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Lord Freeman: My Lords, I am very grateful to the noble Lord for giving way before he sits down. What about the credit rating agencies and their role in this?
Lord Brennan: My Lords, the noble Lord is in rightful anticipation of my two other institutions for checks. Financial advice to investors clearly should be the subject of standards, as should credit ratings. Standard & Poor's credit rating for Parmalat was good up to the beginning of December. All that picture is the financial picture; it is not just auditing and accounting.
As I have suggested before, I invite the Government to consider founding here in London, financed by accounting firms, City firms and/or the Government, a centre for financial standards and corporate governance. Its role would be to scrutinise the present regulatory state of affairs and determine whether change was needed, to educate the commercial world about proper standards and to promote, wherever necessary, reform.
I welcome the Bill. Two years after Enron, action has been taken by wide consultation, by balanced consideration of what is necessary and a piece of effective legislation. It is the stuff of effective government—we should have more of it.
12.59 p.m.
Lord Freeman: My Lords, it is a particular pleasure to follow the noble Lord, Lord Brennan. I agreed with both the thrust and the detail of what he had to say. Obviously, he speaks as a lawyer and not an auditor or an accountant, but his summary was excellent. He touched on the key point of why the legislation is welcome in principle—because it helps restore confidence and sets standards.
I declare an interest as an accountant, but my brief remarks today are my own. I do not speak for the profession, or for my firm, PricewaterhouseCoopers, of which I am still a consultant, or for any of the companies of which I am a director. I strongly agree with the comments of my noble friend Lord Hodgson, on the Front Bench. I shall not repeat any of his points except strongly to endorse them from the Back Benches.
This is a modest Bill, but its principles are correct. Detailed examination in Grand Committee, if that is where it goes, is extremely important. There is one very small point: I hope that, in future, when regulations are introduced, particularly for companies, they can be introduced simultaneously on fixed dates in the course of the year. That is a small point but, I understand, the Government are now working on such a reform.
I believe that your Lordships had hoped that in this Session we would debate a major company law reform Bill. The noble Lord, Lord Sharman, always uses his words very carefully, and I noted what he said—he said that such a Bill was desperately importantly needed. I find it very difficult to explain to my colleagues in the accounting profession, in the City and in business why we are going to spend weeks and weeks on a House of Lords reform Bill, when we are still not able to proceed with a company law reform Bill, although much of the legislation is in excellent shape in draft form.
I shall make three very brief points on the Bill, which I welcome. The simplification of the oversight procedure through the Financial Reporting Council and the Financial Reporting Review Panel is exactly right. The previous system was complicated, and the Bill makes progress in that regard. Secondly, the provisions on the duties of directors not to mislead auditors are correct and welcome. Finally, the devil will be in the detail of the provisions on community interest companies. Your Lordships will want to look not only to the Minister but also to the noble Baroness, Lady Thornton, to ensure that we do not end up with complicated legislation that is difficult to understand and over-regulated for those whom it is intended to benefit.
On the issue of liability of auditors and directors, my noble friend Lord Patten spoke in typically robust fashion, although he was a trifle unfair in his remarks on the accounting profession. He may have misunderstood what should happen and what should be the correct response from the profession to the consultation paper. No one is suggesting that one should not deal with auditors' and directors' liabilities simultaneously; I believe that to be right. No one is saying that either should avoid liability for their errors. The issue is the extent of the liability.
The Financial Times editorial of 7 January fell, if I may say so, into the same error, in misunderstanding the calculation of the liability, about which there is real concern in the profession. The liability is joint and several. When a company goes bust, one of the big four accounting firms will probably be sued first, because they are deemed to have the biggest pockets. Often the accounting firms end up as the only source of recompense for those who have lost money. That cannot be right. What surely is correct is that the liabilities of both auditors and directors should be proportionate—and, in my judgment, capped as well. Otherwise, even when the liability is proportionate, if the auditors or the board of directors are the only people who can afford to make recompense and there is no one else to share the blame, the amounts could be very considerable.
