounts. It provided legislative backing
for the Financial Reporting Review Panelto investigate
complaints that listed or large public limited companies (plcs)
do not comply with the reporting requirements in company law or
accounting standards. The only formal power of the FRRP is to
apply to the courts for an order requiring a company to revise
its accounts. In practice these arrangements have proved a successful
way of upholding accounting standards and the framework of company
19. There is one aspect of the Company Law
Review proposals on reporting, on which it is worth commenting
in more detailthe proposal for a statutory Operating and
Financial Review (OFR), that goes beyond the content of the existing
20. The CLR recommends that listed companies
and large plcsessentially economically significant companiesshould
have to prepare an OFR "to provide a discussion and analysis
of the performance of the business and the main trends and factors
underlying the results and financial position and likely to affect
performance in the future, so as to enable users to assess the
strategies adopted by the business and the potential for successfully
achieving them." The CLR argues that the content of the OFR
must not be unduly prescriptive, to allow room for its development
through standards and guidance and to minimise the tendency towards
set wording or "boiler-plating". It proposes that it
should be the responsibility of the directors to prepare the OFR.
The role of the auditors would be in essence to review the process
used by the directors to prepare the OFR but not to second-guess
the directors' judgements.
21. The OFR would have to include:
(i) the company's business, objectives, strategy
and principal drivers of performance;
(ii) a fair review of the development of
the company's business over the year; and
(iii) the dynamics of the businessthat
is factors which may substantially affect future performance.
22. The other elements of the OFR, for example
policies and performance on the environment, or reputational issues
would have to be included to the extent they are material to an
understanding of the business.
23. As noted above, the Government is developing
legislative proposals in response to the CLR.
24. The Companies Act 1989 also introduced
a new framework for the regulation of auditors, introduced in
part to give effect to the eighth EU Company Law Directive and
to facilitate the recognition of auditors across the EU. In brief,
auditors must hold a recognised qualification and have adequate
relevant experience; they must be registered and subject to a
supervisory regime administered by a recognised professional body,
which includes the external monitoring of their work, disciplinary
arrangements and requirements to uphold their interpretation.
25. The 1989 Act provides for the DTI to
recognise the audit qualification of those accountancy bodies
that meet the requirements of the eighth Directive. The DTI also
authorises a number of bodies to register and supervise auditors.
The DTI monitors the recognised bodies to ensure that these arrangements
are working in practice and remain adequate.
26. Registered auditors must follow not
only the rules and ethical codes of their own professional body
but also standards for audit developed by the Auditing Practices
Board. As noted elsewhere the APB was until recently an offshoot
of the accountancy bodies. It now falls within the umbrella of
the Accountancy Foundation. Auditing standards developed enormously
through the 1990s. We understand that the APB has submitted its
own memorandum that details those developments. As with accounting
standards there are strong moves towards convergence of UK standards
with international standards on auditing. The APB as one of the
world's leading standards setters is closely involved in that
27. The CLR considered the role of audit
and auditors in some depth. While it made some important recommendationseg
that directors and employees should have wide duties to assist
auditors and auditors should be able to limit their liability
within limits to be set by Governmentit proposed leaving
the current regime fundamentally unchanged.
28. Accountancy work in the UK operates
within a statutory regulatory framework only in relation to company
audit and insolvency work. The professional accountancy bodies
impose their own requirements on members, requiring them to observe
appropriate regulations and byelaws, including a code of ethics.
A body may take disciplinary action against members who fail to
meet the requirements on them. The sanctions available to the
bodies are fines and/or exclusion from membership.
