TUESDAY 1 DECEMBER 1998

PROFESSOR P SIKKA

  112. Good afternoon, Professor Sikka, welcome to the Committee. You were probably about the first person to write to us when the word got out that we might well be looking at the draft legislation. I suppose in some respects this is not surprising, because I understand that you have been tracking this issue for a number of years now. How do you see the genesis? We have just had a witness from the Institute of Chartered Accountants who said that it is coincidental that Jersey features in this. What is your view as to the origin and development of the LLP proposal?

  (Professor Sikka) Good afternoon and thank you for asking me. The origin is the phrase we used that the UK Parliament has been held to ransom. I have brought some documentation with me which will show you how Price Waterhouse went about getting the Jersey legislation enacted. I hope that this will go on the public record so that everybody can see what happened behind the scenes. That letter is dated October 1995 and it is clear that Jersey was being used as a lever to secure more concessions from the UK Government. Ernst & Young, together with Price Waterhouse, spent more than £1 million to draft a Bill through Slaughter & May—David Goldberg QC drafted it—and in that legislation the firms awarded themselves virtually every conceivable liability protection with no public obligations. There was nothing in the original Bill at all about insolvency of the LLPs which had to be finally enacted on 19 May this year in Jersey. The Bill finally reached the statute books in September. I became involved with the Jersey aspects because some people in Jersey noted that this legislation was to be rushed through in two hours and some members of parliament there did not understand what the hurry was and they did not understand the Bill either. I was asked to comment and I pointed out that there was nothing about insolvency, nothing about public obligation, not even a requirement for the firms to put on their headed paper that they were located in Jersey; even that bit was missing from the legislation which was drafted. Some of you may well be aware that one of the senators in Jersey spoke up against it and he was suspended indefinitely from the Jersey States because that is the way Jersey operates. It took action from the UK MPs to have him restored with the threat of possibly going to the United Nations. What I am suggesting is that the UK Government as it appears is finally perhaps to yield to the organised accountancy interests and it is interesting that even from the UK Bill lots of aspects relating to the rights of audit consumers are absent.

  113. Is there any good reason in your view why people requiring limited liability should not incorporate as limited liability companies?
  (Professor Sikka) I see no reasons at all, indeed I would argue that an adequate case has not really been made for the LLP legislation anywhere. One of the arguments put forward by firms is that they are hard done by on liabilities, but no evidence has been provided. Where is the evidence of actual settlements? I circulated the members of the Committee with a booklet. We estimate that their liability costs are 2.67 per cent of their total fees, considerably less than those of doctors, dentists and everybody else and they could have incorporated following the Companies Act 1989 when that amendment was made because that is what the auditing industry wanted. However, they did not want the accompanying need to publish accounts and they were not happy to accept the tax implications either. It was at that point that Jersey was used as a lever. I would argue that even now, if we are to go ahead with the LLP aspects, the legislation should be fair and should have due regard to the interests of the ordinary people who are going to consume accountancy auditing services. If I might just expand on that, there comes a time when one has to ask whether people have enough economic incentives to do good audits, if in the UK the position is already, following the 1990 Caparo judgment, that auditors do not owe a duty of care to any individual current or potential shareholder, creditor, employee, pension scheme member. We also have to bear in mind that the 1948 Companies Act was part of a social bargain under which accountants got a statutory monopoly of the external audit function in return for accountants accepting a joint and several liability principle and various speeches made in parliament at that time and since have suggested that audits were designed to protect ordinary people. What I am suggesting is that that social bargain has continued to be diluted, concessions have been made at the producer end, no regard has been given to the consumer end. I listened this morning to various speakers and the previous speaker as well and those kinds of issues have not really come up.

  114. Dealing with the question of insolvency, you said that in company law there are restrictions on the transfer of assets to shareholders but the equivalent does not apply in the case of LLPs. The DTI point out that of course a company's capital is not actually intended to be a buffer for the benefit of creditors but to enable the company to have adequate funds to fund its day to day operations. So why should LLPs be materially different?
  (Professor Sikka) One has to take issue with DTI's interpretation. One would argue that there is a whole host of legislation affecting matters such as distributable profits. Companies can only pay dividends out of realised profits and so on. That legislation to my reading is that it sees a company's capital as a kind of reserve fund out of which creditors can be protected. This is why there is legislation dealing with capital maintenance, restricting payment of dividends and so on. Applying the same logic to LLPs which will also have the benefit of limited liability one would argue that there should be some kind of a reserve fund.

  115. There is no legislation which imposes minimum capitalisation on companies. There is nothing which says if they are doing a certain volume of business then they have to have £1 million of paid up share capital, is there? Surely your argument is a non sequitur.
  (Professor Sikka) I would argue that sure, legislation does not require minimum capital maintenance but that in a sense is left to the management themselves and the law basically ensuring that at any given point in time businesses should not be insolvent. If they are, then the directors can become personally liable. That suggests to me that there is a suggestion that a certain amount of capital is to be maintained to protect creditors.

  116. The company law in relation to insolvency certainly places very onerous obligations on directors but nowhere does company law require minimum capital so I still remain puzzled by your principal contention.
  (Professor Sikka) Company law does not specify minimum capital but I feel that out of the way the companies trade and the way various other pieces of legislation operate they really basically require directors to make sure that the businesses are not trading while known to be insolvent. I believe that the equivalent kind of protections at the moment are not in the LLP legislation.