I believe that the noble Lord, Lord Sharman, has already referred to the fact that the European Union commissioner is considering placing responsibility on the auditor of the top holding company for the audit of all the subsidiaries within the group, irrespective of whether they have actually carried out the audit—for example, in countries abroad. That increases the responsibility and liability of the auditor.
The comments made about liability are clearly part of the consultation process, because the consultation will run until 12 March. I suggest for consideration that if the liability of directors and auditors is to be changed from the unlimited nature at present and should be both proportionate and capped, that the Minister by regulation asks the Financial Reporting Council to devise the methodology for capping. If that proceeds, I suggest that shareholders should approve the procedure in a general meeting. It would be perfectly possible for the Minister, at a later stage, when the Bill has gone to another place and has perhaps come back here, to propose a simple clause to remove the offending Clause 310 of the existing Companies Act. That clause could be repealed with very simple language, and the legislation would be enacted only when there was a proper methodology for introducing capping and proportionality. There is still time for that to be done.
I briefly turn to the question of non-executive directors. Part of the problem for the directors of smaller companies is that the cost of insurance against unlimited liability is now prohibitive. We are failing to deal with the problem of recruiting non-executive directors not only to large listed companies but also to smaller companies. That is an urgent matter, and I hope that the Government will deal with it.
1.7 p.m.
Lord Grantchester: My Lords, I congratulate my noble friend the Minister and the Government on introducing this timely update to corporate regulation. I speak merely as a layman and an investor, but also with some experience of sitting as a non-executive director on several audit committees, although at present I sit on only one—Dairy Farmers of Britain.
I find it interesting when I hear noble Lords talk about the dangers of being an auditor. Some people find auditing the least inspiring aspect of accounting. Indeed, I have heard auditors described as similar to those who go round at the end of a battle checking the dead and bayoneting the wounded. However, that is not to deny that it fulfils a very important role in safeguarding the integrity of business.
The Bill is part of the Government's strategy to help restore investor confidence in companies and financial markets following various recent high profile corporate failures, most notably Enron and WorldCom. A new failure, Parmalat, is unravelling as we speak. While purposeful fraud will always be with us, lessons can always be learnt and procedures tightened up, so that non-compliance will flag up potential wrongdoing. That process has been continuing since the cases of BCCI, Polly Peck, the Maxwell companies and Wickes, among others.
The legislative changes amend relevant provisions of the Companies Acts 1985 and 1989. They are intended to complement various recent non-legislative measures designed to strengthen corporate governance and audit practice. Part 1 is intended to strengthen the independence of the system of supervising auditors by placing new requirements on the recognised supervisory bodies; the enforcement of accounting and reporting requirements; the rights of auditors to information; and the company investigations regime.
The new requirements placed on the recognised supervisory bodies are that they must participate in independent arrangements for the setting of auditing standards to underpin professional integrity and independence and the setting of technical standards; the monitoring of audits of listed companies and certain other companies; and the investigation and taking of disciplinary action in certain cases.
Clause 2 seeks to ensure the independence of these arrangements by providing that the recognised supervisory bodies, for example, the Institute of Chartered Accountants in England and Wales, cannot be involved in the selection and appointment of those who carry out the standard setting, monitoring and disciplinary functions—that is, the Auditing Practices Board (APB) and the Accounting Standards Board (ASB). Most importantly, it also provides for transparency in the disciplinary arrangements by requiring that independent disciplinary hearings must be held in public. The practical effect of these clauses is to make the recognised supervisory bodies subject to a more independent regulatory regime in respect of the setting, monitoring and enforcement of auditing standards.
Part 2 makes provision for the establishment of a new corporate vehicle, the community interest company. This is intended to make it simpler to establish a business whose profits and assets are used for the benefit of the community. Social enterprises bring together the expertise and dedication of the voluntary sector with the flair and flexibility of the commercial world, and can be particularly relevant in the many activities where commerce and public service meet.
