Company Law Reform Bill [HL]

My Lords, I must point out that this has endlessly been the argument. People say with horror in their voices that this will lead to more box-ticking. If it leads to more auditing, that is probably not a bad thing in particular cases. The noble Baroness has constantly been arguing that it will be unproductive work, and the phrase for unproductive work is ““box-ticking””. That is the argument, as I have understood it. If it is now being said that that is not a problem, then I withdraw that, but I thought that that was the thrust of the argument. Let me now turn to the specific amendments, which would narrow the scope of the offences. Amendments Nos. 329 and 331 would change the test of the auditor’s mental state from ““knowingly and recklessly”” to ““dishonestly or fraudulently””. Amendment No. 330 would change the scope from matter that is ““misleading, false or deceptive”” to matter that is simply ““false or deceptive””. First, let me discuss ““knowingly and recklessly””. The purpose of the new offence is not to deal with the auditor who can be proved to have acted dishonestly or fraudulently. As I have just said, there are already many other offences that can be used in such cases, including those in the Fraud Bill currently before your Lordships’ House. So if we were to change it like that, it would be simply pointless because it would duplicate it. It has been suggested that changing to ““fraudulently or dishonestly”” is the only way of reassuring auditors that they will not be prosecuted for an honest mistake. That is wrong, not because prosecutors would have to prove dishonesty—they would not—but because these offences cannot be committed as a genuine mistake or through negligence. ““Recklessness”” is a higher hurdle for prosecutors to clear. No accountant will be at risk of prosecution unless he has made a conscious decision not to do what he knows he should do. I do not want to seek to define ““recklessness”” in other terms. ““Recklessness”” is what we mean, and if there were other words that expressed it better we would use them. In order to make it clearer what we intend by it, let me give you some examples of what we would expect to be covered. As we explained in Grand Committee, an example of recklessness 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. It will be necessary to establish that the auditor has decided to turn a 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 has a drink with the company’s finance director and agrees to sign a clean audit report without seeing the accounts. That is clearly reckless. I am sure noble Lords would agree that it should be punishable, but it may well not be enough to be dishonest or fraudulent. The test of ““knowingly or recklessly”” in these offences for auditors is in line with the corresponding offence for directors in Section 233 of the Companies Act 1985, and restated in Clause 392, which applies to any director who knew that the accounts did not comply with the Act, or who was reckless as to whether they complied. So we are not singling out auditors. Apparently that is all right for directors; we are putting auditors in the same position. The noble Baroness said that no other professional body is subject to this test. I do not think that that is wholly true. There is a special offence for doctors who kill people: the offence of manslaughter by gross negligence was created by the courts, not by legislation, precisely to catch grossly negligent doctors who kill their patients. Again, I think it is wrong to say that this is a unique situation. It is not in any way unique. I am not aware that directors live in fear of being prosecuted under the provisions I have mentioned for honest mistakes. I do not see why auditors, other than those tempted to bend the rules, should change their behaviour either as a result of the new offences. I hope that I have explained why we do want to use the test of ““knowingly and recklessly””. Changing it to ““dishonestly and fraudulently””, as proposed in Amendments Nos. 329 and 331, would render the offence pointless, as it would simply overlap with existing offences. Amendment No. 330 would narrow the scope of the offence by excluding ““misleading”” matter, leaving only ““false or deceptive”” matter. It has been suggested that ““misleading”” is too vague a term and that it will make auditors anxious that missing any possible ambiguity or scope for misunderstanding might leave them open to prosecution. The test is not, of course, whether there is anything in the accounts that might be misleading, it is whether the audit report is misleading. I do not see what is unclear in that, or why auditors should find it hard to avoid being misleading ““in a material particular””. There may be occasions where an auditor is tempted to draft a misleading report. If, for instance, he has no choice but to qualify his report because there are real problems with a company’s accounts, he may not want to alienate the company directors and he may try to write a report that, while not false (wholly untrue) or deceptive (telling less than the whole truth), 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. Amendment No. 332 was put forward by my noble friend Lady Goudie. In Grand Committee we debated whether it was appropriate for auditors to be required to check whether a company was keeping adequate accounting records. The general conclusion was that the duty was a sensible one, but that there were particular risks in applying the criminal offence to an auditor’s failure to make a statement if a company’s records were not adequate. The amendment would effectively limit the offence, so that it was applicable only if the accounting records were inadequate to enable good annual accounts to be drawn up. We have some sympathy with that view. We know that some small companies have fairly informal ways of keeping accounting records and that there are difficult judgments to be made about what would be adequate records in the context of a particular company. I have explained that the main justification for the offence concerns the importance of reliable financial information to shareholders and markets. That does not apply in the same way to companies’ internal record keeping. I therefore agree to consider the amendment, with a view to introducing a government amendment at Third Reading. I think that that deals with the CBI’s opposition to the new offence for auditors. I am aware of the CBI’s briefing and appreciate its concern that the impact of the offence could be to increase the time, money and effort that companies must devote to internal controls over accounting records. Naturally, they look at the impact of the Sarbanes-Oxley legislation in the United States. I note that the CBI’s main concern appears to be the impact on the auditor’s scrutiny of a company’s accounting records. That adds weight to the argument made by the noble Baroness, Lady Goudie, that we should distinguish between the auditors’ scrutiny of the annual accounts and their scrutiny of the adequacy of a company’s internal accounting records. The scrutiny of accounts is based on well established principles, set out in various standards both national and international. The scrutiny of the adequacy of the company’s internal books and records is not backed up with standards in the same way. We understand the argument that applying a criminal offence could be a blunt instrument in this area and might have unintended consequences. On that basis, and with the assurance that we will consider that point, I hope that noble Lords will not press their amendments.