Supplementary Memorandum submitted by
Professor Prem Sikka
INTRODUCTION
The proposed Bill provides a framework of accountability
for Limited Liability Partnerships (LLPs). It contains some good
features which are most welcome. These include the suggestions
that the LLPs should be subjected to the
— Wrongful and fraudulent trading legislation;
— Company Directors Disqualification
Act 1986;
— Companies investigation provisions
in the Companies Act 1985;
— Requirements to publish information
about their affairs.
However, the Draft Bill suffers from a number
of weaknesses and problems and these are highlighted below. Many
of the comments contained in this submission are made in the context
of the accountancy industry. This is not too unreasonable since
this industry has been very vociferous in demanding LLPs. Major
accountancy firms have already used their economic and political
resources to draft their preferred form of private legislation.
They subsequently had this legislation enacted for their benefit
in Jersey and have since used Jersey as a lever to extract concessions
from the UK government (see Cousins et al, 1998 for further details).
THE LLP DRAFT
BILL IS
UNFRIENDLY
The Bill as presently drafted is difficult to
read. Anyone trying to comprehend the Bill needs to simultaneously
read a large number of Statutory Instruments and sections of a
number of other statutes (not reproduced in the Draft Bill). These
include:
— The Bankruptcy (Scotland) Act 1985
— The Insolvency Act 1986
— The Income and Corporation Taxes
Act 1988
— Criminal Justice Act 1988
It is difficult to see how in its present state
the Bill can be subjected to adequate public scrutiny. Its present
way of drafting may be acceptable to lawyers and accountants,
but ordinary people who will be affected by its provisions will
not have the resources to secure all the other relevant statutes
and/or the time to make sense of them in the context of the proposed
LLP Legislation.
MORE PRIVILEGES
FOR THE
AUDITING INDUSTRY
BUT NOTHING
FOR AUDIT
STAKEHOLDERS
The proposed LLP legislation is part of a long
line of concessions to the auditing industry. Successive governments
have diluted auditor responsibility and the redress available
to third parties against negligent auditors. The present LLP proposals
give considerable concessions to "producers" and do
nothing for the benefit of audit consumers.
1 December 1998
The Companies Act 1948 gave professionally qualified
accountants a statutory monopoly of the external audit function.
This social bargain was firmly based upon the principle of "joint
and several" liability of audit firm partners. Through various
parliamentary debates, the legislature routinely assured the public
that audits offer protection. For example, during the passage
of the Companies Act 1929, audits were described as more than
just for the "protection of shareholders and investors, wholly
or even mainly" (Hansard, 21 February 1928, col 1523). During
the passage of the Companies Act 1948, audits were considered
to be "in the interests and protection of the public . .
. " (Parliamentary Debates, House of Lords, 18 February 1947,
col 745). During the passage of the Companies Act 1967, the then
President of the Board of Trade said, "It is right, both
from the point of view of efficiency and of fair distribution
of rewards, that full information should be available to shareholders,
employees, creditors, potential investors, financial writers and
the public as a whole" (Hansard, 14 February 1967, col 360).
Another supporter of the Bill added, "modern company laws
should be concerned not just with the interests of the shareholders
but with the contribution of the company to the economic efficiency
of the whole community" (col 403). The Opposition benches
supported the Bill and added that "We need a number of figures
to be able to make that comparison, and it is this inquiry by
those interested in the company, whether as an onlooker or as
a shareholder in a number of companies, which is so important
to improve the performance of companies in any particular industry"
(Hansard, 14 February 1967, col 444).
In return for the state guaranteed monopoly
of the external audit markets, the auditors were obliged to accept
the principle of "joint and several liability" and would
owe a "duty of care" to audit stakeholders. Yet this
social bargain continues to be diluted. Successive governments
(see below) and legal cases (see below) have reduced the rights
of audit stakeholders against negligent auditors. Today, individual
audit stakeholders have few rights against negligent auditors.
The proposed LLP legislation fails to even consider the issues.
The present UK legal position, as summed up
by the Law Lords in the case of Caparo Industries plc v Dickman
& Others [1990] 1 All ER HL 568, suggests that individual
stakeholders have no rights against negligent auditors. In general,
auditors only owe a "duty of care" to the company (as
a legal entity) rather than to any individual current/potential
shareholder or creditor. The Law Lords said,
"I see no grounds for believing that, in
enacting the statutory provisions [requiring publication of audited
company accounts] Parliament had in mind the provision of information
for the assistance of purchasers of shares or debentures in the
market, whether they be already the holders of shares or other
securities or persons having no previous proprietary interest
in the company . . . For my part, however, I can see nothing in
the statutory duties of a company's auditor to suggest that they
were intended by Parliament to protect the interests of investors.