There are three major types of reason for accounts to be incorrect, which leads to investor lack of confidence. These are, first, quite obviously, error; secondly, deliberate fraud, on which I have already commented; and, thirdly, manipulation of accounts. It is to the third aspect that I shall address my remarks.
Manipulation of accounts includes the bending of accounting policies, the massaging of accounts, and the manipulation of profits—for example, capitalising brand values, the treatment of goodwill and so on. The work of the FRC in this area is crucial, so it is important that both its role and the extent of its reviews are going to be strengthened.
The main area of investor concern focuses on the potential compromising of the audit function brought on by a disproportionately high level of auxiliary non-audit services. Disclosure of fees for non-audit services, as opposed to fees for audit services, is a step in the right direction. However, it does not stop the problem. I do not suggest a complete block on auditors
carrying out non-audit services, as often it is the auditor who is best placed to give this other advice. It may be that some sort of cap is needed on these non-audit services. There is a need for the FRC, or the regulatory bodies, to look at the large level of non-audit fees in a set of accounts. No doubt an investigation could be triggered by a high level of such fees. The Bill seeks to address that issue somewhat. The FRC will be policing, to a greater extent than currently, inappropriate accounting policies and will have added powers.Inappropriate accounting policies have been central to certain high profile corporate failures, notably Enron and Wickes. In both cases, a key issue was the organisation's policy on income recognition. The FRC has an increased role in monitoring the work of auditors, which must be a step in the right direction in this regard. This is bound to encourage auditors to check more carefully the compliance with basic and fundamental policies, such as income recognition.
Increasing the auditors' access to information, a matter with which the Bill assists, is also a step in the right direction. However, giving the auditors wider access may not stop a Maxwell recurring. Whistle-blowing should surely be made easier and more effective. It may be sensible for auditors to be required to have discussions with a certain number of employees each year. I note with dismay the treatment of whistle-blowers in the European Commission. I remind noble Lords that the EU auditors have refused to sign off the Commission accounts for the past nine years—surely a scandal that dwarfs the combination of all the most recent corporate failures put together.
Recognising the importance of the ASB and having it controlled by the FRC is also hugely beneficial. It should ensure that speedy and effective responses are made to large corporate failures, such as Enron, where the importance of income recognition accounting policies was heightened following the failure, causing auditors as a result to become more sensitive to the appropriateness of income recognition policies. Fast and effective responses to problems, and the plugging of holes, should occur under a stricter and more robust regime.
Also as a result of Enron and the lessons now learnt from it, warning lights are now triggered for auditors where there are large, complex group structures. Auditors now have to look hard behind the structure to understand the movement of transactions around the group and the reasons for those movements, to ensure that there is transparency in this regard.
Audit committees need to be more robust, to stop cases of executives bullying and controlling companies in a manipulative way. It is essential that auditors meet with the audit committee without the executives present and can have confidential discussions with it. It is also important that at these private meetings probing questions are asked of the auditors by the audit committee. The improvements to corporate governance brought about by Higgs and Smith have been steps in the right direction, though more are probably needed.
It may, for example, be sensible to have a list of questions for audit committees to ask their auditors because, in practice, it can be difficult for auditors to get their concerns across. Particularly where there are strong, dominant characters involved, auditors can find it inhibiting to initiate criticism. It is likely to be easier for them to address concerns in response to questions and in a more informative way. It can be difficult for them to get their concerns or suspicions across with no tangible basis without it sounding like a personal attack on management.
Examples of the sort of questions that would be useful are, "Do you feel the accounts department and its staff are suitably qualified and competent? Do you feel there are sufficient resources in the finance department? Do you have any concerns about bullying by management or executives? Have you had any indications from staff about bullying? Do you feel there has been a desire to manipulate the accounts in a particular direction?" That is particularly relevant if there are profit-related or share option schemes in place.
