Company Law Reform Bill [HL]

The reliability of company accounts is obviously of vital importance to shareholders, capital markets and the economy as a whole. The auditor’s role is vital in providing assurances of reliability. The new offences for auditors set out in Clause 494 will apply to an auditor who knowingly or recklessly causes an audit report to include misleading, false or deceptive matter, or who knowingly or recklessly omits a statement of one of the shortcomings listed in subsection (2). Later in this part we will reach the provisions that would enable auditors to agree limitations of their liability. Some investors may feel uneasy about this. They may feel that the current risk of unlimited financial liability is one of the incentives that make auditors keen to do a thorough job, and that limiting their liability may reduce this incentive. These new offences could be seen as helping to rebalance the incentives. Of course the overwhelming majority of auditors are diligent and trustworthy, but this provision should increase the incentive for each auditor to check for any potential problems in a company’s accounts and, if there are problems, to reflect them truthfully in the audit report. Amendments Nos. 318, 318A, 319 and 320 would narrow the scope of the offences in two ways. Three of them are aimed at making the test whether the auditor had acted ““dishonestly or fraudulently”” rather than ““knowingly or recklessly””, and one would remove the word ““misleading”” from the phrase ““misleading, false or deceptive””. I am happy to explain why the Government believe that the carefully chosen words in the Bill are appropriate. The purpose of the new offence is not to deal with an auditor who can be proved to have acted dishonestly or fraudulently. There are already many other offences that can be used in such cases, including those included in the Fraud Bill currently before your Lordships’ House. If one puts ““dishonestly and fraudulently”” in the clause, I am sure, as the noble Baroness realises, it would make the clause completely redundant for that purpose. The kind of situation the offences will deal with is when an auditor knows that there is a problem with a company’s accounts and is unwilling to qualify the accounts, perhaps in deference to the director of the company; perhaps even to his partners, who may not wish to lose the client. If such an auditor decides to issue a clean audit report, we believe it is right he should be subject to prosecution or a fine. A further example would be an auditor who suspects that if he looked more closely at a particular area of a company’s books he would discover a problem, and therefore decides not to go further into that area. That is recklessness. It will be necessary to establish that the auditor has decided to blind eye for the offence to be proven. If he had merely overlooked the signs of problems through incompetence or laziness, that could be negligence, but he would not be guilty of this new offence. A further, more extreme example would be the auditor who simply plays a round of golf with the company’s finance director and agrees to sign a clean audit report. That is clearly reckless, and I am sure noble Lords would all agree it should be punishable, but it may well not be enough to be dishonest or fraudulent. Using the test of ““knowingly or recklessly”” in these offences for auditors is in line with the corresponding offence for directors in Clause 387, which applies to any director who knew the accounts did not comply with the Act, or who was reckless as to whether they complied. That offence is essentially restating the existing offence in Section 233 of the Companies Act 1985. Auditors reporting on quoted companies or any company whose shares are traded are potentially already subject to an offence if they knowingly or recklessly make a statement that is misleading, false or deceptive. Section 397 of the Financial Services and Markets Act 2000 even expands on ““recklessly”” in this context by adding in brackets, ““dishonestly or otherwise””—and I emphasise the ““or otherwise””. I hope I have explained why we want to use the test of ““knowingly and recklessly””, why ““dishonestly and fraudulently”” would not achieve our policy, and why we do not believe the word ““recklessly”” should cause undue fear among auditors. I turn now to whether it is necessary to include misleading matter within the scope of the offence as well as false or deceptive matter. It has been suggested that ““misleading”” is too vague a term, which will make auditors anxious that missing any possible ambiguity or scope for misunderstanding might leave them open to prosecution. I think I can explain simply why this concern is misplaced. If I may begin by stating the obvious, the question of whether something is misleading applies to the auditor’s report, not to the accounts themselves. It should not be difficult for the diligent auditor to draft a straightforward report—I believe there are templates available—that says clearly whether the accounts are true and fair or whether there is an issue with them, and, if so, explaining what it is. On the other hand, consider an auditor who finds that he has to qualify his report on the company’s accounts because of a real problem with the company. He may not want to be frank about the problems he has found and he may try to write a report which, while not false, gives the impression that the qualification is merely technical. The purpose of these offences is to encourage frank reporting and so it is right that misleading matter is within their scope. I hope that I have explained clearly why we believe that the two phrases, ““knowingly and recklessly”” and ““misleading, false or deceptive”” are the right ones to use here. If properly understood, these new offences should be of no concern to the overwhelming majority of auditors who would not consider behaving improperly. Of course, it is possible that some auditors may misunderstand the risk of prosecution and if this was left uncorrected it would have adverse consequences. I am grateful to the noble Baroness and the noble Lord who have tabled these amendments for giving me this opportunity to clarify the meaning and intention of Clause 494—and particularly the words ““recklessly”” and ““misleading””—and I hope that the explanation I have given today will help to avoid misunderstandings. Let me deal with two other questions. The noble Baroness expressed concern that the same audit report could give rise to both disciplinary proceedings and to criminal prosecution under Clause 494 and that this could interact in an unfavourable way and make the system more difficult to operate. Ensuring that the two systems work well together is the point of Clauses 495 and 496, and when we get to them I shall be happy to debate why I think we have a system that will work perfectly well. Finally, I should say that we have not had any counsel’s opinion on ““recklessness””, as was implied.