"I therefore conclude that the purpose of
annual accounts, so far as members [shareholders] are concerned,
is to enable them to question the past management of the company,
to exercise their voting rights, if so advised, and to influence
future policy and management. Advice to individual shareholders
in relation to present or future investment in the company is
no part of the statutory purpose of the preparation and distribution
of the accounts".
"As a purchaser of additional shares in
reliance on the auditor's report, he [the shareholder] stands
no different from any other investing member of the public to
who the auditor owes no duty".
This is contrary to all the principles of natural
justice. The Caparo judgement contradicts the public policy
perspective suggested by Lord Denning in his dissenting judgement
in Candler v Crane Christmas & Co [1951] 1 All ER 426.
"the law would fail to serve the best interests
of the community if it should hold that accountants and auditors
owe a duty to no one but their client. There is a great difference
between the lawyer and the accountant. The lawyer is never called
upon to express his personal belief in the truth of his client's
case, whereas the accountant, who certifies the accounts of his
client, is always called upon to express his personal opinion
. . . and he is required to do this not so much for the satisfaction
of his own client, but more for the guidance of shareholders,
investors, revenue authorities and others, who may have to rely
on the accounts in serious matters of business. In my opinion,
accountants owe a duty of care not only to their clients, but
also to all those whom they know will rely on their accounts in
the transactions for which those accounts are prepared".
In the UK, company directors can be held personally
liable for publishing false and misleading accounts. Yet the same
does not apply to auditors (Financial Times, 20 January 1991,
p 6). Auditors have been considered to be at fault in auditing
financial statements (for example, see McNaughton (James) Paper
Group Limited v Hicks Anderson & Co. [1991] 1 All ER 134 and
[1990] BCC 891; Berg Sons & Co. Limited & Others v Adams
& Others [1992] BCC 661) but have escaped any damages
on the ground that they did not owe a "duty of care"
to third parties.
Despite the numerous contradictions and the
inequity of the present legal position, the DTI has failed to
undertake any initiative to give audit stakeholders the "rights"
which are routinely available to stakeholders when they purchase
mundane things, such as packets of sweets and crisps. In other
spheres, public regulators produce "customer" and "public"
charters to encourage rights for consumers and the general public,
but none of the audit regulators have ever produced such a document.
Despite claiming to issue "ethical guidelines" none
of the accountancy trade associations have ever urged auditors
to owe a "duty of care" to audit stakeholders.
Successive governments have neglected the welfare
of audit stakeholders. The House of Lords judgement in the 1992
case of Pepper v Hart stated that in making sense of the
meaning of legislation, the courts should also consider the statements
made by the promoters of the legislation (eg Ministers and other
promoters). Following this landmark decision, the DTI could have
researched the statements made by Ministers during the Parliamentary
passage of various Companies Acts (some are reproduced above)
and correct the Caparo judgement. Successive governments
have done nothing. Yet in response to lobbying by the auditing
industry they have found Parliamentary time, resources for the
Law Commission and various Study Groups to consider and advance
the auditing industry's claims for further liability concessions.
The examples include
— The Likierman Report (Likierman,
1989) which was sponsored by the DTI to examine the case for liability
concessions to the auditing industry.
— At the auditing industry's behest
the government introduced Section 137 of the Companies Act 1989
(to amend Section 310 of the Companies Act 1985). The industry
argued that, under certain circumstances, the company should buy
the insurance cover for its auditors. Hardly any company has shown
any inclination to do so. Indeed, it is difficult to see how any
Board of Directors would be able to justify expenditure on external
audits and then provide insurance for the auditors. What incentives
would auditors have to be vigilant and deliver good audits?
As a result of the auditing industry's campaign,
the Companies Act 1989 reversed the previous legislation and permitted
auditing firms to incorporate. The auditing industry and its patrons
in the early 1970s repeatedly demanded such a right. They argued
that partnership structures are unwieldy for UK major firms (some
of whom have more than 500 partners) and did not easily enable
them to raise finance from capital markets. This, they argued,
hindered their development as multidisciplinary businesses and
placed them in an unfair competition with other forms of consultancy
and advisory businesses, not only in the UK, but in Europe generally
where auditing firms have been able to trade as limited liability
companies. In response to these arguments and the lobbying of
the industry, the Companies Act 1989 granted the auditing firms
the right to trade as limited liability companies. The liability
shield given to auditors was not accompanied by any consideration
of the "rights" of audit stakeholders.