The mere existence of sample questions would better aid corporate governance, as management would be made aware that such questions are to be asked and that such issues are to be considered by the auditors and discussed with the audit committee.
Executives should not have anything to do with the appointment of auditors, but in practice they often manage to have an input. If, for example, an auditor is critical of management or of the chief executive and the audit is going to go out to tender in the short or medium term, the chances are that that auditor will not be reappointed. It is vital that the appointment of auditors is seen to be independent of the executives. It may be an idea for the auditors to have to include in their report reference to the extent of their private meetings with the audit committee each year.
The audit threshold is about to rise from £1 million to £5.6 million. I understand this change is due to come into force through a statutory instrument later this month and to be operative for company accounts for the year ending March 2004. My only reservation regarding the changes we are now contemplating is that raising audit thresholds is likely to be the most significant in removing the major deterrent against fraud and money laundering. That needs to be carefully considered in a strategy of raising investor confidence.
Creditors are one of the major users of audited accounts of companies with turnovers of less than £5.6 million, and arguably they are the ones who are likely to have concerns about the lack of an audit. Small and medium-sized companies are a growing part of the enterprise culture that we are seeking to improve. These company failures can impact on companies of all sizes due to the knock-on effect. Perhaps the £5.6 million threshold should be reconsidered and any future changes limited to the amount of increase in inflation.
While the audit threshold is not strictly relevant to the Bill, it is nevertheless part of the picture. Large companies can go under if a major debtor defaults—credit worthiness having often been assessed by reference to audited accounts. As a director of Dairy Farmers of Britain, I can confirm that checking customer accounts is a very important part of determining whether and to what extent Dairy Farmers of Britain will trade with small companies. I may not have to remind the House of the difficulties in the dairy sector in recent times, where there have been company failures, notably Lancashire Dairies, Amelca and United Milk.
The relevance of audited accounts is usually that third parties rely on them to confirm the accuracy of accounts and the strength of companies' balance sheets. Often the audit report will also give an indication of any going concern problems or other problems, which a simple review of the accounts might not otherwise reveal. Disclosure of financial information may not be complete if the accounts have not been subject to an audit, in that an audit, as well as looking at the accuracy of the figures, also looks at compliance with recent relevant legislation and accounting standards. It may be that certain important financial information is omitted from the company's accounts, either deliberately or through lack of knowledge for example security of borrowings, loans to directors or transactions with related parties. Such omissions should not exist where an audit takes place. I applaud the commendable changes being proposed in the Bill and the strengthening of existing measures to raise investor confidence. I welcome the support given to the Financial Reporting Council, and I wish the Bill a safe passage.
1.20 p.m.
Baroness Carnegy of Lour: My Lords, I will not follow the noble Lord, but I shall confine myself to just two brief, general points and ask the Minister two questions on Part 2 of the Bill. My noble friend on the Front Bench has already commented that this is a somewhat strange time to introduce Part 2. The community interest arrangements are closely linked with charity law. The Government, we understand, are planning shortly to bring Parliament's attention to the matter of charities again. It appears that they are perhaps putting the cart before the horse, entirely unnecessarily.
From the Scottish perspective, the Government's timing of Part 2 is even more peculiar, if not constitutionally wrong, I might suggest. Under the Scotland Act 1998, company law is a matter reserved to Westminster. As the Minister pointed out, Scots law for charities is devolved and is already different from charity law south of the border. It is absolutely right that this Bill, a company law Bill, should, as it does, include Scotland as well as the rest of the UK. At the same time, it happens that the Scottish Executive, like the Westminster Government, I think, hopes to change charity law in Scotland, and issued a consultation paper in May 2003, with a view to legislating. What do the Government do here at Westminster? For their own good reasons, they go ahead with this Bill, drafting it so that, provided the
Scots Parliament does what it is expected to do on charities, Part 2 can in these respects be brought into line in Scotland.The relevant powers to achieve this are in Clause 23(3) and Clause 27(9). An explanation is given in paragraph 205 on page 48 of the Explanatory Notes. Unlike in England and Wales, any changes to Scots charity arrangements will be made by a different parliament from the parliament responsible for this Bill. That is self-evident. Who knows what the Scots Parliament will decide? Their current charities culture and system is a different starting point from that south of the border. There are no charity commissioners in Scotland. Decisions are made by the Revenue and the courts. The Scots Parliament may, I suggest, when the time comes, disagree with its Ministers. It has already been known to do that several times in its short life. It may wish to make charities decisions that render much-needed community interest companies inoperable in Scotland. What happens then? It is surely not Westminster's job to hem the Scots Parliament in on a devolved matter just because of bad timing on the United Kingdom Bill. One could say that the timing is not only inapposite; it may even be constitutionally wrong. That is my first point.
