I beg to move,

That leave be given to bring in a Bill to exempt those who suffer from congenital heart disease from prescription charges.

The Government have achieved a lot in drawing attention to the importance of a healthy lifestyle. They can take much credit for the fact that there is far greater public awareness of the need to make lifestyle choices in order to avoid heart disease. I have tabled this ten-minute Bill on behalf of a group of people for whom the ability to improve their health by pursuing a healthy lifestyle is not an option. Those born with complex congenital heart disorders face a life in which ill fortune has decided that no amount of exercise, healthy diets or avoidance of unhealthy living will allow them to live free from the rigours of a heart that does not function properly.

Avoiding cigarettes, alcohol or junk food will not offer them the level of health that most of us take for granted. Their condition denies them the choices that we enjoy about how we live our lives, and how much importance we place on lifestyle. Most of us make conscious, informed decisions as to whether we smoke or drink, or take regular exercise to try to keep our hearts in good shape. Those born with a congenital heart disorder do not share those choices.

Congenital heart disease is a heart condition resulting from an abnormality in the heart's structure or function that is present at birth. Most congenital heart conditions occur because the heart or its valves and vessels are not properly formed. Additional defects such as holes between the chambers of the heart may also be present.

The House will be aware of the Grown Up Congenital Heart Patients Association. GUCH is a charity that was formed 10 years ago by Professor Jane Summerville, who was then a member of staff at the Royal Brompton hospital, and is the only national charity run by patients on behalf of patients. One of my constituents, Stephanie Tyrer, is a founder member of GUCH, and she is listening very intently as I present this Bill.

I wish to make the House aware of Stephanie's life, as it is typical of those with a complex congenital heart disorder. It is a story of the strength, determination and courage that is necessary if those with such a disorder are to reach adulthood and face the enormous difficulty of simply trying to live a normal adult life. When Stephanie was born, her parents were told to take her home and enjoy her while they had the opportunity. At only 18 months old, she underwent major surgery that was designed to prolong her life. Remarkably, that procedure is still functioning 35 years later.

When Stephanie reached school age, her parents were actually asked if it was worth educating their daughter, given that she was terminally ill. During her teenage years, it became necessary for oxygen to be administered at home, and shortly after her 18th birthday, Stephanie suffered her first heart attack. As a result of constant infections and hospitalisation, she was forced to leave school before taking her A-levels because she was too ill to continue her education. What a tragedy for a person who later achieved membership of Mensa.

In spite of her ill health, Stephanie has dedicated her life to aiding others. As a result of her charity work through Rotaract, Rotary International awarded her the Paul Harris fellowship—the first time that a member of Rotaract achieved this honour. Stephanie is also a keen environmentalist. She has campaigned with me, and—it is only fair to say—against me when our views on a particular environmental issue have differed. She is a highly intelligent, extremely determined and totally motivated woman; if she were not, her condition would have made it impossible for her to achieve a fraction of what she has achieved.

Stephanie lives a few hundred yards from me in my Harwich constituency. I could not begin to imagine how much the effort of coming to Westminster today has taken out of her, and how many days it will take for her to recover from that exertion. It is a journey that does nothing more than irritate myself and fellow Members if our trains are delayed.

Stephanie is one of around 149,000 inhabitants of the United Kingdom who suffer from a congenital heart disorder. The particular significance of those represented by GUCH is that they have become adults and have to face adulthood in a society that is ill prepared to offer them the support that they require and deserve. By that, I am not suggesting that they are denied medical facilities, but those with a complex congenital condition are often denied the opportunity to work, to obtain insurance, to take out a mortgage that would allow them to own their own home and many other basic opportunities that we take for granted.

Those who are fortunate enough to obtain the basic independence and dignity of employment have to pay prescription charges for the drugs that are necessary to keep them alive. That is the specific point that my Bill is intended to address. Since I tabled it, I have received a letter from a constituent, Benjamin Dale, who provides a clear example of the inequality that currently exists. His sister suffers from diabetes and receives her prescriptions free of charge. He has congenital heart disorder and is subject to prescription charges. I believe that those suffering from a congenital heart disorder deserve the same Government support. Their condition does not result from poor lifestyle choices and it most certainly does not result from a lack of willingness to help themselves. They have simply been born with a congenital heart disorder and I believe that they should not have to face the additional burden in adult life of finding the money to pay for the medication that is necessary to keep them alive. Thanks to the availability of pre-payment prescription certificates, the cost can be restricted to £91.80. If such certificates were not available, the cost could easily exceed £500. In my opinion, no cost should be incurred.

In the year 2000, there were 149,000 adults in this country with a congenital heart condition and that number is predicted to rise to 185,000 by the year 2010. In the past, only one in five children born with such a condition achieved adulthood but now, thanks to better diagnosis, better facilities and a greater understanding of the condition, more than 80 per cent. survive into adulthood. It is important that the support and assistance that enables them to achieve adulthood is then tailored to provide the kind of support and assistance that is relevant to adult life.

Around 4,500 babies are born each year with a congenital heart condition—a figure that represents approximately one in every 145 births. Every Member of the House will have constituents who suffer from a congenital heart disorder and who strive to live as normal a life as possible. The simple truth is, however, that to live as near a normal life as possible requires a strength and determination that we can only begin to imagine and everything that can be done to reduce the burden should be done. The Government have a good record of acknowledging such situations and taking the necessary action to offer assistance where possible.

This is one such case and it is a case that does not affect a particularly large number of people. Out of the 149,000 people with congenital heart disorders, we are talking only about those who have a complex congenital heart disorder, have reached adulthood and who are eligible to pay prescription charges. Those people, represented by GUCH, deserve the support of the Government and I commend the Bill to the House.

Question put and agreed to.

Bill ordered to be brought in by Mr. Ivan Henderson, Mr. Stephen McCabe, Mr. Tony Clarke, Mr. Anthony D. Wright, Mr. Stephen Hepburn, Ms Dari Taylor, Dr. Howard Stoate, Bob Russell, Mr. Kevan Jones, Andrew George, Mr. John Bercow and Dr. Doug Naysmith.

Congenital Heart Disease (Exemption from Prescription Charges) Bill

Mr. Ivan Henderson accordingly presented a Bill to exempt those who suffer from congenital heart disease from prescription charges. And the same was read the First time; and ordered to be read a Second time on Friday 5 November, and to be printed [Bill 1641].

I beg to move, That the clause be read a Second time.

With this it will be convenient to discuss the following:

New clause 2—Amendment of Companies Act 1985: limit on auditor's liability (No.2)—

'(1) Section 310 of the Companies Act 1985 (c 6) (provisions exempting officers and auditors from liability) is amended as follows.

(2) In subsection (2) delete "subsection" and insert "subsections".

(3) After subsection (3) insert—

"(4) A company may, in pursuance of such a provision, enter a contract with any such auditor to limit any liability which by virtue of any rule of law would otherwise attach to him in respect of any such negligence, default or breach of duty to an amount equal to twenty times the fees paid in respect of the audit of the company, provided such contract is approved by members in general meeting.

(5) Where an act of negligence, default or breach of duty arises in two or more consecutive periods of account, the liability under subsection (5) shall be restricted to twenty times the average of the audit fee for the company for those periods of account".'.

New clause 3—Amendment of Companies Act 1985: limit on auditor's liability (No.3)—

'(1) Section 310 of the Companies Act 1985 (c 6) (provisions exempting officers and auditors from liability) is amended as follows.

(2) In subsection (2) delete "subsection" and insert "subsections".

(3) After subsection (3) insert—

"(4) A company may, in pursuance of such a provision, enter a contract with any such auditor to limit any liability which by virtue of any rule of law would otherwise attach to him in respect of any such negligence, default or breach of duty to the sum of £75 million.

(5) Where the company is a member of a group of companies the sum of £75 million shall be divided between members of the group pro rata to the audit fee charged to each company within the group, provided such contract is approved by members in general meeting.

(6) Where an act of negligence, default or breach of duty arises in two or more consecutive periods of account, the liability under subsection (4) shall be restricted to £75 million for those periods of account".'.

New clause 4—Amendment of Companies Act 1985: limit on auditor's liability (No.4)—

'Section 310(3) of the Companies Act 1985 (c 6) (provisions exempting officers and auditors from liability) is amended, by adding at the end—

"(iii) From entering a contract with its auditors to limit their liability in respect of any negligence, default or breach of duty provided such contract is approved by members in general meeting.".'.

New clause 5—Limit on auditor's liability (No.1)—

'The liability of an auditor which by virtue of any rule of law would otherwise attach to him in respect of negligence, default or breach of duty shall be limited to an amount equal to the proportion of the total loss or damage suffered which is directly attributable to the negligence, default or breach of duty of the auditor, having regard to the contribution to the loss or damage of any other person.'.

New clause 6—Limit on auditor's liability (No.2)—

'(1) The liability of an auditor which by virtue of any rule of law would otherwise attach to him in respect of any negligence, default or breach of duty shall be limited to an amount equal to twenty times the fees paid in respect of the audit of the company.

(2) Where an act of negligence, default or breach of duty arises in two or more consecutive periods of account, liability under subsection (1) shall be restricted to twenty times the average of the audit fee for the company for those periods of account.'.

New clause 7—Limit on auditor's liability (No.3)—

'(1) The liability of an auditor in respect of any liability which by virtue of any rule of law would otherwise attach to him in respect of any negligence, default or breach of duty shall be limited to the sum of £75 million.

(2) Where the company is a member of a group of companies, the sum of £75 million specified in subsection (1)(b) shall be divided between members of the group pro rata to the audit fee charged to each company within the group.'.

New clause 8—Limit on auditor's liability (No.4)—

'(1) The liability of an auditor in respect of any liability which by virtue of any rule of law would otherwise attach to him in respect of any negligence, default or breach of duty shall be limited to the lower of—

(a) an amount equal to the proportion of the total loss or damage suffered which is directly attributable to the negligence, default or breach of duty of the auditor having regard to the contribution to the loss or damage of any other person; and

(b) the sum of £75 million.

(2) Where the company is a member of a group of companies, the sum of £75 million specified in subsection (1)(b) shall be divided between members of the group pro rata to the audit fee charged to each company within the group.'.

New clause 10—Amendment of the Companies Act 1985: Exemption, indemnity and limits on auditor's liability—

'(1) Section 310 of the Companies Act 1985 (c.6) (provisions exempting offices and auditors from liability) is amended as follows.