  117. Turning to the question of clawback, in your evidence to us you have suggested that a two-year period for clawback is inadequate. What sort of period would you like to see?
  (Professor Sikka) I think it should be longer than two; it could be five. My reasoning would be that the biggest asset many accountancy firms have is in a sense the accounts receivable. After the LLP proposals are implemented, these LLPs would be tempted to run down their accounts receivables and pay the partners very, very quickly their share of salaries and profits. What you are likely to be left with is basically shells which will not really be worth a great deal to creditors. There is likelihood, as was indicated earlier, that as soon as the slightest problem is likely to emerge people are likely to devise procedures, transfer of assets, becoming former partners and so on, to cover themselves. Bearing that in mind, one might argue that a longer period would be safer. It does not necessarily mean that a liquidator would have to draw upon it. It is just that greater protection would be available.

  118. You are suggesting five years; five years. Are you really suggesting that there would be a possibility of members of a limited liability partnership conspiring together over a period of five years in which they knew the company was in trouble to take out more than they were entitled to? Could they really sustain that for five years? One could see that you might want to go back two years but is five not really stretching it beyond the wildest dreams of most people's imagination?
  (Professor Sikka) Many court cases take a long, long time to settle before one knows what the liability of the firm finally is going to be. BCCI litigation may just about be settled now eight years later, perhaps not. Bearing that in mind if we are concerned with protecting creditors then we really need more flexibility I would suggest.

  119. May I take you on to taxation? At paragraph 7 of your August letter you raise the point as to whether the tax advantages of partnership should indeed be transferred to LLPs. What is your view on this?
  (Professor Sikka) At the moment if any ordinary person seeks to transfer their partnership to a limited liability company, they will be treated as liable for corporation tax. They will have to pay a corporation tax within nine months after year end. The expense deduction is not so easy. Expenses have to be wholly exclusively and necessarily for business purposes. It appears to me that the LLP legislation as proposed includes a large amount of anti-competition legislation, that on the one hand you have accountancy firms selling recruitment, executive recruitment services, forensic accounting, some are now printing badges and T-shirts for clients and laying golf courses as well, you have accountancy firms doing these kinds of services versus their competitors. If accountancy firms upgrade to LLP with a limited liability built in then they have concessions which their competitors do not and it seems to me that there is not a level playing field at all. There is a mistake in the legislation: it assumes that accountancy firms only sell regulated services such as auditing and insolvency. If you were to look at the fairly innocuous figures which emerge out of accountancy firms at the moment, the big five make less than 40 per cent of their total income from the regulated sector. The remainder is not from the regulated sector. There are also other problems in this legislation. If somebody does 10 per cent auditing and insolvency and 90 per cent consultancy, they can have the benefit of LLP, but those people who compete with the other 90 per cent of the accountancy firms in business cannot. It does not seem a very reasonable and level playing field at all to me.

  120. A different but not unrelated point, one of the basic arguments in favour of the LLP has been that it will be a way of capping liability, that a group of partners could be subject to a fairly substantial claim for damages which would result in them being bankrupted. Therefore by limiting the liability you are protecting innocent members of a partnership. You mentioned a figure of about 2.75 per cent. Was I right in assuming that that figure was the extent of liability in these accounting partnerships you have identified, the big five?
  (Professor Sikka) That 2.67 per cent is based upon the figures published by accountancy firms and they argued in 1993 that eight per cent of their accounting and auditing income was being absorbed by liability related costs. We argued, with reasons and the booklet I circulated to all Committee members, that it is 2.67 per cent and indeed they are being mischievous with the way they are presenting their figures. As regards capping the liability, I would argue that there is another side to the equation. What is the effect on the consumers and creditors of any concessions you give to accountancy firms or anybody else? By giving more protection to the producers of auditing services, you are necessarily reducing it for the other side. By diluting the joint and several liability or by any other kind of a cap, you are reducing the redress which is available to other parties. As regards the claim for damages, one would argue in a market economy that it is all aggrieved consumers can do. There is an iron law of markets which says that generally those people who feel they are hurt and their interests have been damaged have to go to the courts. At the moment that is the position. One would argue that nobody has really forced any auditing firm to accept a client they did not want, sign an audit report they did not want, but when the liabilities come home to roost, they are crying foul. On the back of joint and several liability we have to remember these firms have built up huge international empires. Where is the evidence that they have been damaged by this?

  121. You would not favour capping of any kind.
  (Professor Sikka) No; none.

  122. You provided us with a letter which we have not had a chance to look at with any care, neither are we aware whether the recipient or the sender of the letter would be prepared for us to make use of it. Therefore I have to say to you one, that we are not in a position to accept it for the purposes of consideration until we have the permission of both the sender and the recipient to use it. Thereafter we may well wish to ask questions about it, either to you or to the parties concerned. We are not in a position to accept for evidence purposes private correspondence which we do not know for sure the parties concerned would be prepared to have published. I am making that point. We will have to put that condition and qualification on the evidence you have given us in addition to your written and verbal statements at the present moment.
  (Professor Sikka) May I seek guidance? Would you like me to write a covering letter?

  Chairman: It would be helpful in the first instance at least to write a covering letter. The contents of that may allay some of our concerns but it is not normally our practice to accept additional evidence handed across the table, albeit with the best of intentions. The fact that it may not appear is not to be seen as disrespect, it is just the procedure we normally adopt as far as the acceptance of additional evidence is concerned. Thank you very much for coming.