My second point is that the so-called social enterprise culture is particularly strong in Scotland. It forms an integral part of local economies and cultures. Since the early 1990s, much of the pioneering work being built on elsewhere has begun in Scotland. There is a long-standing desire north of the border for a statutory framework for the sector. In spite of all that, the Government seem to pay less attention than they should to Scots' needs. In Scotland, because of the lighter-touch charity law, most social enterprises are registered charities. As the law stands, those charities cannot change their status; they simply cannot apply under the Bill. Should they, as the Government intend, become legally able to apply, few, if any, could, in practice, afford to do so, as they depend on tax and rates relief to survive.
From my many years of experience chairing a quango that was a company limited by guarantee, I know that there is a deep belief in Scotland that social enterprise should be governed by voluntary unpaid boards and should involve stakeholders in a democratic way. Those characteristics are, as far as I can see, allowed for under the Bill, but, undoubtedly, they will not be the norm.
During the consultation on the Bill, those and other important points were made to the Government by the sister organisation of that chaired by the noble Baroness, Lady Thornton, the Scottish Social Enterprise Coalition. It seems to me that the coalition has been largely ignored by the Government, so I have some questions for the Minister. First, how do the Government justify the timing of the Bill, when its operation in Scotland depends on future legislation in the Scots Parliament being framed in a certain way? Is that somewhat bullying approach, in fact, unconstitutional? Secondly, why have the Government ignored the advice of the Scottish Social Enterprise Coalition, making it likelier that few, if any, existing social enterprises in Scotland will be able to avail themselves of the new arrangements?
I hope that the Minister will be able to answer those questions. If he feels that he cannot, will he, perhaps, write to me?
1.28 p.m.
Lord Razzall: My Lords, it is noticeable that virtually every speaker in the debate has begun by declaring an interest either as a director of a listed or unlisted company or as a chairman or member of an audit committee. I join those who have done so and declare my interest, as set out in the Register of Members' Interests. In passing, I must take up the reference made by the noble Lord, Lord Freeman, to House of Lords reform. It is a great shame that, in debates such as this, some Members of your Lordships' House who accept the honour and title associated with being a Member of the House and have significant high-profile business careers never seem to find the time to come and give us the benefit of their expertise. I want to record that, and I know from remarks that have been made from other Benches that several of your Lordships share that view.
In effect, as noble Lords will have understood and several have said, this is two separate Bills. Apart from the fact that they both come from the Department of Trade and Industry, they seem to bear no relation to each other. I suppose that that is a modern trend, as the Minister fights for his share of legislative time, and there has been a brilliant accretion of DTI Bills in recent years. However, I think we have to accept that the two Bills reflected in this one Bill have nothing whatever to do with each other.
I turn to the first Bill, as it were, which concerns audit and investigations. As my noble friend Lord Sharman indicated, noble Lords on these Benches broadly welcome that part of the Bill. I believe that the CBI said that no one could fail to support a robust system of company law and governance based on integrity, openness and transparency. I believe that all noble Lords share that objective. Indeed, at the weekend I wondered why that did not appear in the credo of the Leader of the Opposition, if not to the strains of a Batchelors' song. No one can doubt that action has to be taken to ensure that the scandals typified by Enron and WorldCom in the United States cannot be replicated here. To that extent no one could object to the Government taking the necessary steps.
