Examination of Witness (Questions 260-279)|
TUESDAY 2 JULY 2002
260. In your speech you ended up by saying that
all the failures you talked about, management, corporate governance,
audit failures, were all made possible by inadequate regulation
and accounting rules.
(Lord Sharman) Yes.
261. Should we feel confident about the extent
of regulation here in the UK? I am beginning to form a picture
of an accountancy business which is on the whole writing its own
rules, doing its own investigating and funding its own regulator.
(Lord Sharman) You can take some comfort from a fairly
considerable amount of progress which has been made since the
problems we had in this country following the scandals of the
1980s and early 1990s. There is further to go. I certainly subscribe
to the notion that the major accounting firms should not fund
their own regulator. It seems to me that regulation must not only
be independent, it must be seen to be independent. For that reason,
I am quite strongly in favour of independent funding of that body.
There is always the lingering suspicion that "He who pays
the piper calls the tune". On the issues affecting regulation,
the Foundation, which has not been in existence for that long,
is headed in the right direction, but there are clearly some more
things which need to happen, things like how much transparency
there is over quality processes in the accounting firms is an
262. It would appear that some of the activities
of the hedge funds may have exacerbated the demise of Enron. You
mentioned hedge funds in your speech. You said that ". .
. as much as 30 per cent of the daily turnover of the LSE may
be due to hedge funds". Does this mean that a corresponding
risk to financial stability also exists in the United Kingdom
and, if so, what can be done about it and by whom?
(Lord Sharman) The situation in Enron was quite special
in that the hedge fund activity, which I understand was quite
massively shorting the stock, that is selling it in the hope that
it is going to drop and then buying it back more cheaply, triggered
the collapse of the financing arrangements. I do not want to get
into a lecture about financing arrangements because they were
very complex, but the key element in Enron was that if the share
price fell below a certain level then the debt got called and
that is what happened. I think that you would expect, when a company
has problems and hedge funds decide to take positions in it, that
is what they are there for. I do not think the risk is as great
in this country but I am not an expert in that field.
263. On the issue of corporate governance, a
lot has been made of how to give company boards more spine. You
addressed that in your speech. You suggest that work still needs
to be done to establish a practical limit on the numbers of non-executive
appointments. Is this susceptible to a simple limitation? How
do you allow within such a limit for variations in the level of
(Lord Sharman) I do not think it is susceptible to
an absolute limit of four or three or two or five or something
like that. The role and responsibility of non-executives actually
vary within a company. For example, if you are chairing an audit
committee and things develop along the lines which I expect them
to in audit committees, then the chairman of the audit committee
is going to have quite a lot more to do. I do think we need to
look at the time commitment and the time constraint by company.
It ought to be a situation which at least is negotiated between
the non-executive and his board as to how much else he will do.
264. Say some individual had 15 or 20 non-executive
directorships, what would your view on that be?
(Lord Sharman) My view is that if you had 15 or 20
non-executive directorships of listed companies you would be a
265. Would you still be a miracle worker with
eight or ten?
(Lord Sharman) It depends on the size. You are getting
266. How would you like to see the role and
responsibilities of non-executive directors develop? It seems
to me that it is a remarkably ill-defined job which in many cases
basically comes down to years of fairly inactive contribution
followed by moments of panic.
(Lord Sharman) A number of things need to be done.
First and foremost, we need to look at what constitutes independence.
It is talked about a lot in the context of non-executive directors.
We need to look at that because the important thing is independence
of management and independence of the company in the sense of
the management process. The definition of the role and responsibility
is an important issue. So far as I am aware basically our law
provides that the responsibilities of directors, be they executives
or non-executives, are not different. If you sit as a member of
a board you are collectively responsible and individually responsible
as a member of that board. It does not matter whether you are
the chief executive or a non-executive, you share the same responsibility.
I would hope the joint inquiry of the Treasury and the DTI will
come with something on that definition of role and responsibility.
Whether or not, in the fullness of time, there needs to be a distinction
in law, is something which needs to be debated. As regards the
other areas, there is a woeful lack of internal and external training
of quality available for people who want to become directors and
it is not unreasonable to expect non-executive directors to have
what we call in many professions continuing professional education.
You should keep up to date and there should be a means of demonstrating
that you are keeping up to date.