Of course, having secured the right to "incorporate",
the auditing industry had second thoughts because it did not want
public accountability and taxation (see below) obligations that
went with it and are routinely accepted by others. As the Institute
for Chartered Accountants in England & Wales put it,
". . . the obligation on [auditing firms
trading as] companies to publish their accounts is perceived as
a considerable drawback" ". . . firms have always stood
out against revealing any financial information except their annual
fee income" (The Accountant, September 1991, p 2; Accountancy,
April 1994, p 26).
— Under pressure from the auditing
industry, the government asked the Law Commission (DTI, 1996)
to investigate its demands for "full proportional liability".
The Law Commission rejected them and indeed considered them to
be against the public interest.
— Now the government is proposing to
further dilute auditor liability by weakening the principle of
"joint and several liability". It reduces the liability
exposure of many partners.
In contrast to the one-way traffic of numerous
concessions to the auditing industry, the government has failed
to find any parliamentary time and/or resources for the Law Commission
to consider the interests of audit stakeholders.
There is no economic, moral or ethical reason
for any government to continue to grant liability concessions
to "producers" and ignore the rights and needs of audit
stakeholders.
THE AUDITING
INDUSTRY'S
LIABILITY CLAIMS:
WHERE IS
THE EVIDENCE?
In justifying the case for the LLP legislation,
the government echoes the auditing industry's views in that the
firms are facing "excessive litigation" and that measures
are needed to protect them. Such a logic is anti-consumer since
any concessions given to the auditing industry necessarily reduce
the redress available to the innocent plaintiffs. With numerous
liability concessions, the auditing industry is unlikely to have
strong economic incentives to deliver good audits and one would
expect to see major firms embroiled in further cases of poor audits.
Any concessions granted to the auditing industry cannot easily
be denied to other "producers". Where does this leave
the UK consumer protection policy?
As regards claims of "excessive litigation",
neither the DTI nor the auditing industry has provided any worthwhile
evidence to support the claims. In particular it should be noted
that
— There is no systematic public information
about the levels of actual litigation settlements made by auditing
firms.
— Evidence shows that the actual litigation
settlements tend to be for amounts considerably less than the
amounts quoted in the lawsuits.
— According to the statistics published
by the auditing industry, it appears that major firms spend 2.67
per cent of the total fees on liability related costs (see Cousins
et al, 1998 for further details).
— Most of the major lawsuits against
auditors are by another accountancy firm which in its capacity
as a receiver stands to make a considerable financial gain.
— Accountancy firms have the benefit
of the principle of "contributory negligence". This
principle was accepted by the House of Lords judgement in the
case (not involving accountants) of Banque Bruxelles Lambert
SA v Eagle Star Insurance Co Ltd [1997] AC 191 (also see The
Accountant, August 1996, p 11). The judgement established that
a wrongdoer will be responsible for all of the consequences of
his/her wrongful act, but only for those consequences attributable
to the wrongful feature or characteristic of the act—that
which made the act wrongful. Where liability arises for negligently
providing inaccurate information, this means that liability will
extend only to that information being inaccurate. The informed
legal opinion is that the ruling "will act as a check on
the range of losses which clients can claim from their professional
advisers when things go wrong. . . . the House of Lords has moved
significantly towards proportionality of responsibility for professional
advisers" (Simmons and Simmons, 1996). A spokesperson for
the ICAEW accepts that the ruling will have a "dramatic effect
on limiting the consequences of negligence" (The Accountant,
August 1996, p 11).
— Ordinary stakeholders (eg employees,
unsecured creditors) rarely receive any worthwhile amounts from
auditors.
— No one has ever forced any auditors
to accept any client or sign any particular audit report against
their wishes. It seems that as long as auditors collect fees they
have no objections. However, once the consequences of audit failures
require them to meet their responsibilities, the auditing industry
expects the state to dilute the rights of audit stakeholders and
also grant the industry further liability concessions.
The iron law of market economies is that those
delivering poor goods and services should not be protected. There
is no economic, ethical or moral reason for giving auditors liability
privileges which are not available to other suppliers of goods
and services. The granting of any privileges to any supplier should
always be accompanied by a strengthening of the rights of consumers.
Currently, the market mechanisms relating to auditors are weak.
The industry does not have an independent regulator, auditors
do not owe a "duty of care" to individual stakeholders,
audit quality is not known to the public, the regulators do not
name and shame firms involved in major audit failures and stakeholders
have no right to examine auditor working papers for any evidence
of work done. In this climate, any further concessions to accountancy
firms likely to be seen as against the "public interest".
