- Although much of our evidence has concentrated on the role of accountants and auditors, the primary responsibility must rest with the directors of the company, as we have already pointed out. A number of suggested improvements in corporate governance have been put to us, principally relating to the contribution of the non-executive directors.
- In the context of our current inquiry, a number of witnesses have proposed a much more proactive role for the non-executive directors in relation to the auditing function. Sir John Bourn suggested that non-executive directors should report on a range of matters relating to the audit. He added "the external auditors 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." We support this idea. We also agree with Lord Sharman that the role and responsibilities of non-executive directors might benefit from clarification.
- The importance of the role of the audit committee was also stressed, by the Chairman of the ASB and Lord Sharman, among others. We believe that 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, for selecting the firm of auditors to be put to the shareholders for appointment, and for fixing the auditors' remuneration.
- Enhancement of the role of independent non-executive directors will mean that they will need more time available, and greater expertise. This raises a number of issues, such as what 'non-executive' means, conflicts of interest, how they are remunerated, the number of appointments an individual may hold, the degree of training needed, and the size of the available pool of talent. A number of these points have been touched on in evidence to us. We expect the Higgs Review to produce proposals which cover these important matters. We recognise that there have been serious abuses of the practice of non-executive directors undertaking paid work with the same company. We expect the Higgs Review to address this issue positively.
The Company Law Review
- A number of witnesses have drawn attention to the lack of progress on implementation of the Company Law Review. Launched in 1998, this was a fundamental review of the framework of core company law. It reported in July 2001. In its memorandum, the Government reported that it was developing legislation in response to the recommendations, to be published in due course in draft for consultation. It described this work as "a task of great scale and complexity".
- In his evidence, Mr Richard Rogers, Director, Company Law and Investigations, DTI, emphasised the complexity of the exercise. He added that "there is no question of a new Bill being introduced in the second session". On 16 July the Government published its first formal response to the recommendations of the Review in the White Paper 'Modernising Company Law'. Some of the draft legislation has been published in the White Paper.
- We welcome the fact that the Government has now responded to the Company Law Review, but remain concerned that there is no definite Parliamentary timetable for its implementation. If it becomes clear that action is needed in the light of Enron affair, we would not be happy for this to be delayed until comprehensive legislation can be introduced. We consider that the Government should give higher priority to this matter, not least because of the threat identified by the Chairman of the FSA and arising from the current proposals for the EU Prospectus Directive, to the use of the Listing Particulars as a means of imposing new requirements on listed companies. We recommend that, as a minimum, the Government gives a commitment to publish draft legislation in full in the course of the next Session of Parliament.
Competition in the Accountancy Profession
- Professor Sikka and others, including the New Economics Foundation, and Lord Sharman have commented on the dominant position of the 'Big Four' accounting firms. In evidence to us, Treasury witnesses implied that the CGAA might suggest referring them to the Competition Commission. However, the Group's view is that the question of referral is outside the scope of its remit, but rather a matter for the competition authorities to consider.
- Sir Howard Davies regarded the loss of a major accounting firm, leaving just four large global operations, as 'most unfortunate'. It has an adverse effect on the FSA "in that there are circumstances in which it is quite difficult for us to find a firm which can act independently...indeed there have been one or two circumstances in which we have not been able to find an independent firm to act for us". He added "I find it difficult to think that the current position is in fact stable because whereas you might just about argue four was a possible number, in some sectors there are effectively not four competitors because in some sectors, for example, the insurance sector, there are not really four competitors. It is now a position where it is impossible for any one of these four to fail because anybody would agree you could not go down to three or two".
- The FSA told us that "most" of its own business with accounting firms was placed with the Big Four. It doubted whether its own purchasing was on a scale that could materially affect the market, in terms of encouraging other firms to develop the capability to compete more effectively with the Big Four. Sir Howard Davies nonetheless thought that "a competition analysis of the overall state of the market would be useful", preferably on an international basis.
- We note the evidence we have received concerning the increased degree of concentration in the accountancy industry as a result of the collapse of Arthur Andersen. While accepting that there must be a limit to the number of accounting firms that can afford to operate on a global scale, as Lord Sharman recognised, it is not clear to us that the market is truly competitive. There is also the question of whether the combined growth of the 'Big Four' is in part fuelled by a perception on the part of some public companies that being audited by one of the 'Big Four' is a status symbol. We recommend that the Government refer the United Kingdom operations of the 'Big Four' to the Competition Commission. We also recommend that it give careful consideration to whether it could assist in reducing concentration by placing more of its work with suitably qualified and experienced firms outside the 'Big Four'.
THE INTERNATIONAL DIMENSION
- There is an important European dimension to these matters. A programme of legislative and non-legislative measures (the Financial Services Action Plan) is being developed with a view to putting in place a single European market for financial services by 2005, of which the capital market elements are to be completed by 2003.
- We have already referred to the Regulation on International Accounting Standards, adopted in June 2002, which will require all listed companies to use such standards from 2005. The Commission also agreed, on 16 May 2002, a Recommendation on a set of fundamental principles for statutory auditors' independence in the EU. This Recommendation is the result of discussions within the EU Committee on Auditing, which is composed of representatives from the Member States and the European audit profession. In three years' time, the Commission will review the application of the recommendation, and consider whether EU legislation is required.
- The Commission recommendation shares the United Kingdom's principles-based approach and the Committee on Auditing believes that the best way to achieve its objectives is through monitored self regulation. The finalised recommendation takes account of the Enron case. It does not prevent individual Member States setting stricter requirements, if they so wish.