(2) At the end of subsection (1) add—

"; but before considering any exemption, indemnity or limit on auditor liability, the auditors shall prepare a statement of terms for the approval of shareholders and the information of employees.

(2) A statement prepared in pursuance of subsection (1) shall—

(a) recognise a duty of care owed to each individual who is a shareholder or employee;

(b) recognise the auditor's duty to detect material fraud; and

(c) set out how the audit working papers and files to which any exemptions, indemnity or limit of liability is applied will be made fully available to the listing and regulatory authorities.".'.

I begin by drawing the House's attention to my interests, which are declared in the Register of Members' Interests. This is an interesting, complex and much discussed Bill, and on Second Reading I specified the matters of concern that the Opposition wished to discuss in Standing Committee. The matters that we have not brought back to the House for discussion on Report today include the independent monitoring of major audits, the levy, and the unduly burdensome and onerous obligations that the Bill places on those below board level.

In Committee, we also discussed the nature of disciplinary hearings, the effect on them of the European convention of human rights, and individuals' right to representation. The Committee divided on a number of these matters and in the votes on independent monitoring of major audits and on fair disciplinary hearings the Conservative Opposition had the support of Liberal Democrat Members. Unfortunately, we were not successful in either.

Conservative Members forced a vote on the levy without the support of Liberal Democrat Members. We believe the levy to be very burdensome for business, and the Government have said already that they expect there to be a 400 per cent. increase in the level. I am sorry to say that we were again unsuccessful in persuading the Government to move on that matter.

Many important matters were raised in the two days of Committee sittings, but the Minister showed herself to be unflinching, and she remained unmoved by the arguments that we presented. However, since then I have received a very decent letter from her, in which she accepted that the Opposition had identified one lacuna—as she called it—that will be put right today. Obviously we are grateful to her for that.

Today, we shall bring to the Floor of the House the issue of auditor liability, which is covered by these new clauses. We shall then spend some time on the extremely important question of the investigatory powers available to officials of the Department of Trade and Industry. Also, given that lack of time meant that we were unable fully to discuss part 2 of the Bill in Standing Committee, a probing amendment has been tabled to allow the House to discuss the question of community interest companies, if they so wish.

In general, the Bill is unexceptional and modest, but it does not touch on the really big question of auditor liability, even though the DTI consulted on it. The issue is rather like the elephant in the drawing room, in that the Government seem to want to ignore it.

The Opposition's concerns about liability have nothing to do with the auditing profession, which, as far as I know, is not a specific target for the Conservative party at the next general election. Indeed, I have spoken out on the Floor of the House against various tax schemes invented by auditors that deprive the Exchequer of national insurance and tax funds to which it is entitled. I yield to no one, therefore, in my vigorous distaste for sophisticated avoidance schemes. It is wrong, for example, for a doctor earning £60,000 or £70,000 a year to pay 40 per cent. income tax while a well paid and heavily bonused American banker working in the City does not.

The comments that I make today about auditing are not so much about the position of the auditing profession, but about the good and proper management of the UK corporate system. Apart from auditors, I can think of no other group in commercial life in Britain that can neither limit their liabilities through insurance nor by contract with their customers. Auditors, as far as I know, are the only group stuck in that position. They are in that position because of section 310 of the Companies Act 1985. The measure was first introduced in 1929—some 75 years ago—under a Conservative Government, as the Minister was kind enough to remind us in Committee, and was designed to deal with collusive relationships between companies and their auditors. Those relationships were at the expense of the shareholders and Parliament rightly decided that action should be taken.

It is bizarre that men and women in the auditing profession are asked to take on personal risks that the insurance market, with all its resources, experience and analysis, now says are unacceptable.

My hon. Friend is developing a powerful case. As I recall, the Government undertook a consultation online on the very issue of auditors' liability, which ended in March this year. If so, why have the Government not introduced any provisions in the Bill in that regard? One would have thought that they would have had ample time to have reached a conclusion on the consultation and included some provisions in the Bill, making new clause 1 unnecessary.

My right hon. Friend pre-empts much of my argument. It is at the heart of the Opposition's concerns about this Bill that the Government have yet to take action, which we believe is urgently needed, not in defence of auditors but in defence of the good governance of the British corporate system.

I remind the hon. Gentleman that the 1997 Labour manifesto contained a commitment to introduce limited liability partnerships. Such partnerships go a considerable way towards addressing some of the issues that he raises, and that commitment was put into law in 2000.

The hon. Gentleman is correct on those two points, but as I explained in Committee, they do not resolve the problems.

There are four major auditors left. It is common ground on both sides of the House that we need more auditors to enter the market. The big four audit all of the FTSE 100 companies and not quite all of the FTSE 350. We would like more of those who audit at the bottom end of the FTSE 350 to compete with the big four. The law, as the hon. Gentleman just pointed out, allows audit firms to be limited liability companies or limited liability partnerships. That provides some protection for firms and the capital invested by the partners. However, audit firms are funded entirely by their partners' capital, which has often to be borrowed from banks or through leasing agreements. Those frequently have to be guaranteed by the partners and that is why the legislation, although welcome, is not adequate.

I want to make two other points at this juncture. The first is to do with the law of joint and several liability and the second relates to the fact that only four firms in the world are capable of auditing our largest multinational companies.

The law of joint and several liability means that the audit firm is liable not only for its own negligence but also for that of other parties if it is unable to pay for the loss those other parties have caused. That is what hugely increases the jeopardy facing an audit firm. As there are only four firms, we need to ensure that they survive and prosper and, preferably, that others make the necessary investment, as I have just described.

The hon. Gentleman may be aware that in the United States the Federal Reserve has banned Ernst & Young from practising for six months, which has left only three of the major companies available in the US. As a consequence, that has helped smaller and medium-sized audit firms to expand their business. Is not that the opposite approach to the one he advocates?

Were one of the big four to go under, or be banned, in this country, I have no doubt at all that, within a short period, major public firms, with many shareholders and many pension funds invested, would be unable to secure an audit, so it would be most unwise to draw the hon. Lady's conclusion.

Let me give the House an example of the problem that must be addressed. Let us suppose that a major company is bankrupted because its directors either followed a disastrous strategy or had engaged in fraudulent behaviour, notwithstanding the era of shareholder activism, the work of the auditor and, of course, the new corporate governance codes that have been greatly strengthened by this and the last Government. Let us assume that the liquidator successfully sues the auditors and the directors for £1 billion—by no means the largest amount claimed by liquidators in broadly similar circumstances. Let us further assume that, between them, the directors have some insurance and some limited private assets but that that does no more than cover the legal costs and that the auditors are left with a bill for £1 billion, so they, too, are bankrupted.

It is clear that the directors in that case are to blame; they bear the greatest responsibility for having embarked on a strategy that failed and, in the circumstances I described, for perpetrating a cover-up.

I am trying to follow my hon. Friend's argument. He said that in those circumstances the auditors would be sued, but it would be perfectly possible for them to mount a defence.

It would, but because of the way in which joint and several liability works—the heart of my argument—the auditors would be held responsible in the circumstances I described. A judge might conclude that the directors were 90 per cent. to blame but that the auditors were 10 per cent. to blame, as they were responsible for failing to discover what had been going on. But for the law of joint and several liability, the auditors' liability would be £100 million—a large amount, but one that the big four could probably manage, even bearing in mind that they would also have to pay legal fees, regulatory fines and so on.

Could not the situation be worse than my hon. Friend describes? Under joint and several liability, the plaintiff can choose who to sue; he does not have to sue every person who may share responsibility, so it would be perfectly possible for a liquidator to mount an action against the auditors and not bother with the directors of the company.

My right hon. Friend, who is a distinguished lawyer, is absolutely right.

I am having some difficulty following the argument about joint and several liability. Unless the auditors and the directors were in some way involved together in the situation that the hon. Gentleman describes, I do not see where joint and several liability would come into it. If, as he suggests, the directors were involved in fraudulent activity, that would be a separate matter from the auditors. Either the auditors would have to be involved in that activity, or—if my understanding is correct—they would be extremely negligent in not discovering an obvious liability. Would not that be the case?

I think that the hon. Gentleman's point was answered by the intervention made by my right hon. Friend the Member for East Yorkshire (Mr. Knight). Although I am reluctant to get involved in a detailed seminar on the workings of joint and several liability, my understanding is that my right hon. Friend is correct.

The Government rightly recognise that there is a real problem relating to stability in the audit profession. More important, there is a significant threat to UK capital markets, which is, I believe, why the Government launched their consultation in December 2003. The Department of Trade and Industry seemed to be conducting that consultation sensibly until the big feet of the Treasury intervened and a compromise deal was done: the Office of Fair Trading was to produce a report, and if it said that the result of the measures that the DTI was considering would promote competition—I argue that that is the case—all would be well, but if not, the DTI proposal could not proceed.

The OFT produced a report that was not one of its best, which commentators rightly branded suboptimal and which has led to an embarrassing stand-off between Treasury Ministers and DTI Ministers, who are red-faced and doubtless extremely irritated. The Opposition offered to go with the Minister for Industry and the Regions to a meeting with the Chancellor of the Exchequer during the Committee stage, to try to persuade him to listen to his DTI colleagues. The right hon. Lady has yet to take up that offer, but it remains on the table.

It is the duty of the Opposition to help out. It is bad government not to proceed; it will let down the business community, which could have serious consequences for business, savers and pensioners. We face the real prospect that the big four could become the big three and that a major company would be unable to obtain an audit. The Government are behaving like a rabbit caught in the headlights and it is time that they took action. That is why we have offered every possible way out of the problem that we can think of; we tabled amendments in Committee and have re-tabled today no fewer than eight new clauses and amendments. The Minister thus has a galaxy of choice and opportunity; she can choose which measure she wants to adopt. I hope that she will either make it clear that the Government will legislate with one of our proposals as soon as possible, or that she is moving towards a conclusion and will soon be able to announce to the House a programme for action.

New clause 1 would accommodate the Government's recent but much welcomed conversion to the concept of limiting auditors' liability on a proportionate basis by contract. Until recently, according to last December's DTI consultative document on director and auditor liability, the Government believed that the adoption of proportionate liability would need to be part of major reform of the law of negligence. As a result, the document concentrated on forms of monetary capping rather than examining proportionate liability. Although the document explicitly ruled out reform permitting proportionality, a large number of respondents volunteered the view that it was the solution that they most favoured. Indeed, it may be the widespread support for proportionality evident in the responses to the consultative document, which the Minister has most helpfully placed in the Library, that has led to the Government's new-found enthusiasm for proportionality. Whatever the reason for their conversion, it is extremely welcome.