267. This is all very reminiscent of pension
fund trustees and school governors and other people who have lots
of responsibility but you do not really have the time to do the
job properly. What positive benefit is there in having non-executive
directors which outweighs these drawbacks? Do we actually want
them at all?
(Lord Sharman) If you look at Enron and you look at
WorldCom and you look at the others, in all of the cases you get
very powerful executives at the centre of a business. I cannot
see any other system, other than a system of corporate governance,
which involves people who are not executives. Be it a two-tiered
board, which is what you see in continental Europe in many places,
be it a unitary board with non-executives here, I cannot think
of another system which can get people close enough to exercise
268. How do you think the role of audit committees
might be enhanced?
(Lord Sharman) In three ways. First, the audit committee
should assume responsibility for the appointment of auditors,
that is to say, it should be an audit committee activity, recommending
to the board. In many cases when auditors are appointed, there
is usually a heavy involvement of the finance group in deciding
who to recommend to the board. I think that should be exclusively
the remit of an audit committee. They should become much more
responsible for managing the relationship with the auditors, that
is to say that the key interface between the corporation and the
auditor should be the audit committee, which in my book is composed
entirely of non-executive members. Finally, they should establish
a series of processes which ensure that their auditors remain
independent. They should report against all of those things in
the annual report, saying here is a report. We have a great report
of the remuneration committee but the audit committee does not
say anything about what it has done and those things would help
enhance the audit committees.
269. I was struck in your speech where you said
that you were disappointed that other major firms did not follow
the example of KPMG and Ernst & Young in publishing financial
statements about themselves as auditing firms. You say, ".
. . the affairs of some of these firms are remarkably opaque".
Which ones are those?
(Lord Sharman) The other firms are the other big firms,
that would be PriceWaterhouseCoopers, Deloitte & Touche and
270. What are they hiding?
(Lord Sharman) I do not know.
271. Was the decision by KPMG to publish a financial
statement in part related to its structure which limited partners'
(Lord Sharman) Yes, it happened at the time at which
we decided to incorporate the audit practice. It was related to
that but at the time we had the option just to publish the financial
statements of the audit practice and we decided to go much further.
272. You would now like to see all the audit
firms publish full financial statements and audited to the same
standards of public companies that they audit.
(Lord Sharman) Yes, I would.
273. Why do you think they are not?
(Lord Sharman) Why do I think they are not publishing
them or not auditing?
274. Not publishing.
(Lord Sharman) I do not know. I only know that I believe
that when you have a crisis of confidence, which is what you have
in a profession, one of the ways in which you can overcome that
is to be more transparent about what you are, what you do and
what you make out of it.
275. Are you now talking about PriceWaterhouseCoopers?
(Lord Sharman) I am talking about PriceWaterhouseCoopers,
Deloitte & Touche and Andersen.
Mr Fallon: All three of them.
276. Do you think the Government struck a very
soft deal when they agreed to limited liability for accountancy
(Lord Sharman) I do not believe it was that soft.
Having been one who campaigned for the introduction of limited
liability partnerships, I believed that it was necessary at the
time, I believed that most, if not all of the major accounting
firms are heading in that direction, which will mean they have
to publish financial statements. I believe also that transparency
in that regard needs to go further than just financial statements.
I do not think it was a soft deal.
277. My question was not really about the advantages
or disadvantages of limited liability but whether the Government
could have struck a stronger deal when it provided the legislation
allowing for limited liability for accountancy?
(Lord Sharman) You asked me whether I thought they
had. I think they could have done obviously. One of the things
which was an option, and I cannot speak for those who put forward
the legislation, was that there should have been something in
return. You could have had stronger regulation and that was certainly
being negotiated at the time. You might well have asked for more
transparency than just financial transparency, which is all that
is required within that Act. You might have asked for transparency
over the quality control processes and things like that.
278. Governments now are big customers of the
Big Four accountancy firms. Do you think there can be collusive
relationships between Government and the Big Four just as there
can be collusive relationships between big companies and the Big
(Lord Sharman) The obvious answer to that is that
there can be collusive relationships between any two parties if
they decide to become collusive. It is not just accounting firms
and governments. Any two people can agree to collude if that is
what they want to do.
279. What could you suggest to prevent the risk
of collusive relationships between Government and the Big Four
(Lord Sharman) Openness and transparency is the way
you do it. You have to disclose everything. In my judgement if
everything is in the public domain it makes it that much more
difficult to collude.