- A Commission Communication is to be issued later this year on the policy priorities on the statutory audit. These are expected to include:
the use of International Standards on Auditing for all EU audits by 2005;
minimum requirements for proper public oversight of the auditing profession at national and possibly at European level;
corporate governance in relation to the statutory audit, in particular the future role of audit committees in European listed companies;
the possible adoption of a Code of Ethics to underpin professional integrity within the Union;
the provision of a proper legal underpinning for the EU initiatives on statutory audit, notably by a modernisation of the 8th Company Law Directive on statutory audit; and
a review in 2003 of how the Recommendation on a minimum requirements for systems of external quality assurance for statutory audit in the EU (adopted in November 2000) has been implemented in Member States.
- It is clear that the EU expects to be a serious player in the ongoing debate about the role and regulation of auditors, and the development of corporate governance standards within the EU. We urge the Government to ensure that United Kingdom interests, and regulatory standards, are fully protected in developing common European approaches. In this context, we were concerned by Sir Howard Davies' comments that the proposed Prospectus Directive could undermine the present role played by the Listing Rules in enforcing corporate governance requirements on listed companies. Other groups have also expressed concern. We recommend that the Treasury seek to ensure that the United Kingdom's standards of financial disclosure and corporate governance are fully safeguarded during negotiations on the Directive.
The United States of America
- It is, of course, the United States which faces the greatest challenge, as the Enron collapse occurred in its jurisdiction. Both Houses of Congress have now passed legislation in this area, the more radical legislation being the Senate bill (the Public Company Accounting Reform and Investor Protection Act of 2002) introduced by Senator Paul Sarbanes, Chairman of the Committee on Banking, Housing and Urban Affairs, which was passed by the Senate on 15 July. The extent to which this will pass into law will now depend on the conference with the House of Representatives, which has passed a rather more limited measure sponsored by Congressman Michael Oxley, Chairman of the Committee on Financial Services. Initiatives have also been taken by other bodies, such as the Securities and Exchange Commission, and the American Institute of Certified Public Accountants.
- Concern has been expressed in the United Kingdom that aspects of the Sarbanes bill could have extraterritorial implications, in that the proposed Public Company Accounting Oversight Board would be able to demand audit working papers from any foreign accounting firm that helped prepare accounts for a US public company. We intend to follow the progress of the proposals for a Public Company Accounting Oversight Board and to consider whether a similar body would be appropriate in the United Kingdom, possibly with reciprocal powers.
- The Enron and Worldcom collapses have shaken confidence in company accounts, and consequently in the professionals responsible for running companies and for financial reporting. Although these cases have, for the most part, arisen in America, the crisis of confidence has spread far further.
- We acknowledge that the regulatory environment in the United Kingdom is very different from that of the United States. We also recognise that a large amount of work has already been done in the United Kingdom to improve accounting, auditing and corporate governance. But there can be no room for complacency. There are still features of the accountancy regime which appear to us to be insufficiently robust. We are not convinced that the accountancy bodies appreciate the scale of the problem. These risks must be minimised in the interest of confidence. The oversight system must be made more effective.
- The business of accountants is almost wholly based on confidence. The rapid demise of Arthur Andersen in the light of the Enron scandal is eloquent testimony to this point, as was the decline of Spicer and Pegler. We accept the argument of the professional bodies that the potentially catastrophic consequences for its firm and their employees of poor quality work act as very powerful disciplines on partners, and that the public perception of what auditors can be expected to achieve may be unrealistic. Nonetheless, we believe that public expectations demand a greater degree of accountability from the accountancy profession.
- We agree with the Government that a principles-based approach is preferable to a rules-based approach. Although the, sometimes difficult, judgements that must be made in a principles-based approach lack the apparent certainty of a rules-based approach, we take the view that the events of Enron demonstrate the hazards of the latter, legalistic, approach. We have seen no evidence that the lawyer-dominated approach favoured by the US offers advantages over the professional judgement approach favoured here.
- We also think that there are public expectations of a greater degree of activity from the Government. Very shortly, it will publish the interim report of the CGAA. We shall be looking for clear evidence that issues we have identified in this report are being addressed with urgency and firmness of purpose. We expect to look further into this matter when we have had a chance to study this report.
- We share concerns about the problems of 'revolving doors', whereby personnel involved in public sector contracts move from the public sector to the profession, and vice versa. We recommend a cooling-off period between employment in accountancy or consulting firms or contracts with the Government.
- Although, perhaps inevitably, this report has concentrated on the role of accountants and of company management, the responsibility for ensuring that companies are well run and providing proper reliable information rests on all the stakeholders, including the shareholders. We believe that considerable improvements in the governance of companies can be brought about by greater shareholder interest in its affairs. We urge all shareholders, and institutional shareholders in particular, to face up to their important responsibilities in this respect.
59 Q206 Back
60 Q206 Back
61 QQ266-8 Back
62 Q325 Back
63 Q268 Back
64 Modernising Company Law for a Competitive Economy - the report of the Company Law Review Steering Group Back
65 HC 758-iv Back
66 Q42 Back
67 Q422 Back
68 Cm. 5553-I Back
69 Cm. 5553-II Back
70 Q281-2 Back
71 Q442-3 Back
72 Q381 Back
73 Q381. See also Q384 Back
74 QQ386-88 Back
75 Q382 Back
76 Q383 Back
77 Q281 Back
78 Commission Recommendation 2001/6492. Back
79 See Commission Memorandum 02/96, of 16 May 2002 Back
80 QQ400-02. Back
81 Financial Times, 11 July 2002. Back
82 The Corporate and Auditing Accountability, Responsibility and Transparency Act of 2002 (H.R. 3763) Back
83 See Accountancy Age, 11 July 2002. Back
84 Auditors of UK registered companies which are listed on a recognised American stock exchange are already required to comply with SEC independence requirements, in addition to those of the United Kingdom. Back
85 QQ139-40 Back