The current system of joint and several liability, which I have set out, allows a claimant to sue any party who has contributed to their loss for the full amount of that loss, regardless of the extent to which that party was directly responsible. It is, of course, open to that party to sue all the other people who may have contributed to the loss, but if they have no money the first party has no redress.

The hon. Gentleman raises some interesting issues about one case—I certainly do not want to dwell on the case—but, surely, those are issues for the courts, not for the House of Commons. It is not for the House to ring-fence and protect some of the actors involved with special legislation.

The hon. Gentleman is entirely wrong on that point. The House determines the law and the courts interpret it. It is very much a matter for the House to consider whether the laws that we pass and the regulations that we make are in the best interests of the good governance of the British corporate system.

I am grateful to the hon. Gentleman for giving way to me again, but let me make the point clear. The new clauses that he proposes would entrench protection for one of the actors in such an action. How can it be right for the House of Commons to do that?

The hon. Gentleman's point is a matter for debate. If he catches your eye, Mr. Speaker, he will be able to progress that argument, but I do not agree with him.

Of greater significance—in no way do I ignore the current consequences for Equitable Life policyholders or the possible consequences for employees and partners at Ernst & Young—the bankruptcy of Ernst & Young would be a disaster for UK plc. The big four would become the big three, further restricting the choice of auditor available to our largest global companies. Ernst & Young's clients would have to find a new auditor, but it cannot be assumed that the remaining big three or the next tier of audit firms would necessarily wish to take on all Ernst & Young's clients. The shock waves from the collapse of a firm of Ernst & Young's size and stature would make the remaining firms even more risk adverse. It seems almost inevitable that some companies in the riskier segments of the marketplace would end up without an auditor. That would be a crisis for UK plc, and the Government would have the task of trying to find a solution.

It would not be possible to create a new global firm either by dividing the remaining big three in half or by forcing some of the mid-tier firms to merge. Neither route would create a new global auditor firm, with the global reach, specialist skills and ability to invest in new technology necessary to audit the largest multinational companies that make up the FTSE 100. The Government would, however, have to introduce liability reform if there were to be any hope that the remaining big three and the mid-tier firms would take on those audits that they would otherwise reject. It is never easy or sensible to legislate in a hurry. Rather than introducing reform in the midst of a crisis, it would be far better to do so now, before the crisis erupts.

Will my hon. Friend clarify a matter that may indicate whether the hon. Member for Newcastle upon Tyne, Central (Mr. Cousins) made a valid point in his intervention? If my hon. Friend is arguing that we should accept new clause 1 and the associated new clauses, that is a perfectly legitimate point to make, but if he is urging us to accept new clause 1 and is saying that its operation should be retrospective, the hon. Gentleman's point might have some merit.

I reassure my right hon. Friend that I am certainly not suggesting that new clause 1 should apply retrospectively. I am trying to propose a range of different opportunities to resolve the problem. New clause 1 contains the solution that the Government will eventually reach—it is certainly my preferred solution—but it is not the only way to resolve the problem, as I shall attempt to persuade the House.

Permitting auditors to limit their liability by reference to proportionality does not remove financial risks from audit firms. Furthermore, proportionate liability does not guarantee the survival of an audit firm. In an extreme case, the loss caused by a firm's negligence could be greater than its financial resources. However, such liability would reduce significantly the likelihood of a catastrophic corporate failure bankrupting an audit firm, while making it far more attractive for some of the mid-tier firms to compete more vigorously to audit companies in the FTSE 350, and perhaps later, in the FTSE 100. For all those reasons, new clause 1, which would permit auditors to limit their liability by reference to proportionality, has a great deal to commend it, and I hope that the Government will at least accept the principle today if not the new clause.

I offer new clause 2 as an alternative approach. Although the Secretary of State for Trade and Industry has ruled out the introduction of a cap, she had concluded in favour of doing so until she learned of the Chancellor's strong opposition. The OFT confirms in its report, to which I referred a moment ago, that a cap set appropriately would not be anti-competitive, so clearly, any cap would have to be set by the Secretary of State or by someone else with delegated authority, such as the Financial Reporting Council. That would be necessary to ensure that the cap was set appropriately.

New clause 2 proposes to set the limit at twenty times the UK audit fees. I am not wedded to a multiple of twenty. Some have argued that it is too high and others have suggested that it is too low, but it represents an appropriate level, high enough to provide proper redress when something goes wrong and low enough to reduce significantly the possibility of a large claim bankrupting the auditors. There are not many providers of services and goods in the UK that face a penalty of twenty times.

Sometimes, a single failure at a certain moment gives rise to the audit failure. More often, however, the problem has arisen over several months or occasionally years, and it is necessary for that purpose to regard the failure as what the insurance industry calls a single event. In other words, if the auditors fail to detect a fraud that begins in one accounting period and it is detected in a later period, the auditor's liability would be limited to twenty times the average fees paid to it in those years. That is an important principle if we are to avoid double counting, and it forms the substance of new clause 2.

New clause 3 is similar to new clause 2, except that a single monetary sum—£75 million—would be imposed on all companies. PricewaterhouseCoopers suggested that sum in its response to the Government's consultative document. I am persuaded by its logic that £75 million is not an unreasonable figure. In its submission to the Department, it says:

"For all but the very largest companies, losses arising from an auditor's negligence are very unlikely to exceed this amount, so such claims would effectively not be capped. For the very largest companies, which give rise to risks of loss greater than £75 million, it is appropriate that they should carry the excess risk themselves. We further believe that a statutory cap at this level will improve the likelihood of mid-tier firms taking on larger audit engagements, thereby increasing choice in the marketplace."

The Government have made it clear that they expect any form of limitation of auditors' liability to be such that it promotes competition. I can certainly understand that a cap of more than £75 million would be so far in excess of the ability of mid-tier firms to meet an award of damages against them that it would do nothing to encourage them to compete for larger audits. Indeed, even for the big four, a settlement of damages much above that figure could be met only by the firm mortgaging its future, with the inevitable consequence that the firm would become unattractive to possible new partners and, indeed, many of its existing partners. Inevitably, therefore, in the long term, such a settlement would lead to terminal decline. Such a firm's ability to invest in new technology and in the development of the people whom it was able to retain would be severely damaged. That would not be in the interests of either competition or preserving high-quality audits, which are dependent on the involvement of high-quality people as audit partners and audit managers.

New clause 4 is both the simplest and most deregulatory measure in the group. It would permit a company to enter into any contract to limit liability with its auditors provided that shareholders approved such a contract in a general meeting. The requirement for any contract to limit auditors' liability to be approved by shareholders in such a meeting would address the abuse that gave rise to the provision in the Companies Act 1929 that I cited at the start of my speech, which eventually became section 310 of the Companies Act 1985. The measure was required because of directors and auditors who conspired to enter into cosy contracts to limit their liability that became known to shareholders only after a loss had been suffered and an action had been launched against the directors or auditors. No doubt some would argue that the 1929 Act would have been better if it had simply required such contracts to be approved by shareholders. In any event, 75 years later, in a radically different and more litigious and transparent age, we can ensure that any contract would be effective only if it were visible to, and approved by, shareholders.

Before my hon. Friend moves on from new clause 4, does he accept that there could be an alternative danger? A big four auditor could put huge pressure on a company by saying that it would withdraw its services unless the company approved such a contract in a general meeting.

My hon. Friend might be on to a good point, but once a new system were set up—albeit not necessarily that outlined in new clause 4—the risk of such an event would be less than he suggests.

New clauses 5, 6 and 7 effectively mirror new clauses 1, 2 and 3. However, they would impose a limitation by statute, whereas new clauses 1, 2 and 3 are permissive and would allow companies to limit auditors' liability by contract if shareholders so wished. New clause 8 combines the benefits of proportionality with those of a cap. It would provide for a belt-and-braces approach that would combine the equity of proportionality with the safety net of a cap to guard against a catastrophic claim.

We have tabled the eight new clauses to help the Government. Conservative Members have no vanity of authorship, so we are happy to be corrected by the many skilled officials and draftsmen who serve the Minister.

Several events have taken place since Committee. It was said in Committee that the Government would amend section 310 of the 1985 Act to permit auditors to limit their liability by contract with reference to proportionality if it were made clear that the audit profession, the business community and investor organisations supported it, and that such an amendment would enhance competition in the audit market and improve the quality of auditing. I understand that all those conditions have been satisfied—I shall deal with each in turn—yet the Government have failed to table an amendment to address the matter.

The Institute of Chartered Accountants in England and Wales, which represents the auditors of almost every listed company in the United Kingdom, supports proportionality by contract and has said that the big four and mid-tier audit firms, which are the actual auditors of the listed companies, support such reform. Other accounting bodies, especially the Institute of Chartered Accountants of Scotland, also support the reform. It is thus clear beyond doubt that the Government's first requirement that the audit profession supports the reform has been met. The CBI, which represents larger quoted companies, and the Quoted Companies Alliance, which represents smaller quoted companies, support the concept of auditors being permitted to limit their liability by reference to proportionality.

Would there not be a further benefit if liability could be limited by entering into free contractual negotiations because there would be no need to alter the law on negligence, which is a tort?

My right hon. Friend makes an extremely good point.

I apologise to you, Mr. Speaker, and to the hon. Member for Sutton Coldfield (Mr. Mitchell) for missing the first two or three minutes of his speech.

The debate is remarkable in that the Conservative party seeks to entrench the powers of a cartel by embedding new principles in legislation. To pray in aid the company laws of Greece to allow that to happen is a double conversion to more badness of an extraordinary kind.

I shall be frank. I see little requirement or necessity to consider the idea of limiting auditor liability. None the less, having regard to the debate on Second Reading and some of the discussions in Committee, it is clear that the Government are at least willing to consider the principle of limiting auditor liability in some form.

The hon. Gentleman opposes limiting auditor liability. Will he therefore explain why new clause 10, which he has tabled, does precisely that?

I am about to do so.

That limit on auditor liability could be achieved by one of the three methods outlined by the hon. Gentleman: proportionate liability, a cap on the sum or a system of contract between the company and its auditors. I remind him of the intervention by the hon. Member for Sevenoaks (Mr. Fallon), who explained to him some of the risks and dangers in a system of limiting liability in a contract between a company and its auditors which could give the company's auditors an even greater control of its workings and their activities within it. That is a new and unfortunate principle. To entrench a cartel is one thing, but to entrench a cartel by giving it new rights over companies to enforce its will is wrong.