The strength, however, of the United Kingdom system, not particularly the English system—I bow to the noble Baroness, Lady Carnegy, in this respect—is a combination of statute, common law and a voluntary code. The recent company law review recommended the continuation of that approach. I believe that all the different parties in your Lordships' House accept that that should continue to be the approach towards these matters. However, the company law review stated that that required the immediate modernisation of company law.
It is noticeable that speaker after speaker in the debate has tried to get the Government to say when we shall see the comprehensive reform of company law that we all wish to see and that industry and the public demand. I
have no doubt that when the Minister replies to the debate, he will not be able to give us a commitment on that. I have no doubt that he will say that the Government remain committed to reform of company law. However, the decision on when a comprehensive Bill will be brought forward is undoubtedly out of the Minister's hands and will, I suspect, be subject to the vagaries of electoral politics as his lords and masters consider the timing of the next election and decide whether the Bill can be introduced in that period of time. Nevertheless, the Minister should take on board the overwhelming view of your Lordships that we need a comprehensive reform of company law; and that we need that Bill soon.There is clearly a danger of a piecemeal approach reacting to the scandals of the day or the fears of the day. An example of the continuation of that piecemeal approach to which a number of noble Lords referred is the current position on auditor and director liability. A consultation paper was issued in the autumn. We now have a Bill to deal with the audit and investigations element of company law reform. We do not know whether or not the Government will decide that they can tag on to the end of the Bill recommendations regarding auditor and director liability if the consultation period is completed before the Bill is passed and indicates a conclusive view regarding what the Government should do. That is an unsatisfactory state of affairs. If the Bill is passed without the question of auditor and director liability being dealt with, the Government will be faced with exactly the same problem in the next Queen's Speech; namely, whether there will be legislative time to deal with it. That cannot be a satisfactory way to run a railroad or even the Department of Trade and Industry.
As I indicated at the beginning of my speech, we, of course, support the Bill. We support its general aim and its general principles. In Committee we shall seek to check that the Government have the balance right between catching wrongdoers and imposing unreasonable burdens on business. Every clause needs to be looked at to check that that balance is right. Without going into the detail there are three particular areas on which I believe that we shall need to probe the Government.
First, in Clause 9 we shall need to probe whether or not the obligations of disclosure have a reasonable materiality test to avoid unnecessary burdens being imposed on perfectly honest businesses and businessmen. Secondly, in Clause 8 we shall need to probe how the mandatory disclosure requirements, particularly regarding subsidiaries, foreign subsidiaries and subsidiaries in the United States, can be squared with the obligations being imposed on directors. Thirdly, we shall need to probe the extensive provisions that permit Inland Revenue information to be made available to auditors and other bodies to check whether and to what extent appropriate protection is given to individuals regarding invasion of
their privacy. Those are three critical areas on which we shall want to test the boundaries of reasonableness as against the necessity to catch wrongdoers.I turn to the second Bill, as it were, which concerns the community interest company. Again, noble Lords on all sides of the House welcome this part of the Bill. As my noble friend Lord Phillips indicated, we shall want to probe a number of areas in Committee, particularly the interrelationship between charitable law in its existing or potentially reformed state and the community interest company.
I should like to press the Minister on a substantial point. He will be aware that a number of local authorities responded to the consultation last summer in a very welcoming manner. A large number of local authorities have expressed an interest in using the CIC format to develop public services. Shall we pronounce it "kick"? The noble Baroness, Lady Thornton, used that pronunciation. Looking round the Chamber, I suspect, however, that we shall not continue to use that pronunciation. I am not sure how Hansard will record that. The Local Government Association specifically drew the attention of a number of noble Lords to Somerset County and Taunton Deane borough councils that think that the CIC format is a very good means of delivering a range of community based leisure and cultural services.
