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Lord Haskel: My Lords, the noble Baroness, Lady Miller, referred to the noble Lord, Lord Borrie. He had intended to speak, but he is unwell.

6.46 p.m.

The Parliamentary Under-Secretary of State, Department of Trade and Industry (Lord Sainsbury of Turville): My Lords, I congratulate the noble Lord, Lord Brennan on initiating this timely debate. I agree that we should never forget the human consequences of the financial scandals that have occurred in recent years. I also agree with almost everything that he said about non-executive directors and board remuneration. I am pleased that the noble Lord, Lord Freeman, believes that our significant reforms have been "tough and measured". That is how we would like them to be seen, and it is important that they are seen in that light.

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The noble Lord, Lord Razzall, suggested that the House was totally split on this issue, but I disagree. There seems to be almost overwhelming support for what we are doing—with the exception of the noble Lord, Lord Marsh, who was in a small minority. However, that is where he is normally most happy, so I was not deeply worried about it.

We all recognise that sound corporate governance and reliable financial statements are vital for sustained investor and market confidence. There is no doubt that the failures in the United States shook that confidence severely, and continue to do so. The consequences of a lack of faith in our markets should not be underestimated. Lower share prices, higher costs of capital, lower investment and a more risk-averse attitude to innovation can all, to some extent if not totally, be traced back to the catastrophic collapses of Enron, WorldCom and Arthur Andersen.

I agree with the noble Baroness, Lady Cohen, that there are differences between UK and US accounting. As she said, the UK relies heavily on a principles approach and a true and fair view. That emphasises the substance of accounts over the form, which is a strength. The US relies much more on detailed rules, which tends to promote a different approach. However, it is wrong to be complacent about the UK's position. For example, the UK Auditing Practices Board recently warned about the dangers of aggressive earnings management in the UK. The problems with Enron and WorldCom may have been less likely to happen here than in America, but we cannot be certain. The Higgs report recommendations, and the other changes that we are making, will help to make such problems less likely to occur here.

We need to take a long hard look at corporate governance issues across the piece. The Co-ordinating Group on Audit and Accounting (CGAA) was established to ensure that auditing and accounting issues raised by the Enron collapse were addressed thoroughly by appropriate regulators. Separate reviews were taken forward by Derek Higgs on the role of non-executive directors and by Sir Robert Smith on audit committees, as well as a DTI review of regulation of the accountancy profession.

I listened carefully to all the points made about the various reports and reviews, and I shall address the specific points in due course. First, however, let me stress that the proposals need to be seen as a mutually supportive whole; they should not be judged in isolation.

Some of the proposed changes address the issues from a boardroom perspective, some from the perspective of the auditors, and some address the issue of oversight and regulation. The overall objective is to raise standards of corporate governance, strengthen our accountancy and audit professions and provide for a more effective system of regulation of those professions.

In her Statement to the House on 29th January, my right honourable friend the Secretary of State for Trade and Industry strongly welcomed the Higgs

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report and emphasised its importance. She highlighted Derek Higgs's conclusion that at least half the board, as well as the chairman at the time of appointment, should be independent; that all members of the audit and remuneration committees should be independent; and that the separate roles of chairman and chief executive should be reinforced. She also stressed how crucial she thought it was that appointments should be made on merit—not, as is the case for over half the appointments at present, through personal contacts and friendships.

However, my right honourable friend also stressed that that was not a regulatory approach. The way to raise corporate governance standards is to use the existing, very successful approach of the combined code guidance. The principle is "comply or explain", whereby a company—for example, a small listed company—that is unable or considers it inappropriate to comply with the recommendations can, as now, explain why it is not doing so. Its shareholders and the market will judge whether that explanation is a reasonable one.

Since publication of the Higgs report, we have seen plenty of media coverage about its implications. I agree with the noble Lord, Lord Brennan, that the CBI's response was disappointing. I am glad that the noble Lord, Lord Freeman, and the noble Viscount, Lord Chandos, were supportive of its overall approach. We are well aware of the responses to what I thought were very selective and biased questions from the CBI. Of course we note the concerns. However, the institutional investor community is supportive of the report, and many in business have supported the report's findings.

As the Secretary of State said, there is a strong belief that British corporate governance is the best in the world. The Government are committed to maintain that position, but we cannot afford to be complacent. The Secretary of State has already made clear to Parliament, and confirmed in her Mansion House speech, that the Government welcome the Higgs report. We think that it marks an important contribution to corporate governance and restoring investor confidence.

I am delighted to be able to give the noble Lord, Lord Barnett, an answer which he has not already given me. The recommended changes to the combined code are presently out for comment under the auspices of the FRC. It is the FRC that is responsible for the combined code, not the Government. The FRC has invited comments by 14th April on the proposed changes to the combined code before it issues a definitive revised code. I am sure that the FRC will consider all the comments it receives. The issues now need to be considered carefully and debated sensibly, and that is what the FRC will do.