It is clear that the Government are considering the matter. We all know the way in which debates work. I thought that it might assist the Government, who are coming under intense pressure from one side of the argument, to consider opposite views and the factors that might be relevant were they minded to consider proportionate liability in the future. I have set out some of those factors in new clause 10 as a contribution to the debate.

I referred to a cartel, which is perhaps unkind but not untrue. The hon. Member for Sutton Coldfield said that the FTSE 100 companies are audited by the big four auditors. I am informed that all but eight of the FTSE 250 companies are audited by the big four. That looks like an embedded, entrenched and powerful cartel that has a stranglehold on the current marketplace, effectively barring access to smaller companies, many of which are not small by any normal judgment but small by comparison with the big four.

If limited liability were in place, might not the auditing work be more attractive to the smaller companies, which would enter the market?

Not if the limit on liability was carried out in the form of a contractual relationship between the auditor and company. That method of limiting liability gives the mechanism to entrench the existing cartel.

As for the financial cap, the Opposition's new clauses set a cap that would be way too high for most medium-sized firms to enter into if money were a consideration. So that is not a powerful argument. We are talking about a fundamental principle of British company law since at least 1948. In that year, the Government of the day—a Labour Government—agreed to the requirement that audits would be acceptable only if they were carried out by a limited range of firms. In effect, that gave the auditor firms a professional monopoly over such work.

The other part of that understanding, however, was that the moral hazard that was thereby created would be dealt with by exposing those auditor firms to the full test of absolute liability. That principle has guided the House in its discussions of the issues and through the company legislation of the 1980s steered by the Conservative party. That approach recognises that once we remove the fact of moral hazard, and if we are also prepared legally to entrench a cartel, we are moving in a profoundly wrong direction.

In new clause 10, the hon. Gentleman seems to accept a diminution of the moral hazard that he is now championing, as it refers to "exemption, indemnity or limit". Could he elucidate?

If the Government were tempted to limit liability a wide range of market actors should be able to contribute to that decision. Also underlying new clause 10 is the principle that the auditors owe a duty of care to people concerned with the company that they are auditing. I shall discuss the duty of care later, as it is a legally contested principle with a bearing on our debate. Finally, if we wish to limit liability, new clause 10 would give the regulator full and automatic right of access to all the documents and working papers of both the company and the audit firm. If, therefore, we go down the route of limited liability there must be an exchange—there must an increase in both the regulator's power and the ability of other market actors to contribute to the debate, and the duty of care that ought to guide the new relationships that are created should be much clearer.

Among the motives that underpin new clause 10 is a recognition of auditors' duty of care. Auditors' responsibility has been eroded by case law. Under the Caparo Industries judgment of 1990, auditors generally owe a duty of care to the company only as a legal person rather than to individual shareholders. The Law Lords further decided that the audit report was prepared to enable shareholders to exercise their rights as members of the company, and not to enable them to make any investment decisions. That reversal of the principle of the duty of care has had some unfortunate effects. It is doubtful whether we can always rely on audit reports to provide public actors, market participants, investors in the market and shareholders with a guide to what is going on in a company. Another legal judgment in 1996 held that auditors may be liable to third parties beyond the company and the auditor where

"the purpose of audit work has been widened so that it is no longer confined to the statutory one . . . and the auditor in all the circumstances ought to have regarded himself as carrying out the audit for the plaintiff's purpose as well as the company's."

Such circumstances, however, are rare, which is why I have sought to revisit the auditor's duty of care in new clause 10. If the Government wish to limit auditor liability, in exchange we should at least be able to re-establish the broad principle of the duty of care that existed before the Caparo judgment.

The Law Commission reviewed those issues in 1993 and 1996, and rejected the call for a cap on auditor liability. It concluded that

"we can find no principled arguments for a 'capping' system . . . that . . . cuts across a principle that a wrongdoer should compensate the plaintiff for loss caused by its tort or breach of contract".

It also said that a capping system would

"put the plaintiff at a disadvantage, since the cap would represent the upper limit in negotiations for a limit".

That demonstrates the unfortunate implications of the new clauses tabled by the hon. Member for Sutton Coldfield. The sum of £75 million in new clause 3, for example, would be significant in discussions and negotiations between companies and auditors. The Law Commission regarded

"the policy objections to joint and several liability to be at worst unproven and, at best, insufficiently convincing to merit a departure from the principle".

It responded to propaganda from the big four accountancy firms by arguing that it was

"misleading to say that defendants can currently be called on 'to provide 100 per cent. of the damages even though they are only 1 per cent. at fault' since the principle of joint and several liability is . . . relative to the plaintiff".

I made that point in an intervention on the hon. Gentleman.

The Limited Liability Partnerships Act 2000 passed by the Government increases the concessions and protection given to accountants. We have already moved a long way from the 1948 bargain, but very few of the concessions made in the intervening period have been accompanied by a compensating quid pro quo to increase the rights of companies, shareholders, employees and other market actors. If the Government embrace limited liability, new clause 10 would create a clear quid pro quo so that powers and rights are given to participants other than the big four accountancy firms.

I am listening carefully to the hon. Gentleman's argument, but what is the rationale in new clause 10 for extending the duty of care to existing shareholders, but not future shareholders who may rely on a previous auditor's report?

That point was covered backhandedly in the speech of the hon. Member for Sutton Coldfield, who rightly drew a distinction between the liabilities of auditors in mainland Europe and those of their British counterparts. In Europe, there are shallow financial penalties, but auditors can cast a wide net. The UK has evolved a different principle—auditors' rights and obligations are narrow but deep. I have therefore framed new clause 10 in a way that respects the traditional narrowness of obligation at the heart of the British approach. I do not want to move towards a mainland European system in which obligations are shallow but responsibilities are much wider. I want to maintain the traditional British principle of a network of narrow auditing obligations that are specific to a limited range of actors but have a deep application. I hope that that is helpful to the right hon. Gentleman.

Some of the mainland European principles that guide the connection between auditors and companies were prayed in aid by the hon. Gentleman to support his new clauses. However, they are full of bad consequences and under future legislation could allow all sorts of people to pursue action on various grounds against company auditors. My purpose, however, is to defend the traditional British principle of maintaining a pattern of narrow but deep obligations.

I do not want to detain the House too long. I have sought to put a contrary view to that being expressed by Conservative Members, and I have sought to introduce into the debate some discussion of issues that might be helpful to the Government when they consider their next moves on these matters. We should all bear in mind as legislators that major accountancy firms are sometimes fairly adept at non-co-operation with regulators. In the case of Parmalat, an Italian company, we heard recently that the UK parts of Parmalat were audited by a firm called Grant Thornton, but the firm says that the real auditor was Grant Thornton International, an Italian firm, and that the UK firm would not share its working papers and files with the regulators. That illustrates some of the mechanisms that auditors currently use to defend their position, without the House being motivated to entrench their powers still further.

I could go on at length, discussing some of the disciplinary schemes and some of the issues of Enron that have guided American legislation. I will not do so. Suffice it to say that when the hon. Gentleman says that the Institute of Chartered Accountants in England and Wales supports the principle of Parliament adding to the entrenchments of limits on auditor liability, it is difficult to avoid the conclusion that they would say that, wouldn't they?

If the House is minded to consider moving in the direction of further entrenching the powers of a cartel, it must also consider what additional rights it gives other actors in the situation to defend themselves and their interests. It must also make sure that we do not accidentally contrive a situation in which we agree to limitation by a contract between a company and an auditor that could result in new forms of blackmail being applied to companies in order to secure an audit. That would be wholly wrong. The House should never engage lightly in the entrenchment of cartels. When it does so, it should seek new rights and obligations in exchange.

The hon. Member for Newcastle upon Tyne, Central (Mr. Cousins) mentioned Parmalat. I would have cited Parmalat as one of the special reasons why the Government should reform the present arrangements and support my hon. Friend the Member for Sutton Coldfield (Mr. Mitchell) on new clause 1.

The hon. Member for Newcastle upon Tyne, Central also said that all our new clauses would strengthen what he described as the cartel of the big four companies. If that were the case, why would the organisations on the other side of the fence—the Federation of Small Businesses, the Institute of Directors and the CBI—be enthusiasts for reform of the law in this area? They would surely not campaign for a change if they thought it would be disadvantageous to them and strengthen the monopoly that the four major players had in the market.

The hon. Gentleman should also consider the comments of the hon. Member for Sutton Coldfield that some of the support given by those trade organisations to the idea of further limiting auditor liability is accompanied by all sorts of caveats about the need to consider the details. What will probably not commend itself to them is the principle of limiting auditor liability by a contract with the company.

I agree that the trade organisations will want to see the small print of the Government's proposals, but that does not affect the broad principle that all the organisations on the business side of the fence are keen on a change in the law. The hon. Gentleman cited the 1993 Law Commission report. The world has moved on considerably since 1993. Equitable Life, Enron and Parmalat are all major events that have happened since the Law Commission reported in 1993, and it must be right for us to look again at the issue. I cannot say whether the Government will go for new clause 1, 2, 3, 4 or any other of my hon. Friend's new clauses, but it is a matter of considerable urgency.

I remind the House of my business interests recorded in the register.

Like the hon. Member for Newcastle upon Tyne, Central (Mr. Cousins), I initially found the new clauses somewhat unappetising. My hon. Friend the Member for Sutton Coldfield (Mr. Mitchell) is vulnerable to the charge of entrenchment. No Member of the Opposition likes to be in the business of reinforcing cartels, and the hon. Member for Newcastle upon Tyne, Central was right to draw our attention to that.

It is dangerous to legislate because of a particular case: that of Equitable Life, which is before the courts. We should not legislate in advance of the case—my hon. Friend the Member for Sutton Coldfield assured us that the measure would not come into effect in time—and we should not legislate alongside it. If we did, we might well be asked why liability should be limited for auditors, rather than for the unfortunate shareholders in the event of the sort of catastrophic business failure to which he referred. However, I do not disparage my hon. Friend's motives. Clearly, if the big four were reduced to the big three, that in itself would reduce competition and choice for the large companies. There may well be other work that needs to be done to improve the audit marketplace, and the banks, insurance companies and lawyers may need to be better educated as to the merits of the mid-cap firms.

My hon. Friend the Member for Sutton Coldfield is in that position because we are not where we would like to be. Her Majesty's Government have, of course, reneged on their commitment, have not followed through on the consultation and, although we have yet to hear from the Minister, do not appear to be in a position to legislate. If the Department of Trade and Industry has failed to win its battle with the Treasury, and if the Government, who have a massive majority, cannot make up their mind on auditors' liability, my hon. Friend the Member for Sutton Coldfield is right to step into the breach and offer the House a range of alternatives.