THE JERSEY
RANSOM
The UK government has been forced to introduce
the LLP Bill because it has been held to ransom by major firms
who are using Jersey as a lever to secure concessions from the
UK government.
The background is that Price Waterhouse (now
part of PriceWaterhouseCoopers) and Ernst & Young hired Slaughter
& May (a London based law firm) to draft a LLP Bill for Jersey.
The firms spent more than one million pounds on this exercise
though the Jersey civil servants subsequently had to put the draft
Bill in its traditional language. Rather unusually, the preface
to the Bill also contained an acknowledgement of
"the contribution of Price Waterhouse, Ernst
& Young and others . . . to the structure and detail of the
draft law" (page 2 of the Draft Limited Liability Partnerships
(Jersey) Law 199).
In this Bill (subsequently an Act), the major
firms gave themselves virtually all the concessions they had been
looking for—secrecy, limited liability and proportional
liability, no rights for audit consumers and no dedicated audit
regulator in Jersey. Under the registration conditions specified
in the Act, only major accountancy firms could take advantage
of LLPs in Jersey. To prevent any informed public scrutiny, the
Jersey LLP Law was given a so-called "fast track passage".
A Price Waterhouse senior partner is on public record claiming
that he was assured that the Jersey LLP Law would simply be "nodded
through" (Accountancy, September 1996, p 29).
The Jersey LLP legislation diluted the principle
of "joint and several liability". Any partner not directly
connected with a negligent audit or assignment is protected and
the liability is instead attached to the LLP itself and individual
partners who have been guilty of a negligent act or omission.
The Bill contained no public accountability requirements although
the eventual Act (as a result of amendments secured by Deputy
Gary Matthews) required firms to state on their letterheads and
invoices that they were registered in Jersey. In particular, Article
9(2) stated that "Subject to the partnership agreement, it
shall not be necessary for a limited liability partnership to
appoint an auditor or have its accounts audited". The Act
contained no provisions for investigating errant auditors and
offered no rights to audit stakeholders. It contained little,
if any, provisions relating to the insolvency of the LLPs. Indeed,
the insolvency aspects were finally tabled in the Jersey States
in May 1998 and 95 pages of legislation were nodded through in
less than 30 minutes.
The Jersey LLP Law is the first time that any
major Western business (eg major accountancy firms) has indulged
in DIY legislation, persuaded a smaller state (eg Jersey) to pass
it and then used that legislation to hold larger states (eg the
UK) to ransom. With the Jersey LLP Law, the major firms (with
the full support of the Institute of Chartered Accountants in
England & Wales) have sought to reconfigure the international
regulations to their advantage. The accountancy firms got the
LLP law and the political lever that they sought, but the Jersey
LLP law caused considerable political turmoil and led to "hate"
campaigns against those who opposed the Bill. Senator Syvret drew
attention to the conflicts of interests in relation to the promotion
of the LLP Law. He was given "indefinite suspension"
from the Jersey States, a device not used in any other democratic
state in relation to the conduct of any democratically elected
representative of the people. After a suspension of nearly six
months, Senator Syvret was grudgingly restored because 57 UK MPs
signed an Early Day Motion (EDM) condemning the Jersey government.
It was also suggested that some UK MPs would pursue Senator Syvret's
suspension through the United Nations. Currently, Senator Syvret
is pursuing a case in Strasbourg for violation of his human rights
and a file entitled "Syvret v United Kingdom" has been
opened. The above brief background is necessary for understanding
the emergence of LLP legislation in the UK. By hastily enacting
the LLP legislation and bowing down to major accountancy firms,
what kind of message will the House of Commons be sending to other
businesses?
It should also be recalled that the move for
the Jersey lever was made at a time when, following the Companies
Act 1989, the auditing industry already enjoyed the right to trade
through limited liability companies. At its behest Section 310
of the Companies Act 1985 had also been reformed (see above).
Following the Caparo judgement it did not owe a "duty
of care" to current/potential individual shareholders, creditors,
employees or any other stakeholder. It made its Jersey move at
the very time when the Law Commission (DTI, 1996), at its request,
was conducting a feasibility study on the possibility of replacing
joint and several liability with full proportional liability.
It is clear that the Jersey legislation was
intended to hold the UK Parliament to ransom. "Give us what
we want or we go offshore" has been the main demand and threat
by major accountancy firms. Despite threats, to date no major
firm has relocated to Jersey. In practice, there are a number
of difficulties inhibiting the firms from carrying out their threat
of abandoning the UK in favour of Jersey. There was never any
possibility that the firms would sack all their UK staff, close
their offices and re-open afresh in Jersey. To do so would have
invited enormous complications with the UK employment, taxation
and other laws. Their method of business would not have changed.