29. The most significant recent change to
these self-regulatory arrangements has been the introduction of
a new framework for the oversight of the regulatory activities
of the accountancy bodies. This followed concerns within parts
of the accountancy profession itself about the appropriateness
in a contemporary context of "pure" self-regulation,
and responded to a commitment in the 1997 Labour Party Business
Manifesto for independent regulation of the profession. An agreement
between the Government and the six chartered accountancy bodies
in 1998 led to the establishment of the Accountancy Foundation
and its related bodies. These arrangements are summarised at paragraph
three above. It is too early to assess the impact, but the UK
model has attracted a number of favourable comments from overseas
jurisdictions, including the US. Although funding comes from the
accountancy bodies, the Foundation and the Review Board include
no practising members of the accountancy profession and there
are non accountant (or in the case of the APB, non auditor) majorities
on the other boards. The Government has made clear that it will
review these arrangements after five years.
30. The 1990s also saw the development of
a series of non-statutory codes of best position on corporate
governance culminating in the Combined Code. This sets out good
practice in the structure and operation of boards of listed UK
companies, including the relations between shareholders, directors
and auditors. Whilst there is no requirement to comply with the
Code, the Listing Authority (now the FSA) requires listed companies
to disclose the extent to which they comply and explain non compliance.
Most recentlyfrom the end of 2000following the Turnbull
Report, a company's directors must report to shareholders on the
effectiveness of their internal controls and their procedures
for risk management.
31. The table at Annex A
shows a summary of the Regulatory System for:
I. Company Law (relevant parts only).
II. Securities Regulation.
III. Corporate Governance.
GOVERNMENT REPONSE TO THE ISSUES RAISED BY
RECENT CORPORATE FAILURES (INCLUDING THE COLLAPSE OF ENRON)
32. On 27 February, the Secretary of State
for Trade and Industry announced the setting up of a group to
ensure that there was a co-ordinated and comprehensive programme
of work by individual regulators to review the UK's current regulatory
practices for statutory audit and financial reporting. The collapse
of Enron and the resulting concerns over financial reporting and
the role of the auditors have focused attention, amongst other
regulatory issues, on our own corporate governance arrangements,
including the relationship between companies and their auditors
and financial reporting requirements. Although all the factors
involved in the Enron case are unlikely to emerge for many months,
we want to be clear that the regulatory regime in the UK, for
financial reporting and audit, continues to be effective and provides
appropriate underpinning for strong and efficient national and
international capital markets.
33. Some of the main issues that have been
raised in relation to accounting and audit are as follows:
the adequacy of the existing ethical
standards of the professional audit bodies in ensuring the independence
of auditors, and in particular whether they provide sufficient
underpinning independence where auditors also provide non audit
services to audit clients;
a possible requirement (for some
or all companies) for the mandatory rotation of audit firms; or
for the mandatory re-tendering for company audit; or for a strengthening
of existing requirements for the rotation of the audit partner;
the need for more detailed disclosure
in company accounts of the fees paid to the auditors for audit
and non audit services;
the role of the Audit Committee in
relation to the appointment of auditors and the purchase by the
company of non audit services from the auditor;
the implications for accounting standards
in the UK;
the implications for auditing standards
in the UK.
34. There are a number of important factors
to take into account in addressing such issues. The first is that
they can no longer be seen simply in a UK context. As markets
become increasingly global, careful account must be taken of what
is happening elsewhere in Europe, in the US, and more widely.
Secondly, while there are significant differences between the
US and UK systems, it would be complacent to suggest that the
UK is immune to the problems highlighted by the collapse of Enron.
Third, much has changed for the better in the UK in recent years
in terms of accounting and auditing standards, the regulation
financial services business, and the regulatory framework for
auditors and accountants. Fourth, it is also the case that much
of the work relevant to the concerns raised by Enron was in progress
before the collapse of Enron.
35. The Government recognises that different
regulators have their own responsibilities. They have submitted
or will submit their own memoranda to the Committee on the issues
and how they are responding.