I sympathise with new clause 10, which was tabled by the hon. Member for Newcastle upon Tyne, Central. However, the definition of the recognition of the duty of care is unclear, so I cannot support it without further detail as to how it would work, although I certainly applaud the motivation behind it.

On the alternatives—we are being offered a menu of hot and cold food—I do not set much store by new clause 4, which is naive. Perhaps my hon. Friend the Member for Sutton Coldfield has spent too long in merchant banking rather than the business world. In the real world, auditors would simply to say to firms, "This new companies legislation has come in, and unless you sign this kind of contract, you will lose us as your auditors." New clause 4 would put auditors in the driving seat.

The flaw in my hon. Friend's argument is that if new clause 4 became law, a thrusting, up and coming firm might say, "We will offer better contractual terms than the four auditors in the cartel." That would weaken the cartel, rather than strengthen it, and more big players would enter the arena.

My right hon. Friend and I share the objective of widening the audit marketplace for companies that are outside the FTSE 100, so I hope that that scenario would occur. Because firms do not change their auditors that often, however, the equal and opposite danger is that the auditor who holds the contract with a particular firm would simply go to the directors and say, "We are offering you this new contract because the new companies legislation has come in. We want you to put it to the general meeting in these terms; otherwise we will no longer be your auditor." My hon. Friend the Member for Sutton Coldfield has clearly toiled hard in the kitchen over his menu of options, but new clause 4 is not his best offering.

I say to my hon. Friend what I said to the Minister: it does not matter which of my new clauses you do not like, so long as you like one of them. We have tried to lay every possible option before the Commons today, so that hon. Members can make a decision. Saying nothing, a policy to which the Minister has been getting perilously close, is not an option, and that is the lacuna that we seek to address today.

I applaud my hon. Friend's hard work, but I want to comment on the individual options. We must choose one of the options, but new clause 4 is not the strongest.

I am not particularly attracted by new clauses 2 and 3, because a cash-terms cap is vulnerable to changing circumstances and nobody knows exactly how the mid-market audit firms will evolve. I am always suspicious when PricewaterhouseCoopers or any of the other large firms proposes a cash ceiling, and handling matters on a fee-related basis would not work either.

If the Minister does not come up with a solution, which she has promised and to which the Government were initially committed, the House must choose one of the options. As my hon. Friend the Member for Hexham (Mr. Atkinson) said, new clause 1, which is based on proportionality, has received support from not only PricewaterhouseCoopers, but across the business community and is therefore the least worst option. If my hon. Friend the Member for Sutton Coldfield were to press new clause 1, I would support him.

I congratulate the hon. Member for Sutton Coldfield (Mr. Mitchell) on new clause 1. It is an acceptable response to the issue of proportionate liability, which, as we all know, must be addressed.

In a moment, I hope to congratulate the Minister on making a clear commitment to a solution along the lines of new clause 1, which, as the hon. Member for Sevenoaks (Mr. Fallon) said, is supported by much of the business world. I hope that the Minister will make such a commitment, because, as she knows, we need such a solution, which is why it is incumbent on her to accept new clause 1 or to make a precise commitment on when and how the solution will be produced.

We are all taken by the galaxy of choices offered by the hon. Member for Sutton Coldfield, who, like Father Christmas, has many tempting trinkets that glitter in front of our eyes, but a solution based on new clause 1 is the prize that we want. I hope that the Minister will respond positively; she knows that she should respond positively and that everybody is calling for such a response.

The debate has been interesting. I congratulate my hon. Friend the Member for Sutton Coldfield (Mr. Mitchell) on having done his homework. I trust that the Minister has done her homework too, although Conservative Members fear that it has been retained on the desk of the Chancellor of the Exchequer. The hon. Member for Newcastle upon Tyne, Central (Mr. Cousins) also made an interesting and thoughtful speech. If the Minister has other things to do this afternoon, she could rise to the Dispatch Box and indicate that she is minded in principle to accept one of the new clauses tabled my hon. Friend the Member for Sutton Coldfield, and we could all get away earlier.

It is odd that the DTI conducted a consultation on auditors' liability. The consultation commenced in December 2003 and specifically covered that issue. Responses were requested by 12 March this year, so the closure date has long since passed. One would expect the Minister to have assessed the value of that consultation and to have reached a policy decision. I do not like piecemeal legislation or a piecemeal approach to problems, which is the approach taken in the Bill.

A full overhaul of company law is required and provisions such as the new clauses tabled by my hon. Friend the Member for Sutton Coldfield should be encompassed in wider company law legislation. I am therefore disappointed that the Government are seeking to proceed in one area, while we await whatever proposals they may have to change company law in the future.

My hon. Friend the Member for Sevenoaks (Mr. Fallon) said that he was attracted to new clause 1, which I, too, find the most attractive of those tabled by my hon. Friend the Member for Sutton Coldfield. However, I do not share his concern about new clause 4, which could have the opposite effect to that which he suggests; that is, it could lead to mid-market firms entering the marketplace, thereby weakening the cartel that was mentioned by the hon. Member for Newcastle upon Tyne, Central. New clause 4 is not as bad as my hon. Friend suggests, because it seeks to allow free contractual relations to take place. The benefit of proceeding in that way is that the law on negligence does not need to be reviewed because free contracting parties are allowed to build into their agreements a scope on the limit of liability.

I am grateful to the right hon. Gentleman for his kind remarks. Does he also accept that recognising a duty of care would be a significant change to the legal framework in which the big four accountancy firms operate?

I am attracted to a duty of care provided that it is circumscribed and well defined so as to avoid court actions of the sort that take place all too often in the United States.

I hope that the Minister will be prepared to respond positively to the constructive suggestions that have been made, particularly by my hon. Friend the Member for Sutton Coldfield, and that she will tell us what action the Government intend to take.

In response to the opening remarks of the right hon. Member for East Yorkshire (Mr. Knight), I can think of nothing more rewarding or enjoyable to do this afternoon than to take part in the Report and Third Reading debates on this Bill. Having said that, I do not intend massively to extend the proceedings, because, as the hon. Member for Sutton Coldfield (Mr. Mitchell) said, we had a relatively short but good-natured and well-informed Committee stage in which we dealt with many important issues. That followed considerable scrutiny, and changes that the Government were willing to make, in the House of Lords.

With these new clauses, we return to the aspect of the Bill—auditor liability— that has given rise to the most significant debates, not least because the eight new clauses that the hon. Member for Sutton Coldfield has tabled for consideration today are those that we also debated at some length in Committee.

I am grateful to my hon. Friend the Member for Newcastle upon Tyne, Central (Mr. Cousins) for tabling his new clause, which enables us to widen the debate.

It is worthwhile returning to first principles. There is widespread agreement that audit plays a crucial role in our market and in ensuring trust and confidence in our businesses. It is therefore important, as the hon. Member for Hexham (Mr. Atkinson) observed, that all those who need and want to access high-quality audit services are able to do so. We need to maintain a complete market in which the principles of competition ensure that completeness and help to drive quality through the system. In addition, we need to maintain, and preferably to improve, the quality of the audit process and of the information that is available to those who need it.

Those are the criteria by which we should judge any reforms that we make, and I shall use them to judge the eight different dishes that the hon. Member for Sutton Coldfield has served up to us.

I shall start with new clause 4 because it is the most straightforward. It would remove auditors from section 310 of the Companies Act 1985 and allow them to negotiate limited liability with their clients, free of statutory constraints and subject only to shareholder agreement to any proposed limitation of liability. The Government consultation considered a similar option and found that just over half of respondents were opposed to the proposal, partly for reasons that hon. Members rehearsed today.

Under that system, the market would set the level of any limit. That was a key fear of some of the respondents to the consultation. One major company commented:

"if the cap is left to individual negotiation, lack of competition would probably mean that the audit profession will push liability caps down over time".

Other respondents were concerned about the client's ability to negotiate an appropriate limit. There was concern that companies could find themselves in a weak bargaining position, particularly in situations where only a very few firms are capable of conducting the audit or where there have been past issues arising out of the audit. It is obviously important that the Government take note of those concerns and of the fact that more than half the respondents did not see this option as the way forward.

Furthermore—I hope that this is music to the ears of my hon. Friend the Member for Newcastle upon Tyne, Central, although I cannot promise to provide that all afternoon—we are conscious that the current rules were introduced in the late 1920s in the light of difficulties whereby directors and auditors had, in effect, colluded to the detriment of shareholders. We certainly do not want to see the return of those scandals.

New Clauses 2 and 6 would restrict, or permit restriction of, any liability to a figure of 20 times the audit fee, or—when the auditor has committed the same act of default in two or more consecutive audits—the average of the audit fee paid by the company in those periods. An upper ceiling set as a multiple of the audit fee has the merit of making the limit proportionate to the audit fee. However, it does not in any way reflect the loss caused to the company. To that extent, it is an entirely arbitrary figure in relation to any actual loss, and it will have arbitrary results.

At one extreme—where there are very high audit fees, for example—that approach could result in liability at levels that auditors suggest they cannot afford, thereby not solving the problem that hon. Members set out in the first place. At the other extreme, where there are low audit fees, it could mean investors being compensated for only a small proportion of the loss that they suffered through the auditor's negligence.

That dichotomy and problem cannot simply be addressed by changing the multiple from, for example, 20 to 10 or 20 to 40, because what improves the position at one end of the scale makes it worse at the other. That is a fundamental problem with the idea of a cap that reflects a multiple of the audit fee. It is of further concern that any limit that is based on a multiple of the audit fee would create a potential incentive for auditors to keep the fee as low as possible. At first sight, that might appear to be a good thing, but it is not in shareholders' interests for auditors to take short cuts. Indeed, under the regime set out in the new clauses, they have a positive interest in paying a high fee so that they can claim more back if things go wrong. It is therefore ironic that the new clauses could create a position whereby, because of the potential for claiming back in the case of a problem, the purchaser wishes to pay more than the supplier wants to charge.

The Government have considered the options in new clauses 2 and 6 carefully and concluded, again with the majority of the respondents to the consultation, that they are wrong in principle and in operation.