I should add—I thought that there was no mystery about this—that the Treasury and the DTI were both very much involved in all the work, particularly in relation to the co-ordinating committee. The two departments worked very carefully on the matter, as we both have an interest in it. I think that joined-up

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government is a rare commodity and that, when we come across it, we should celebrate it and not consider it a demonstration of lack of clarity about responsibilities. I should also add that we are not considering legislation. We are working on the principle of "comply or explain". I am, however, not saying that we would never change that.

It is worth remembering that Derek Higgs publicly consulted last June. He saw and spoke to a great many players during the conduct of his work and took soundings with the major representative organisations on his proposals as well as doing detailed research, the results of which are available on the review website. I have stressed that the corporate governance improvements—not just Higgs, but also Sir Robert Smith's very important recommendations on the role of audit committees—are not about regulation or coercion, but rely on the very effective mechanism of "comply or explain". However, we must also recognise that Enron raises issues about "who guards the guards"—about the role of the auditor, the relationship between the professional accountancy bodies and the independent regulators, and about the enforcement of standards. That is why my right honourable friend announced in her Statement on 29th January a number of tough new measures to ensure independent oversight and auditor independence. Various issues have been raised concerning those measures and I shall attempt to address them in a moment.

First, I should like to set out the main changes that we have announced. There is to be a unified national body to oversee the accountancy profession—an expanded Financial Reporting Council, under Sir Bryan Nicholson—with three clear responsibilities: setting accounting and audit standards, enforcing or monitoring them and overseeing major accountancy bodies. That body will be more accountable and transparent. The setting of auditor independence standards by the Auditing Practices Board under this new structure, and a new unit for inspection of major audits, mean a tougher independent challenge of audit. Those roles will become clearly independent of the professional bodies.

The changes to the oversight regime, when combined with the recommendations of Sir Robert Smith's review, to which I have referred, will help safeguard auditor independence. Specifically, they will provide a clearer and stronger role for audit committees in approving the auditor and the purchase of non-audit services, backed up by stronger combined code provisions and detailed guidance, and tougher ethical standards for the audit profession. These standards are to be set by a fully independent body with independent monitoring and discipline. Finally, and importantly, we are toughening up enforcement of the accounting requirements through a new more proactive regime which will make more effective use of Financial Reporting Review Panel and FSA expertise.

I turn to some of the specific points raised. I very much agree with the noble Lord, Lord Haskel, about the need to widen the pool of non-executive directors and to deepen their involvement. Non-executive directors must not be seen simply as policemen; they

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must be seen as bringing valuable skills and knowledge to the board and to help rather than hinder the achievement of competitive advantage. Derek Higgs placed strategy at the top of the list—alongside performance, risk and people—as the main elements of the role of a non-executive director. He described the non-executive director's role as a constructive challenge and contribution to the development of strategy. Research commissioned for the review showed that there was no contradiction between the strategic and monitoring roles of the non-executive director.

I assure the noble Lord, Lord Freeman, that we will certainly continue to pursue with the SEC the point that it should take account of the excellent regulation in this country. There has been a recent visit to the United States and I think that we may be making some progress.

The noble Lord, Lord Freeman, also asked about the timing of the new company law Bill and how we will handle it. We will bring forward a Bill as soon as practicable. However, as I am sure he will appreciate, this is a task of great scale and complexity. We are considering having a pre-legislative committee as a useful device to help take forward that legislation. He was also right to say that the EU is proceeding on the very sensible basis of "one size does not fit all". We agree that that is the right approach.

The noble Lord, Lord Sharman, raised a number of points, including whether to allow the chairman to chair the nomination committee; the role of the senior non-executive directors in relation to investors—which I think is rightly described as the backstop approach in the Higgs report; and rotating the board of non-executive directors. I do not want to get into the detail of the specific proposals now because, as I said, they are being reviewed and consulted on by the FRC. However, I should like to clarify the position, not for the noble Lord, Lord Sharman, but possibly for other noble Lords. He was quite right to describe that approach as a backstop. It would operate only when communication between the chairman and the investors had essentially broken down and there was a lack of confidence. Only then is it envisaged that the senior non-executive director would take action. Such action seems very practical and not to be a threat to the chairman's overall role.

As regards the rotation of non-executive directors—the noble Lord, Lord Stewartby, also raised that point—Higgs says that there is a need to be flexible on that issue. He accepts that there will be cases where a non-executive director remains on a board for longer than six years and recommends that shareholders should be asked to re-elect non-executives each year after they have served for nine years. That seems an eminently practical approach.

The noble Baroness, Lady O'Cathain, asked whether the proposed changes would raise the performance of a board. If the changes prevent a few of the failures of corporate governance that we have seen in recent years, they will be worth while. The

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essence of regulation is that it should be proportionate. We believe that the proposed changes are proportionate to the seriousness of the issues involved.

The noble Baroness also asked what would happen if investors and a board were unhappy with a chairman. She suggested that they and the board should confront the chairman. In my experience that is not the way these things work. Having another channel of communication between board members, investors and the chairman may result in action being taken in circumstances where board members are not at all keen to tell the chairman that he should not be in charge of the board.