They would have audited their normal audit clients with UK based
staff from normal UK offices. To move to Jersey, the firms would
need to renegotiate all contracts with existing clients and suppliers
and persuade them that in the event of dispute, all matters would
be resolved according to the Jersey laws. This is hardly a practical
proposition as UK citizens want disputes heard according to UK
laws. At best, the firms are more likely to set-up "brass
plate" operations whilst retaining their statutory monopolies
and lucrative fees in the UK. To operate in the UK (regardless
of the place of their domicile), the firms would need to be licensed
by a UK regulator and be subjected to its monitoring visits, on
the same basis as that applicable to all other UK based auditing
firms. As there is unlikely to be any real change in the trade
by major firms, the UK courts may well decide that the Jersey
move is a "sham" deliberately designed to disadvantage
creditors (Accountancy Age, 19 September 1996, p 3).
Another major obstacle to any Jersey migration
has been taxation. The Inland Revenue stated that the firms moving
to Jersey will be taxed as limited liability companies rather
than partnerships. This would require them to pay tax earlier
rather than later and make deductibility of some expenses harder,
possibly raising their tax bill by as much as 10 per cent (Accountancy
Age, 29 May 1997, p 1). The partners of Jersey based firms may
also be liable to pay capital gains tax as they would be deemed
to have dissolved a partnership, realising a large gain on their
initial investment, and commenced a new corporate and overseas
business. Major firms are contesting the Inland Revenue's interpretations
of tax laws and are seeking a judicial review (Accountancy, July
1997, p 17; February 1998, page 18).
The Jersey Bill, however, did what it was intended
to do. It alarmed the UK government and the then President of
the Board of Trade promised that legislation would be introduced
within a week (Financial Times, 28 June 1996, p 22; 24
July 1996, p 9). Eventually, the UK government published its consultation
document (DTI, 1997) and the draft LLP Bill (DTI, 1998) is likely
to appease the firms even further.
PARTNERSHIP STRUCTURES
ARE NOT
APPROPRIATE FOR
MAJOR ACCOUNTANCY
FIRMS
As the UK LLP legislation is primarily designed
to benefit major accountancy firms, some questions should have
been asked about their mode of operations and accountability.
However, the draft Bill does not do so. By default, it assumes
that partnership structures are appropriate for accountancy firms
even though major firms have "Boards" and individuals
carry titles such as "Director of Marketing", "Director
of Professional Developments", etc. It is hard to believe
that major firms with more than 500 partners somehow consult every
partner before making any decision.
The appropriateness of partnership structures
for major accountancy firms needs to be questioned, especially
as accountancy firms themselves have argued, in the past, that
such structures are unwieldy and inappropriate for them. This
is why they demanded the right to incorporate and the Companies
Act 1989 duly obliged. In addition, international regulators have
also argued that the partnership structures are inappropriate
for major firms. These structures have enabled the firms to avoid
their responsibilities and obstruct investigations into audit
failures.
Some episodes are cited below to argue that
partnership structures are inappropriate for major auditing firms.
— During the disciplinary hearings
against Coopers & Lybrand partners for violating ethical guidelines
(for which they were fined the princely sum of £1,000), their
defence was that the partnership affairs were so complex that
they did not have any easy way of knowing that the firm had already
acted as auditors and advisors to Polly Peck, its subsidiaries
and officials (see Mitchell et al, 1994 for further details).
— The Joint Disciplinary Scheme's 1996
inquiry into the audits of The International Signal and Control
Group Plc (part of Ferranti) noted that though the company was
audited by Peat Marwick Mitchell (now part of KPMG), part of the
audit was actually conducted by the firm's American firm. The
regulators state that "very considerable difficulties were
experienced in gaining such access" and that the UK investigators
were "not permitted to photocopy relevant material on any
of the American firm's files, rendering extensive note-taking
necessary".
— The 1992 US Senate's report on the
closure of BCCI (Kerry and Brown, 1992) and the role of its auditors
(there is still no report on the role of the UK audits) argued
that partnerships structures for accountancy firms are not appropriate.
It would be recalled that in this case Price Waterhouse (which
advertised itself as "international", "global",
"multinational" business) suddenly argued that various
national practices are separate entities (in which case all their
advertising is misleading). Price Waterhouse (UK) refused to honour
the subpoenas issued by the US Senate. In a letter dated 17 October
1991, the firm argued that
"Price Waterhouse firms are separate and
independent legal entities whose activities are subject to the
laws and professional obligations of the countries in which they
practice . . . PW-US, like other Price Waterhouse firms throughout
the world, is a distinct partnership. Each firm elects its own
senior partner; neither firm controls the other; each firm separately
determines to hire and terminate its professional and administrative
staff . . . each firm has its own clients; the firms do not share
in each other's revenues or assets . . ." (Kerry and Brown,
1992, p 257).