Let us consider new clauses 3 and 7, which, in some ways, are even more arbitrary in their effects. Under the proposals, the auditor's liability could or would be limited to £75 million. We have serious concerns that the approach would be anti-competitive. Some alternative arguments have been put today, but a major difference already exists between the big four audit firms and the next group, the so-called tier A firms, on the proposal. The Government have been told that a simple limit, which is fixed at a figure such as £75 million, would benefit the biggest firms but do little or nothing for some of the smaller and medium-sized firms, which risk being wiped out by such a sum. That approach could therefore entrench the current position and do nothing to aid our objective of enhancing competition in the audit market.The option clearly does not have the unanimous support of auditors, let alone investors. It is seriously flawed and the Government cannot accept it.

Let us consider new clauses 1 and 5, which, as hon. Members have said, are based on proportionality. New clause 8 mixes that idea with the sort of numerical cap against which I have just argued. New clauses 1, 5 and 8 raise more questions than they answer in running together contract and tort, and contribution between two or more liable people and that between company and auditor. However, despite the comments of the hon. Member for Sutton Coldfield on the disadvantages of the system of joint and several liability, I welcome his apparent agreement that any solution such as a proposal to limit liability proportionately by contract should be placed in the context of the current law on joint and several liability.

One of the attractions of a proposal to limit liability proportionately by contract is that it would not involve some of the much wider implications and unintended consequences of a full-scale reform of the law on joint and several liability but could enable the introduction of elements of proportionality.

The response to the proposals, especially in new clause 1, is that there may be scope in the system of joint and several liability for the auditors to limit their liability in some way to an amount that, in lay terms, is proportionate to their responsibility. That idea emerged in the course of our consultation. The Government did not present such a proposal for consultation but, as happens in good consultations, it emerged during the process and has rightly received serious consideration. It has come to be known as proportionate liability by contract.

The Minister has explained at some length and helpfully some of the prevailing arguments about the difficulty of following the route of new clause 1. However, we are considering a companies audit measure. Is she genuinely claiming that it is not possible to propose such a package before the Government's Bill, which deals with audit, is passed?

I have pointed out some of the problems involved, and I am now going to talk about some of the possible solutions. While I cannot support any of the amendments that are before the House today, I am personally determined to make progress on these issues, not least because of the importance of maintaining confidence in the operation of our capital markets.

Since the House last debated this issue, in Committee on 14 September, the Government have taken the lead by bringing together all the parties involved. Our goal in doing that was to see whether a joint approach could be developed which would meet the different concerns of the parties, as well as meeting the Government's objectives of ensuring that all companies that require them can readily obtain audits, that further improvements in the quality of audit are delivered, and that competition in the audit market is improved. These discussions have resulted in some progress being made, and they are continuing.

In particular, it is crucial that we should be able to address the issues of competition as well as some of the issues raised in report of the Office of Fair Trading. It is only right, when we set up an independent competition authority, to take seriously the issues raised in such a report. The job now is to move from the principle that the approach involving proportionality by contract could well be the appropriate way forward, as the Government believe—I acknowledge that there is agreement in this regard—to the detail of how that will work, and the consequences that will ensue. To ensure that that happens, following further discussions involving officials, I plan to meet the key players personally soon, and I hope to gain an agreement that meets all their concerns. Urgent though the issue is, it is also important that we get this right.

If an appropriate package of reforms can be constructed in time—I reiterate my concern to ensure that that happens—the Government will aim to consult further next year on the details of proposals to be included in the forthcoming companies Bill. We have the opportunity to legislate at that time, and I will certainly work hard to ensure that we move from the principles on which there is agreement to the details that will enable us to take this issue forward.

I want to turn to the points raised by my hon. Friend the Member for Newcastle upon Tyne, Central. He has made clear his objectives. While he opposes caps on auditor liability, he believes that the law may be changed to permit auditors to limit their liability at some point in the future, and he is seeking to establish a framework within which any such limitation would operate. I agree with his desire to protect the interests of groups other than auditors, and I hope that I made that clear when I described the process that we have undertaken and will undertake as we go forward on these issues. He is not alone in having concerns in this regard. I have also explained that the Government are determined to protect the interests of all key stakeholders, including shareholders, in this work. The representatives of investing groups will also be fully involved and consulted.

My hon. Friend expressed his concern that proposals to limit auditor liability could lead to the entrenchment of cartels. I have made it clear on every occasion on which I have talked about this issue that the reason that we have already ruled out many of the more simple, unsophisticated limits and caps is that they would not help to improve competition and would therefore not fulfil our objective in that regard. I can assure my hon. Friend that the proposals that we introduce will ensure that competition is sustained and improved. The whole point of an approach involving a contract that limits liability proportionately with respect to responsibility is that it would not introduce a crude limit that would entrench or over-protect the position of auditors. Instead, it would enable liability to be more effectively divided in proportion to responsibility. That seems to be a reasonable way of going forward.

I am also grateful to my hon. Friend for raising the issue of audit working papers and files. He rightly said that, in order to maintain the quality and regulation of audit that we need, it is important that such documents should be available to the regulatory authorities. The work of all audit firms and individual auditors is subject to monitoring by their supervisory body, and part of the monitoring process consists of the review of audit working papers and files.

Clauses 1 and 2 of the Bill will ensure that the monitoring of the audits of listed companies, and other companies in whose financial condition there is a major public interest, is carried out independently of the supervisory bodies. We expect that this independent monitoring will be carried out by the audit inspection unit which will report to the professional oversight board for accountancy of the Financial Reporting Council. Clause 1 specifically requires supervisory bodies to have rules to ensure that the auditors registered with them

"take such steps as may be reasonably required of them"

to enable their performance as auditors to be monitored. This will include making available audit working papers and files where these are required by the audit inspection unit.

The new power contained in clause 12 of the Bill will give the financial reporting review panel—the body authorised to investigate departures from the accounting requirements of the Companies Act 1985—the power to obtain information and explanations from, among others, the auditor of a company. I can confirm that auditors could be required to disclose audit working papers to the panel if those papers are reasonably required by the panel to carry out its statutory functions.

I thank the Minister for many of the things that she has said. May I press her, however, on whether the provision of a framework for the auditors' duty of care will form part of the debate that she expects to take place before the next companies Bill is introduced to address these issues?

I was just coming to that point. My hon. Friend has raised some important issues about the duty of care, but it is not the case that they have not already been considered in some detail by the company law review, which gave detailed consideration to the arguments—some of which my hon. Friend made—for extending the duty of care. The review consulted twice on possible ways of resolving the issues identified. Some of those were highlighted today by the right hon. Member for East Yorkshire, who said that he could see benefits in extending the duty of care but instantly provided caveats involving how broadly it should be extended and whom it should apply to.

Those are precisely the difficulties that resulted in the company law review—despite having consulted twice on ways of resolving these issues—concluding that it did not believe that the case had been made for the statutory extension of the duty of care of auditors. That is why the Government's own consultation sought further views on this matter—the majority of respondents were opposed to any change—and why my right hon. Friend the Secretary of State therefore announced to the House on 7 September that the Government were not planning to extend the duty of care at this point. That consultation was carried out at the same time as we considered the issues surrounding the limitation of auditor liability. These issues have, therefore, been given quite a considerable airing.

To conclude, I hope that hon. Members feel that we have given serious consideration to the issues raised during this debate. We have made considerable progress. I am committed to ensuring that that progress continues, and we have the ability, and I hope that we will have the wherewithal, to legislate in the draft companies Bill next year on the basis of an agreement not only on the principles but on the detail as to how we can make the proposals work.

This has been a most interesting debate on an important matter. It is important that those outside the House see that such issues are properly addressed in this place.

I beg to move, That the clause be read a Second time.

I shall have regard to the Government's intentions as set out during the last debate. They have made it clear that auditor liability will be debated again in a future companies Bill, which is why it was unnecessary to press new clause 10 to a Division. I shall also have regard to the fact that, according to the Government, we shall have an opportunity to revisit all these matters in the fairly near future.

Nevertheless, new clause 9 draws attention to two issues that the Bill does not cover, but which I hope will be dealt with in some form in any new Bill that comes before us next year. I shall deal as rapidly as I can with those issues, the first of which is the importance of rotating auditors. The current position is that the auditing and accountancy world has accepted the need to rotate audit partners, but not the case for rotating audit firms. That contrasts with the provisions applying to our colleagues in local government, in respect of whom the Audit Commission has insisted on a review of audit relationships every five years and required a test of the continuity of the audit service provided by an audit firm. That service must include the ability to report irregularities, and to report independently and clearly on the effectiveness of the organisation involved. Of course, that provision is not framed in quite the same way as a requirement to rotate audit firms, but it perhaps provides the Government with some guidance on how they should address such issues. It would be wholly wrong for the Audit Commission to impose on local government and other public bodies requirements that were not to be imposed on public companies in general.

It is also true that the rotation of auditors is an issue that constitutes unfinished business so far as the famous Sarbanes-Oxley legislation is concerned. The United States Congress did not resolve that issue clearly through its discussions, but that is no reason for this House to avoid addressing it. There is a need for a clearly independent relationship between auditors and those whom they audit. It is difficult to see how that can be achieved where there is a long continuity of relationship between audit firms and those whom they audit. Such a relationship clearly leads to collusion and connection, and to established practices that might not be in the interest of a fully independent audit.

The current practice of changes in audit partners—itself achieved as a result of much campaigning and debate in the 1980s—has not led to robust audits. There is no example of an incoming audit partner produced by rotation having blown the whistle on the conduct of a previous audit partner. Of course, audit partners change anyway—some retire and others leave the firm in question—but even in those contexts, there are no examples of partners commenting unfavourably on the work of other partners.

A further concern, about non-audit services, is addressed in new clause 9. In a recent case involving the Royal Automobile Club, the outgoing firm of auditors suggested that the incoming auditors, PricewaterhouseCoopers, had undercut it by 50 per cent. in order to secure the audit. It claimed that that demonstrated a determined approach to price audit work on a predatory basis, so as to secure an appointment that might enable PWC to introduce higher priced consultancy services to the RAC in due course. Yet that seems not to have produced any corresponding robustness in the first year of the PricewaterhouseCoopers audit.

There is considerable evidence that big investment management organisations would prefer a system involving the rotation of audit firms. The pension fund company Hermes has called publicly for such rotation and, in a survey published in February 2002, a majority of finance directors expressed the belief that companies should be compelled to rotate auditors every few years. The issue is very much on the agenda and the risk of collusion certainly informs the debate on corporate governance.