I agree with the noble Lord, Lord Holme, that companies need respect and trust if they are to operate effectively and recruit idealistic young people. The noble Lord, Lord Fyfe of Fairfield, mentioned the senior independent director. The detail of the Higgs report makes clear that that is a very limited role in particular circumstances.

The noble Lord, Lord Stewartby, may not have been selected at his golf club, but the record shows that half of non-executive directors are selected on a personal basis. It is interesting to note that only 4 per cent have a formal interview. Therefore, in general, the system is open to charges of cronyism, which is something we all want to avoid.

I agree with the noble Lord, Lord Marsh, that standards of corporate governance in the UK are certainly very much higher than they were in the past. However, it is a mistake to be complacent. The boards on which the noble Lord has sat may be comprised only of paragons of good sense and virtue. However, I think that the noble Lord, Lord Sharman, who has probably had experience of more companies than the rest of us put together, would agree with me that in the past many non-executive directors joined boards without being aware of all the activities or of the financial practices of the company that they joined.

I agree with the noble Lord, Lord Paul, that corporate governance rules will always struggle to control energetic and skilful entrepreneurs. However, government and investors must try to make certain that the rules are as good as they should be. We cannot rely on society providing a stream of individuals of great personal integrity, although we should in all areas try to stress the importance of personal integrity.

I agree with the noble Lord, Lord Williamson, that we should not see boards in terms of two blocks of executive and non-executive directors. But, equally, we should appreciate that they have different roles. I agree with him that it is crucial to have a strong link between remuneration and performance. That is why we introduced the remuneration regulations 2002.

The noble Lord, Lord Berkeley, mentioned the parallels between corporate governance and quangos. There are important similarities, but we should always remember that they are not exact. We should see what can be learnt from Higgs but not think that one can

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make exact comparisons. The existence or not of shareholders is an important difference here and one that cannot be ignored.

The noble Baroness, Lady Hayman, referred to the same issue. She mentioned some of the difficulties of applying the Higgs principles to the voluntary and public sectors. It is valuable to explore those issues, even if it is sometimes difficult to apply the principles to voluntary work.

The noble Lord, Lord Razzall, asked whether the National Audit Office could audit private companies. I do not think that the Government have any strong views on that issue. It is not a particularly important issue in terms of corporate governance one way or the other. I do not believe that we have considered the question of the imbalance of each shareholder carrying the same "weight" as regards certain decisions. Perhaps that is because that is not a very good idea. It seems to me that that is not an idea that commends itself immediately to many people.

I was surprised to note that the noble Baroness, Lady Miller of Hendon, appeared to move in two directions at the same time. Apparently, she wants a detailed timetable for the implementation of the regulatory changes but she does not want action to be taken too quickly. We have already begun to put the regulatory changes into practice. Some changes will be implemented quicker than others. I am sure the noble Baroness is not surprised to hear that the fact that Tesco left the report on the shelf does not move me strongly one way or the other.

In summing up, I welcome the debate. These are important issues and not easy ones. We may all agree as regards the overall objective, but, as the debate has shown, there is more than one way of achieving that objective. Of course, these are issues that are being grappled with around the world. The US has already made its response—a strong and immediate response—through the Sarbanes Oxley Act. The European Commission is taking forward work on both corporate governance and auditor independence—work which the UK is in a good position to influence and lead. Others such as Australia and Japan are also carrying out fundamental reviews.

If Enron has shown us anything, it is that these are truly global issues, not national ones. But I think it is fair to say that the UK's response has been widely recognised around the world as sensible and effective. It is neither knee-jerk and disproportionate, nor complacent and foot-dragging. It is tough where that is needed but measured and mature, building on our existing, well respected system of corporate governance. That is the basis on which we shall go forward.

7.7 p.m.

Lord Brennan: My Lords, the continued vibrancy of British corporate life has been richly illustrated this evening by our finding out that the noble Viscount, Lord Chandos, and the noble Lord, Lord Marsh, manage to sit together on the same board. I thank

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them both for their contributions. I thank the noble Viscount, Lord Chandos, for making sharp satire appear merely delicately sardonic. I thank the noble Lord, Lord Marsh, for eventually being able to overcome his natural capacity for reserve.

I thank all other noble Lords who contributed to the debate, especially those who gave us what I call wisdom. I refer to the noble Lords, Lord Barnett, Lord Paul and Lord Haskel, on my side of the House, to the noble Baroness, Lady O'Cathain, and the noble Lord, Lord Stewartby, on the Conservative Benches, and to the noble Lord, Lord Holme, in particular on the Liberal Democrat Benches.

We can extract from the contributions three conclusions. First, we are in a process of consultation about something that is immensely important. It is not just a matter of avoiding another Enron situation but of ensuring competence in British corporate life. That requires a balanced debate about how to match commercial freedom with public protection. In making a balanced judgment we should surely apply good values. Finally, we should take action sooner rather than later. I commend the Government's expedition and the clarity of the exposition of the Government's views by my noble friend the Minister. I hope that we shall not discuss the subject again next year. I beg leave to withdraw the Motion.

Motion for Papers, by leave, withdrawn.

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