On the one hand, the firms claim that they are
"global" and thus pitch for multinational audits. But
such claims are dissolved when the firms are confronted with regulatory
inquiries. The Kerry and Brown report made three recommendations
(Kerry and Brown, 1992, Chapter 10). Firstly, that a condition
of licensing to operate in a country (say USA or UK) be that the
firm be required to respond to any subpoenas issued by the host
country and produce the evidence requested, regardless of where
the affiliated entity is located. Secondly, the firms could be
persuaded (voluntarily or through legislation, if necessary) to
devise schemes and procedures (say a worldwide Memorandum of Association),
which bind all other members (eg firms in the UK, USA etc). Thus
if Price Waterhouse (UK) is subpoenaed by a Select Committee and
is required to produce documents possessed by any of its affiliates,
it will have to provide that information, subject to the laws
of the jurisdictions (as modified by any treaty with the UK) in
which the firm operates. Thirdly, legislation (say in the UK)
could require that only UK based firms (or their affiliates who
agree to the requirements of the UK regulators) could audit a
UK based or UK registered entity.
It is submitted that partnership structures
enable firms to dilute their responsibilities and should not be
permitted without an extensive investigation. The UK LLP proposals
do not even consider such aspects. The proposed LLP legislation
does not offer any practical way of regulating major multinational
accountancy firms.
THE PROPOSED
UK LLP LEGISLATION IS
ANTI-COMPETITIVE
The Government's proposals are contrary to its
own policies which seek to provide "level playing fields"
for all those engaged in a similar business field. The legislation
as currently drafted favours accountants, lawyers and other occupational
elites. It discriminates against their competitors. LLPs should
be available to everyone.
Currently, three broad categories of business
vehicles are available in the UK, ie sole traders, partnerships
(including limited partnerships) and limited liability companies.
They are generally available to almost everyone regardless of
the business sector, wealth, age etc. The draft LLP legislation
marks a sharp departure from the above principle. The LLP structure
would be available only to those businesses who have designated
professional regulators (eg accountants, lawyers, architects,
etc). The considerable tax, liability and disclosure privileges
accompanying the LLP legislation are not being extended to other
businesses even though many of them compete with accountancy firms
to sell consultancy, executive recruitment, forensic accounting,
merger advice etc.
The government's proposals are based on a mistaken
view (see chapter 4 of the Draft Bill). They assume that the main
business of accountancy firms is auditing and/or insolvency. From
what little information the firms allow to fall into the public
domain, it is evident that probably less than 40 per cent of the
income of major firms is derived from the regulated activities
ie auditing, financial services and insolvency (Accountancy Age,
10 June 1993; 30 July 1998, p 12-13). Arthur Andersen is reputed
to be earning less than 25 per cent of their total income from
the regulated sectors. A large part of the major firms' income
is derived from sources which are neither subject to any formal
regulation, nor covered by any monitoring arrangements exercised
by the Recognised Supervisory Bodies (RSBs) and/or the Recognised
Professional Bodies (RPBs). Yet the DTI seeks to restrict the
LLP to accountants, lawyers, architects, actuaries etc on the
basis that these businesses (presumably in their entirety) are
formally regulated. This simply is not true.
Under the terms of the Draft LLP Bill, any accountancy
firm would be able to secure the LLP status even if the regulated
business only forms a very small part of its business. In contrast,
anyone competing with an accountancy firm and seeking to sell
consultancy, forensic accounting, advice on mergers, cost-cutting,
executive recruitment, secretarial work, book-keeping, etc would
not be able to secure the LLP status. They can only limit their
liability through incorporation under the Companies Acts. This
route requires fuller disclosure (ie more than that required for
LLPs) and in most cases an external audit. These businesses have
to pay corporation tax payable within nine months of the year-end.
Companies are taxed on an "accruals basis" rather than
the "cash basis". Their expense deduction is also less
generous. In contrast, the government is demanding lower levels
of disclosure from LLPs. The LLPs will have the benefit of "cash
basis" of taxation (on 22 December 1997, the government indicated
that the "cash basis" is likely to be withdrawn or diluted
from the tax year 1999-2000) onwards which gives them a considerable
opportunity to smooth their taxable profits. They will also generally
be taxed on a "preceding year basis", giving the firms
up to 21 months after the year-end to pay tax.