New clause 9 also deals with the separation of audit services from non-audit services. It is a fact that almost three quarters of accountancy firms' income derives from selling non-audit services to their audit clients. That creates the danger that audits might be used as loss-leaders to secure non-auditing work, with big firms sometimes undercutting mid-market ones in precisely the way that I described in respect of the RAC case. It is clearly essential that auditors be completely independent of the company in question and that they have no material interest in the judgments that they make concerning the financial statements that they audit. By selling non-auditing services, auditors acquire a material interest in protecting and defending aspects of those financial statements. Their position is no different from that of an employee and the potential for conflicts of interest is clear.

According to a poll carried out on behalf of the accountancy regulators, nearly 83 per cent. of company executives said that a desire to gain more non-audit work impairs auditor independence. Nearly two thirds of auditors themselves agreed with that point of view, and more than half the auditors surveyed also agreed that the remuneration of audit partners is affected by their ability to generate non-auditing services within the same company. Such a connection between the audit function and non-audit services in respect of the same source has been a factor in a number of well-known company failures. Recent examples include Enron and Parmalat, and there are a whole host of examples from the more distant past. Enron's auditors, Arthur Andersen, also supplied quite expensive non-audit services to that company. Its financial rewards were directly connected to those sales, and the same incentives and possible collusive relationships are also a factor in the UK audit market.

Similarly, the Department of Trade and Industry's inspector's report on Maxwell called for major reforms of auditor independence. That has been reflected over the years in a whole host of DTI inspectors' conclusions. In 1979—a year that many of us in this Chamber will remember for other reasons—one such report reached the following succinct conclusion: "In our view, the principle of the auditor first compiling and reporting upon a profit forecast is not considered to be good practice, for it may impair their ability to view the forecast objectively and must endanger the degree of independence essential to this work."

Finally, I should tell the House, that whether it likes it or not, this issue will come before us in some form. Under the Sarbanes-Oxley Act 2002—the recent legislative result of the Enron affair—the provision of nine kinds of non-audit services from a company's own auditors is now banned. Congress did not accept the idea of a disconnection between audit and non-audit services, but it did set out nine things that would be banned from being provided by an audit firm to the firm that it audits.

The House can well understand the background against which the hon. Gentleman introduced the new clause. As he said, there have been too many financial and accounting scandals, not just in the United States, but in the UK. That is why many of our international companies, as well as American companies, now face having to implement Sarbanes-Oxley. When we consider Cousins-Jones against Sarbanes-Oxley, I fear that Cousins-Jones—the new clause before us—is equally vulnerable to some of the difficulties of implementation. I would like to take issue with some of drafting of the new clause.

First, the proposed new subsection 27A pejoratively lumps together tax-avoidance schemes with consultancy and advisory services. The hon. Gentleman might have strengthened his case if he had not linked them so ostentatiously.

Secondly, as the hon. Gentleman told us, Sarbanes-Oxley makes a clear distinction between the different types of advisory service, which is an important point. It is too easy to say that there is "audit" on the one hand and "non-audit" on the other. It is possible for an auditor to identify some important tax advice that is needed in a company. There is no one more natural than the auditors themselves to carry forward that tax or other accounting advice that is needed. That is why it is interesting that tax advice is not on the list that the hon. Gentleman read out. With great respect to the hon. Gentleman, who has followed this subject for a very long time, it is too easy to brand in a single sentence consultancy and advisory services and tax-avoidance schemes. There are many non-audit services that may be directly linked to audit and many others that may not.

With respect to proposed new subsection 27B, the hon. Gentleman's example from local government was not a valid one. As he recognised, the test in local government is a continuity test. What new subsection 27B proposes is an absolute bar. Auditors would not be allowed to carry on after the five years, even if they met some of the criteria laid down under the local government test. That is why I am not attracted to that proposal.

Let me clarify what the important issues are. Where there is an imbalance between the audit fee and the remuneration for non-audit services, there should be some recognition of the fact and perhaps some test of proportionality. Clearly, if predatory pricing is taking place or an audit firm is simply offering an incredibly cheap audit in the full knowledge that there will be a whole package of non-audit work that it will then secure, that amounts to a real issue. The hon. Gentleman may recall that I raised that matter with the Financial Services Authority, which was itself engaging in the practice of paying its own auditor three times as much for its non-audit work as it was for the audit. The issue is real but, with great respect, it needs to be tackled in a slightly more sophisticated way.

Will the hon. Gentleman expand on the point about balance? Does he mean balance in respect of the volume of work or the value for money of that work as between the audit and the non-audit function?

I was thinking neither of the volume of the work nor of the value for money, but of the fee that would be available to a particular firm. Predatory pricing takes place in any business or industry and I would like to see some safeguard so that audits cannot be bought on the cheap and new audit firms cannot buy their way in with the knowledge that a great volume of non-audit work would immediately fall to them. It is an issue that we need to reflect on and tackle, but it is not properly covered by the new clause.

The independence of partners is also an issue. We have already discussed the practice of ensuring that partners are fully independent not just from one audit to the next when they take over the audit from another partner, but within an audit firm as between partners responsible for audit work and those responsible for non-audit work. It may well be that more could be done to ensure that those Chinese walls remain impenetrable.

Finally, will the hon. Gentleman reflect again on what never seems to be considered when proposals such as this come up—the whole issue of costs? There is a related issue because, if all firms have to rotate their audit every five years, that could well reinforce the cartel rather than opening it up, with firms being passed round between the big four on an automatic rotating cycle. That is one issue, but there is also the issue of cost. It may be that a firm is perfectly happy with the auditors that it has, and simply has to go through the whole process of tendering the audit out, with all the extra cost that that entails, simply to meet some box-ticking requirement.

Cost is an issue, not so much for the big firms that have big auditors, but for the others. The new clause refers to "a large company", but I am not sure whether that is a Companies Act 1989 definition or refers to the FTSE 100 or 300 companies or to all public limited companies. In any case, there is clearly a cost to such requirements and we need to be more careful to establish what exactly it is before going down the route of automatic rotation. For all those reasons, I have some doubts about the new clause.

I pay tribute to the hon. Member for Newcastle upon Tyne, Central (Mr. Cousins) for tabling this interesting new clause, but I fear that I cannot be much kinder about it than my hon. Friend the Member for Sevenoaks (Mr. Fallon).

Early on in his remarks, the hon. Gentleman referred to Sarbanes-Oxley, which I fear he was praying in aid. He will be aware that the US decided against the mandatory rotation of audit firms and against a prohibition on auditors providing advisory and other non-audit services. Sarbanes-Oxley was largely about the US catching up with the UK. Where Sarbanes-Oxley leapfrogged the UK, the Government's consultative group on accounting and auditing recommendations brought the UK up to the level of the US. Indeed, there is some argument that this Bill completes that process.

It is clear that, taken together, the proposals in new clause 9—and new clause 10 in the previous group—would mean that the private sector would withdraw from auditing listed and public interest companies. Perhaps the hon. Gentleman believes that a state-owned auditor such as the National Audit Office should undertake the audit function. I do not, but I recognise that it would be the fastest way to persuade the Treasury that auditors should have limited liability, as under no circumstances would it wish to have to fund the NAO—or any other state auditor—on a joint and several liability basis when something went wrong, as it assuredly would.

The combination of mandatory audit firm rotation, together with a prohibition on the auditor selling non-audit services such as tax or consultancy advice to the company—both while it is that company's auditor and in the previous five years—would mean that the large firms of accountants will simply concentrate on everything that they do other than audit. Frankly, on any sensible commercial criteria, those large firms could hardly come to any other conclusion.

As I have said, the combination of the various proposals would certainly drive all private-sector audit firms out of the business of auditing. However, each measure on its own would be likely also to have that effect. Furthermore, each of the measures would have exactly the opposite effect from that which I assume is intended, in that the quality of audit would be reduced rather than enhanced. First and foremost, the quality of an audit depends on the quality of the people conducting it. Auditing is not simply a question of following a rulebook but of the exercise of judgment. It is about understanding a business and recognising where risk may lie. It is also about making sure that the audit is directed into the right areas and that the findings are understood, so that the right conclusions can be drawn from the audit.

I am advised that, almost without exception, the very high quality of people attracted into the accountancy profession say that they have chosen that qualification above other business qualifications because of the diversity of activity conducted by chartered accountants. It is essential, therefore, that we continue to permit auditors to conduct a wide range of activity, so that they can attract the very high-quality talent necessary for them to conduct high-quality audits.

Secondly, it is ludicrous to imagine a situation where an auditor could not offer any advice to a client. The auditor's knowledge of accounting, internal controls, corporate governance and many other related issues qualify him or her to give such advice. The auditor's deep—indeed, intimate—knowledge of a business that he will have gained from conducting an audit frequently makes him far and away the best person to give advice. The new clause would deny that source of advice to companies, thereby lowering the standards of financial reporting, internal controls and corporate governance in the UK, rather than improving them.

The Auditing Practices Board is independent of the accounting profession and is chaired by an eminent lawyer. It has just published new ethical standards for auditors. Broadly, they permit auditors to provide a wide range of services to their audit clients, subject to appropriate safeguards. That approach builds on earlier standards pioneered in the UK that since have been adopted around the world. The approach also makes sure that auditors have appropriate objectivity and independence and allows companies to take full advantage of the particular skills that the audit firm can bring to them. It would be insane to move away from that well-developed and much-copied system.

The second proposal is every bit as unwise as the first. If I understand it correctly, the intention is that a large company should be required to change its auditors every five years. I imagine that the hon. Gentleman is aware that such a system using a nine-year rotation period has operated in Italy for some years. I remind him that it was in Italy that the largest corporate scandal in Europe—to which he referred twice—took place. I do not know whether he has had a chance to look at the research conducted by Bocconi university in Milan, but it concluded that that system of audit firm rotation has reduced rather than improved the quality of auditing in Italy.

The fact that I can present that information shows that the Conservative party's research facilities have been working overtime. The hon. Gentleman must have been unaware of the Bocconi research, as he could not possibly have tabled this new clause if he had read it. I am sure that he is aware that the US General Accounting Office recently conducted a study into whether a system of mandatory audit firm rotation would improve audit quality. It concluded that the opposite would be the case.

Indeed, the concept of a system of mandatory audit firm rotation was considered here in the UK as recently as last year by the Government's consultative group on accounting and auditing issues, under the joint chairmanship of the then Financial Secretary to the Treasury and the DTI Minister then responsible for consumer affairs. The conclusion was that the risks associated with such a system more than outweighed any benefit. It found that the benefits could be achieved in other ways and, indeed, that they were being achieved as a result of measures introduced by the profession voluntarily and by the Auditing Practices Board.