36. It is also important, however that the
work of each regulator is well informed by that of others, and
there is close co-operation and co-ordination. The Secretary of
State for Trade & Industry and the Chancellor of the Exchequer
therefore invited Melanie Johnson, Minister for Competition, Consumers
& Markets, DTI, and Ruth Kelly, Economic Secretary, HM Treasury,
to lead a co-ordinating group on accounting and audit issues,
ensure that there is a comprehensive
work programme, to be undertaken by individual regulators, and
avoiding unnecessary overlap;
provide a progress report by the
summer, with a final report at a later stage;
commission additional work or reviews,
if that is judged appropriate; and
reach a view on the adequacy of the
proposals, and, if appropriate, make specific recommendations.
37. The members are as follows:
Melanie Johnson MP, Minister for Competition, Consumers
& Markets, DTI;
Ruth Kelly MP, Economic Secretary to the Treasury;
Sir John Bourn, Chairman, Accountancy Foundation's
Review Board; and Comptroller and Auditor General;
Michael Foot, Managing Director, Deposit Takers and
Markets Directorate, Financial Services Authority;
Mary Keegan, Chairman, Accounting Standards Board;
Professor Ian Percy, formerly Chairman, Accounts
Commission for Scotland. Former Deputy Chairman, Auditing Practices
Rosemary Radcliffe, formerly a member of the Company
Law Review Steering Group and Chief Economist, PricewaterhouseCoopers.
Complaints Commissioner, Financial Services Authority.
38. The group held its first meeting on
11 April. There was an initial discussion about the work the regulators
have in hand to address the key regulatory issues for audit and
accounting raised in the wake of the Enron collapse. This focused
on audit quality and auditor independence, financial reporting
and auditing requirements, and corporate governance, in particular
the role of the Audit Committee. The group will ensure that there
is a comprehensive and co-ordinated work programme to be taken
forward by regulators over the coming months. It will provide
a progress report by the summer, with a final report at a later
39. The group also agreed to invite the
principal accountancy bodies to be represented at the next meeting
in view of their regulatory responsibilities, and to report relevant
work they are undertaking.
40. The Government is also involved in international
work to examine issues arising from recent corporate failures
such as Enron, both within the European Union and beyond. In particular,
the Financial Stability Forum (FSF), comprising finance ministries,
regulators (both national and international groups) and international
financial institutions, discussed this at its meeting in March.
The FSF chairman will submit a report on the work being taken
forward to G7 Ministers and Governors at their meeting in Washington
later this month. The European Commission is expected to adopt
shortly a Recommendation to Member States on auditor independence,
and is working with Member States to identify policy areas for
consideration in the light of Enron.
41. Also on 27 February, the Secretary of
State for Trade and Industry announced an independent review of
the role and effectiveness of non-executive directors. From the
point of view of UK productivity performance the progressive strengthening
of the role and quality of non-executive directors is strongly
desirable. The review will consider how this can be delivered,
building on the work of the CLR and the Myners Review Institutional
Investment in the UK, including the Government's recent proposal
to strengthen the duties of institutional investors. The CLR also
noted "a growing body of evidence from the US suggesting
that a strong contingent of non-executives produce superior performance".
42. On 15 April, the Secretary of State
for Trade and Industry and the Chancellor of the Exchequer announced
that Derek Higgs would lead this review. Derek Higgs is Chairman
of Partnerships UK and a non-executive director of Egg plc, The
British Land Company plc, Allied Irish Banks plc and Jones Lang
La Salle Inc. The terms of reference of the review are set out
in Annex B.
43. Overall, the work announced by the Secretary
of State for Trade and Industry is aimed at:
ensuring that companies can fulfil
their potential and improve productivity;
strengthening the UK's framework
for how companies operate; and
and encourage greater transparency.
18 Company Law matters relating to Scotland are reserved
to the UK Parliament and those relating to Wales have not been
transferred to the National Assembly. Back
Association of Chartered Certified Accountants (ACCA), Institute
of Chartered Accountants in England and Wales (ICAEW), Institute
of Chartered Accountants in Ireland (ICAI), Institute of Chartered
Accountants of Scotland (ICAS). Back
Some, but by no means all, public companies are listed companies. Back
By amending the 1985 Act. Back
Ev 80. Back