The government's LLP proposals are anti-competition
and do not create level playing fields for the businesses competing
in an identical field. There are additional complications as well.
— Accountancy firms are predatory and
have been expanding aggressively in the field of consultancy,
software marketing, etc. If the LLP status is given to accountancy
firms, it would presumably also be extended to the business they
acquire thus further distorting the competition.
— Currently, CSL is a consultancy subsidiary
of Deloitte & Touche. Would an LLP status given to Deloitte
& Touche also apply to CSL? Would Andersen Consulting enjoy
the LLP status just because Arthur Andersen have acquired one?
Besides, the RSBs have no jurisdiction over the consultancy parts
even if they do not trade separately. So how will the LLP status
apply? It is difficult to see how it can only apply to the auditing,
insolvency and the financial services segments.
— The LLP proposals, as drafted, are
unlikely to be durable. They ignore the trends which are emerging.
For example, in the USA, some banks (eg American Express) have
begun to enter the accounting and audit market and offer one-stop
shopping. Should the same happen in the UK (perhaps with a specially
created offshoot), the legislation would be faced with a dilemma.
Should American Express be given LLP privileges and be encouraged
to dilute its public accountability? If American Express is to
be forced to create a separate offshoot to compartmentalise audit
business, why are the accountancy firms not forced to do the same?
— Under the LLP proposals, a limited
liability company such as KPMG Audit Plc would be able to re-register
as an LLP and acquire the partnership tax perks and liability
shields, but the same privileges would not be available to other
limited liability companies even though they are competing with
KPMG and selling similar products and services.
Overall, the Government's proposals are anti-competition.
It is desirable that the LLP status should be available to everyone.
THE LLP TAX
PROPOSALS DO
NOT CREATE
LEVEL PLAYING
FIELDS
The Draft LLP Bill proposes to extend all the
privileges of partnership taxation to LLPs (clause 10). In contrast,
the Government is currently proposing to tax any offshore-based
LLP as a limited company. Presumably this is to shackle the firms
in the interim period and prevent any of them from moving offshore.
Once the Draft LLP proposals are implemented, other commercial
enterprises which are denied the benefit of LLPs will only be
able to compete with accountancy firms through the medium of limited
liability companies. This is the only way their owners will be
able to shield themselves from liabilities. However, they will
not have the tax advantages available to LLPs.
Suppose a person (not an accountant) is trading
as a sole trader or in conjunction with another is trading as
a partnership. Suppose this business sells consultancy, bookkeeping,
secretarial and other services, but wishes to obtain the benefit
of limited liability. Under the Government's current proposals
that person cannot secure an LLP status and will have to form
a limited liability company. All the assets of the previous business
would need to be transferred to the new limited liability company,
triggering possible capital gains and other liabilities, subject
to various reliefs. In future that person would have to pay coporation
tax within nine months of the year-end. Expenses would only be
deductible if they can be shown to be "wholly, exclusively
and necessarily" for business purposes.
In contrast, an LLP would have anything up to
21 months to pay tax and expense deduction is much easier. Both
business owners have liability shields, but one enjoys a more
favourable tax position. There does not appear to be any ethical
reason for creating the two somewhat unequal tax regimes.
It would appear that the LLP tax regime, ie,
partnership tax concessions could also be available to a single
person trading through an LLP. The Draft Bill states that an LLP
needs a minimum of two partners at the date of its formation.
Suppose subsequently, one partner dies or retires. The Bill does
not appear to contain any provisions relating to the number of
partners at a subsequent date.
THE LLP PROPOSALS
FACE PRACTICAL
PROBLEMS
The LLP proposals face practical problems. Under
the LLP Draft Bill, the liability for audit failure is primarily
restricted to the assets of the LLP and the negligent partners.
The assets of other partners are shielded. But the stakeholders
are rarely aware of the identity of the partners or the audit
teams conducting an audit. In addition, shareholders appoint firms
to the office of an auditor rather than the individual partner.
Audit reports are produced on a firm's headed paper and often
signed by or on behalf of a firm. It is the firms which facilitate
the organisational structure, training, staff, continuity, policies
and procedures for the conduct of an audit. All the partners share
the resulting profits. Yet the proposed legislation seeks to individualise
audit failures.
The Bill does not contain any provisions for
making the public aware of the financial standing of the individual
partners, or their standards of work. Indeed, the Draft Bill states
that LLPs "will not be required to publish the details of
their internal arrangements" (page 7). Why not? In the absence
of information how is the public to make informed choices? Would
a statement showing the financial positition of the partner-in-charge
of an audit be appended to each audit report and distributed at
each annual general meeting? More crucially, as the burden of
liability shifts to the negligent partners, the public needs to
know the arrangements relating to individual partners.