It appears that local government will regard the use of the CIC as a very essential part of their work in the community. The question that I should like to put to the Minister is, does he or does he not agree with the statement that I understand the Home Secretary made that, so far as he is concerned, the CIC will not be used in any way to provide services that are the responsibility of central government? If the Minister agrees with that statement, it appears that a big opportunity will be lost. In the National Health Service in particular, as the Government develop their proposals for devolution to community hospitals, CICs could play a major part in the development of those hospitals. I hope that the Minister will say whether I have misinterpreted the views of the Home Secretary, or, if I have not, that he does not share them.
1.39 p.m.
Lord Glentoran: My Lords, this has been a very good debate. I wish to make a few brief points. It is the Government's duty to ensure that company law creates an environment where risk taking and entrepreneurs can flourish and where public confidence can be maintained in the knowledge that fraud and malpractice will be detected, controlled and punished.
Before I continue, like other noble Lords I need to declare some interests that I believe are relevant. Until I retired I was a director and chief executive of a number of Redland plc companies, some offshore. I am in my 10th year as a member of the Millennium Commission and chair both its audit committee and finance committee. I am also currently a non-executive director of the National House-Building Council and sit on its finance and audit committee. The NHBC
comes within the remit of the FSA as an insurance company. In the past, I also served on the board of the Ocean Youth Club, a national sail-training charity. The noble Lord, Lord Sharman, was at one time chairman of that board.That is a varied mix of businesses, with some commercial, some charitable and some for the public good. However, they have one thing in common; namely, that they all are or were in the risk business. In one way or another, a number of noble Lords have supported the cliche of no risk, no profit.
Some people might like to think that the Bill is a technical Bill, the business of lawyers and accountants. It is not. It will impact on everyone, as the Minister pointed out. It is a people's Bill. It will affect jobs, pensions, SMEs, big businesses and, perhaps most importantly, the competitiveness or not of UK plc. We think it doubtful whether, in its present form, Part 1 gets anywhere near achieving what we had hoped were its intended aims. That has been clearly supported by noble Lords around the House.
The second part of the Bill proposes the establishment of a new type of Companies Act company which would exist primarily for community interest purposes. We welcome that. When first reading about the proposal for the creation of CICs I was quite excited. I thought that their creation could add something very positive to the community sector, with more flexibility for small enterprises and local companies focusing on the public interest. However, the implications of CICs are significant, especially as they cannot be charities and would be subject to a more stringent level of oversight than normal companies.
In practice, as a result of the establishment of a regulator, the Bill is effectively establishing an entirely new sector of community and company activity. That was pointed out by the noble Lord, Lord Phillips of Sudbury. The aim of the Bill appears to be to produce a form of corporate body which occupies the space between a Companies Act company and a charity. It would presumably have greater financial freedom than a charity and could borrow money or sell shares. We applaud that concept if it can be made to happen. However, the role of the regulator and his ability to intervene in payments or to transfer assets leads us to wonder whether a bank, or indeed any creditor, would feel that sufficient security could be obtained against loan capital. We wonder whether that would inhibit the desire not only of lenders to fund CICs, but of contractors and suppliers to trade with them.
It is also questionable how popular shares in CICs would prove, as opposed to other ethical investments. The regulator's powers could, in certain circumstances, constitute a significant infringement of normal shareholders' rights. Shareholders could find directors removed, management changed and new directors appointed, all without their approval. The use of the powers is carefully circumscribed in the Bill, but they are none the less very significant.
We must also wonder about the role of directors of CICs. Some noble Lords have already talked about remuneration of directors. Their ability to carry out their fiduciary duties could be compromised by the regulator. The regulator is specifically empowered to intervene in transactions and disposals if he believes that the community interest test is not being met. What if, for example, a CIC can balance its books only by compromising its community activities? Would the regulator prevent directors from doing so? Would that be recognised in company law? If not, could they find themselves unable to manage the CIC as they believe necessary or to meet their fiduciary duties? Presumably, they would have no option but to resign.