THE DRAFT
BILL WILL
KEEP THE
PUBLIC IN
THE DARK
Even on the publication of financial information
by LLPs, the government proposals are backward. For example, if
LLPs are permitted 10 months after the year-end to deliver accounts
and report to the Registrar of companies (page 25). This means
that most of the information contained in the accounts would be
more than a year old. No self-respecting company director or LLP
partner would use such information for any whorthwhile business
purpose. Yet the government expect the public to use the very
same information. We all know that to be useful all information
must be timely. The government should require all large LLPs to
file their accounts within 90 days of the year-end.
Those trading through limited liability companies
are required to publicly file the company's Memorandum and Articles
of Association. In contrast, those trading through LLPs are also
able to limit their liabilities, but the Draft Bill states that
LLPs "will not be required to publish the details of their
internal arrangements" (page 7). This is contrary to the
principles already in existence and there is no ethical reason
for exempting LLPs from it.
It is disappointing that the government has
made no attempt to develop any qualitative disclosures for LLPs.
The qualitative disclosures are necessary because accountancy
firms enjoy state guaranteed markets (eg audits, insolvency).
The privileges should be accompanied by social obligations which
need to be given visibility by disclosures.
It is possible that the government will expect
the accountancy trade associations to develop the details. Such
an approach to public policymaking is disappointing and is unlikely
to secure "qualitative" disclosures. The accountancy
trade associations were formed to promote and further the interests
of "producers" and accountancy firms. They are funded
by their members and will inevitably represent the concerns of
their members. They are unlikely to pay adequate attention to
the public's needs. For proper discharge of their social obligations,
accountancy firms should inter alia be obliged to publish
the following (not meant to be an exhaustive list) additional
information.
— An analysis of their income by major
business segments;
— Details of any regulatory findings
against them;
— Details of any "related party
transactions" including the transfer of any assets to any
partner, their families, and any settlements made;
— Conflicts of interests;
— Details of the longest-running insolvency
so that the public can make some assessment of their efficiency;
— Number of jobs that have been lost/saved
since the firm became receiver, administrator, liquidator, etc.
LLPS DILUTE
ECONOMIC INCENTIVES
FOR GOOD
AUDITS
One argument is that liablity rules should be
devised to provide economic actors whose activities may cause
harm to others with an incentive to take the socially optimal
level of care to avoid causing such harm. How has the DTI squared
this circle, especially as auditors to not owe a "duty of
care" to individual stakeholders?
It appears that institutional investors are
not convinced that LLPs or even incorporation provides the basis
for securing "quality" audits. The government has not
offered any assurances about their concerns. If anything the insolvency
aspects (eg "clawback") mentioned in the 1997 consultation
paper have been further diluted by the Draft Bill. Some of institutional
investors' concerns have been publicly aired.
— British Steel Pension Fund (BSPF)
whose portfolio on investment funds amounts to more than £6bn,
and itself is unhappy that KPMG has incorporated the auditing
side of its business. KPMG incorporated the auditing side of its
business in January 1996 and since that date BSPF has voted against
all AGM resolutions to re-appoint KPMG as auditors of the companies
in which it holds investment. The Fund feels that incorporation
of audit firms (even in the UK) takes away some of the pressures
on partners to improve the quality of audit work (Financial
Times, 5 September 1996, page 6).
INADEQUATE
PROVISIONS FOR
DEALING WITH
OVERSEAS LLPS
Recently, the Edwards Report on the operation
of financial regulations in the Channel Islands has suggested
that all overseas businesses located there should be registered
and regulated. Therefore, it is somewhat surprising that the Draft
Bill states that "There is at this stage no intention to
implement regulations for overseas LLPs. Any decision to introduce
provisions for overseas firms will be subject to separate consultation"
(page 16). Such a lacuna is unacceptable and does not lead to
good regulatory environment. The Government is also non-committal
about when the proposed consultation will take place and why it
has been postponed. Some certainty would be most welcome.
It would be recalled that a previous Ministerial
statement stated that to
"keep a level playing field with companies
and partnerships registered in the UK, limited liability partnerships
registered abroad but operating from a place of business in the
UK will be required to file financial information equivalent to
that to be required from limited liability partnerships registered
in this country" (Hansard, 7 November 1996, col 700).
The 1997 consultation document (DTI, 1997) stated
that "The policy is to impose on overseas LLPs the requirements
of the Bill" (page 39). Why has the Government reversed its
previous policy?
7 December 1998
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