It is therefore difficult to understand the incentives for establishing a CIC from the Bill. The structures do not seem to offer any particular advantages per se, and the level of oversight and potential interference is significant. However, that is not surprising, as the Bill establishes only the legal framework, and we have not yet seen any regulations. As other noble Lords including my noble friend Lord Hodgson have pointed out, we have been promised the regulations. It is vital that we have them before Committee, or the debate will be fairly meaningless.
The CIC would seem to be a vehicle tailor-made for the kind of private-public joint ventures which the NHS is keen to establish, and which local authorities look excited about developing, as the noble Lord, Lord Razzall, pointed out. One area of control which could be problematic for CICs is the eligibility restriction on political parties or political campaigning organisations. That is a very broad definition. What is a politically campaigning organisation? Depending on the political issues of the day, that could vary from Greenpeace to asylum seekers' rights and the Ramblers' Association.
Under the proposals, CICs would be Companies Act companies and therefore subject to the Companies House regime. However, additional levels of oversight would be applied. Indeed, the Bill proposes the establishment of not one but three new offices—the regulator, the official property holder and the appeals officer. We understand that CIC directors would be appointed in the usual way for Companies Act companies. However, another significant issue with regard to the directors of CICs is the ability of the regulator to appoint new ones and dismiss existing ones. Although those powers can be exercised by the regulator only if the company default condition is satisfied, that could occur if the CIC puts financial concerns before community ones. I referred to that idea earlier.
We support the basic concept of CICs, but feel that that good concept is at risk of being undermined by detail and possible over-regulation, a point made by my noble friend Lord Freeman. Would it not have been wiser to have waited for the long overdue revision of the whole of charity law before launching this excellent initiative? Other noble Lords have also made that point.
We have had a wide-ranging and interesting debate at Second Reading of this rather inadequate Bill. We on this side of the House agree with many noble Lords who have spoken that, as a whole, company law urgently needs reforming. As the Bill stands, however, it will not lead to the modernisation and reform that is required to make it fit for the 21st century and beyond, as called for by Patricia Hewitt in 2002, and mentioned by my noble friend Lord Hodgson. The Bill increases the regulatory burden on directors. The noble Lord, Lord Sharman, pointed out that there was little clarification of company law to help directors.
Although we support all necessary regulation where justified, we do not support onerous regulation for regulation's sake. My noble friend made clear the tests that we shall apply to the Bill, and the noble Lord, Lord Razzall, made some very clear comments on the tests that the Liberal Democrats will apply to it in Committee.
It has been stated that the UK's regulatory system is widely acknowledged to be among the best in the world. By the time that the Bill leaves your Lordships' House, we must have ensured that the balance is fair and just.
1.49 p.m.
Lord Sainsbury of Turville: My Lords, from what has been said today we can be certain that the Bill will be subject to a high level of detailed and expert scrutiny. The Bill has been the subject of extensive consultation with business, the accountancy profession and other interested parties. Yet today we have had a number of new perspectives and insights from speakers. Many interesting points have been raised. I shall try and deal with the key issues in taking the Bill forward.
The noble Lord, Lord Hodgson, instantly raised the question of the main Companies Bill as did the noble Lord, Lord Sharman. We are committed to such an important reform. We want to modernise and simplify UK company law to provide a flexible law with quicker and simpler processes for companies, reduce burdens particularly for smaller firms and start-ups and make the UK a good place to set up and run a business. We intend to publish a draft Bill for comment before we introduce it into Parliament.
However, there is an essential requirement to the main Companies Bill, which is that we obtain the right balance between giving companies stability, so that we do not put aside a whole raft of common law precedent while moving the law forward. That is a difficult balance to achieve. It is one that we are working on and we are committed to introducing the legislation as soon as possible. I do not think that anyone would want us to bring it in if it led to instability in that area.
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