I have some sympathy with the notion that auditors should make clear to shareholders the reasons for their resignation. However, that requirement is part of the law at present, and so that aspect of the new clause is not necessary.

We have had a short debate, but the quality has been high. I assure my hon. Friend the Member for Newcastle upon Tyne, Central (Mr. Cousins) that the Government do not have a closed mind about anything that might help to improve confidence in financial reporting and the quality of audit, but I said on Second Reading that there are two approaches to audit regulation. We can either take the rules-based legislative approach adopted in the US, or we can build on the principles-based approach that we already have in the UK.

The new clause adopts a rules-based approach to the questions of non-audit services and of rotation of the auditor. In many ways, that allows me to set out more fully why the Government believe that the better route for the UK is to build on the existing principles-based approach.

There is a general consensus about what we want to achieve. We all want to be sure that auditors act with integrity, objectivity and independence. We want to guard against two specific risks: the provision of non-audit services alongside audit services, and the development of a relationship between the auditor and the company being audited that is inappropriately familiar, cosy or collusive. However, there are many other possible risks in the relationship between auditors and the companies that they audit. I shall deal with them in a moment, when I explain about the ethical standards of the Auditing Practices Board.

One of the difficulties of adopting a rules-based approach dealing with only two specific areas of the problem is that it can imply that other matters are not important. The benefit of the ethical standard is that it covers a broader area. However, we recognise the risks that were outlined by my hon. Friend the Member for Newcastle upon Tyne, Central, and we share his overall objective. We depart from him only in respect of how that objective can best be achieved.

As the hon. Member for Sutton Coldfield (Mr. Mitchell) noted, in 2002 the Government established the co-ordinating group on audit and accounting issues. That was a direct response to the events at Enron and later at WorldCom. One of the group's key concerns was auditor independence, and it devoted a great deal of time to looking at non-audit services and at auditor rotation in particular.

The conclusions that the group reached were firmly against imposing a ban on non-audit services or on compulsory rotation of audit firms—precisely the two measures proposed in this new clause. In its final report, the group stated that

"firm rotation is a blunt regulatory instrument, and there are a number of arguments against mandating it."

The report went on to list those arguments, some of which have been touched on in today's debate. The first problem has to do with the quality and effectiveness of audit in the years immediately after a change of auditing firm. That is especially difficult given the ever-growing complexity of large groups. In other words, there can be some benefits as well as dangers in the development of continuity and understanding.

Secondly, rotating auditing firms would impose substantial costs on business, as it would take up a lot of management time. The third factor is that there is no evidence that the rotation approach is effective. It has been tried and abandoned in Spain, for example, and the hon. Member for Sutton Coldfield pointed out that it is still in operation in Italy. Other countries that have considered the issue have all decided against it. Indeed, my hon. Friend himself highlighted the fact that despite the rigours of the Sarbanes-Oxley Act 2002, the US has not gone down that route either.

The fourth issue was the problem of being able to find large audit firms to carry out all the audits if frequent rotation were required, especially as some might be prevented from taking on the work as a result of auditor independence requirements also being introduced. As we discussed in the debate on the previous group, the market for large audits is very concentrated.

Finally, the Office of Fair Trading expressed concerns about rotation being in effect a form of compulsory retendering with one of the potential bidders excluded. That is what the group had to say about compulsory rotation of the audit firm.

My hon. Friend the Member for Newcastle upon Tyne, Central identified the alternative approach, which we have adopted—ensuring the rotation of the leading audit firm partner through the application of ethical standards. The previous rotation period was seven years, but it has now been reduced to five.

Let me deal next with what the co-ordinating group had to say about banning certain non-audit services. I will then come to what steps have been taken as a result of the group's recommendations to further auditor independence and, in particular, the role of the Auditing Practices Board. I do not oppose my hon. Friend's proposals because I think that there is no issue to address. On the contrary, we should perhaps take a broader approach to the problem than he adopts in new clause 9.

The co-ordinating group concluded that the provision of non-audit services was indeed a problem—in appearance, if not in fact—but that the solution was not to impose a ban on particular types of services being provided; rather, it was to re-emphasise and strengthen the key principles that were already in place in the UK, namely that auditors should not carry out work for a company that they are auditing if that would involve the auditors taking management decisions, auditing their own work, or acting as an advocate for the client. The group concluded that tougher mechanisms were needed to safeguard those principles. Specifically, it recommended that ethical standards on auditor independence should be set by an independent standard-setting body; the audit firms should be monitored frequently and by an independent monitoring unit in the case of public interest audits; the audit firms should be more transparent in publishing details about their own structures, processes and financial position; the role of the audit committee within the company should be enhanced through changes to the combined code guidance; and companies should be required to disclose more detail in their annual reports.

The last of those requirements, of course, is the subject of clause 7. In response to the point made by the hon. Member for Sevenoaks (Mr. Fallon), I can say that clause 7 also requires more transparency about the costs of non-audit services that are bought by the company.

The combined code has been expanded as a result of the excellent work of Sir Robert Smith and his group on the role of audit committees. The major firms have published more information about their own internal practices, and that is also a matter that is covered in the draft European directive on audits. The audit investigation unit is up and running as part of the newly created Professional Oversight Board for Accountancy, itself part of the newly expanded Financial Reporting Council.

Finally, and most importantly in the context of new clause 9, the Auditing Practices Board has been taken out of the control of the professional bodies, brought into the expanded Financial Reporting Council family and given responsibility for setting ethical standards for auditors on auditor independence. We now have independent standard-setting for audit standards. That covers a lot more than just the provision of non-audit services and the rotation of auditors.

There are five standards and they cover, to take some examples at random from a lengthy list, issues such as financial relationships, employment relationships, family and other personal relationships, fees, remuneration and gifts, litigation and the overall principles of integrity, independence and objectivity. They set out clearly the standards to which auditors are expected to adhere in the provision of non-audit services to a company to which they also provide audit services more broadly than could a legislative list that simply banned certain services.

I accept my hon. Friend's objectives in tabling his new clause, but I am not convinced that the solution he has chosen would work. It has been tried in the US, but we have seen nothing to change our view that lots of rules mean only lots of lawyers looking for ways to get round the rules. The new clause lists three services that it would be unacceptable for an auditor to provide for a client, but that might imply by omission that other services are acceptable. That is clearly not the case. If the rules cover long association with a company and the provision of non-audit services, why should they not cover all the other threats to auditors' integrity? There are many, as I have demonstrated, and we need to ensure that they are all covered. That is where standards play an important role.

To anticipate my hon. Friend's reply, I should say that just because the standards are not set in legislation, it does not mean that they have no force: they do. They are not just "guidance" or "recommendations". Auditing is a statutory function and to carry it out an auditor must be a member of a recognised supervisory body. The supervisory bodies are required by law to have rules and practices designed to ensure that audit work is carried out with integrity and without conflicts of interest. Clauses 1 and 2 require such standards for the purposes of those rules to be set by a body independent of the profession and for the recognised supervisory bodies to require the auditors registered with them to comply with those standards. Compliance with those standards is rigorously monitored and enforced. Clauses 1 and 2 increase the independence of audit monitoring and disciplinary processes by requiring that they must be carried out independently of the recognised supervisory bodies where the audits are of public interest.

I hope that I have given my hon. Friend some reassurance. I do not take the defensive approach that the hon. Member for Sutton Coldfield takes, because I share my hon. Friend's concerns that we need to ensure that a cosy relationship does not develop between auditors and the companies that they audit. We need much more clarity and transparency in respect of the value and provision of non-audit services to firms. The principles-based approach, with the additional independence and rigour brought in by the legislation, is the most appropriate way to achieve those objectives.

The debate has been short but illuminating. I especially thank my right hon. Friend the Minister for her remarks and for taking this opportunity to set out the Government's approach. We shall obviously be able to debate all these matters again in the context of the companies Bill that we have been promised this afternoon. That is a joyous prospect for those of us gathered here today. What an opportunity it will be to convince many of our colleagues that they should join us in considering these intricate and interesting matters.

I beg to move amendment No. 1, in page 27, line 29, at beginning insert

'Where there appears to be good reason.'.

With this it will be convenient to discuss the following amendments: No. 20, in page 27, line 29, after '(1)', insert

'If he thinks there is good reason to do so'.

No. 2, in page 29, line 12, in clause 23, leave out 'thinks' and insert 'reasonably believes'.

No. 3, in page 29, line 12, in clause 23, after 'thinks', insert 'on reasonable grounds'.

No. 21, in page 29, leave out line 14 and insert—

'(2) Subject to subsection (9) an inspector or investigator may at all reasonable times within the first 30 days following his authorisation under subsection (1)(a)–'.

No. 4, in page 29, line 14, after 'may', insert

', subject to subsection (3A),'.

No. 5, in page 29, line 14, at end insert 'during normal office hours'.

No. 6, in page 29, line 16, after 'there', insert 'during normal office hours'.

No. 7, in page 29, line 16, leave out 'thinks' and insert 'reasonably believes'.

No. 8, in page 29, line 16, after 'necessary', insert 'on reasonable grounds'.

No. 9, in page 29, line 16, after 'necessary', insert

', not exceeding one month,'.

No. 10, in page 29, line 16, after 'necessary', insert

'not exceeding one month (or such longer periods as may be authorised by the Secretary of State)'.

No. 22, in page 29, line 17, at end insert

'provided that unless authorised to do so by the Secretary of State under subsection (9) he shall not remain on the relevant premises for the whole or substantially the whole of the company's normal working hours for a period of more than 7 consecutive days.'.

No. 11, in page 29, line 17, at end insert—

'(2A) Except when the investigator or inspector reasonably believes that the exercise of his functions under this Part would otherwise be seriously impaired the powers under subsection (2) shall be exercised between the hours of 9 am and 5.30 pm and between Monday and Friday.'.

No. 23, in page 29, line 18, after second 'premises', insert

', or if in mixed use the parts or parts thereof,'.

No. 12, in page 29, line 20, after subsection (3) insert—

'(3A) Where the relevant premises consist either of premises all parts of which are used for residential purposes or of premises which can only be accessed via premises or parts of premises which are used for residential purposes an inspector or investigator shall not exercise his powers under subsection (2) without a warrant issued under section 453C by a justice of the peace and if such a warrant is issued the inspector's or investigator's powers under subsection (2) shall be limited to his powers under such warrant.'.

No. 13, in page 29, line 21, after '(2)', insert

'subject to the terms of any warrant issued under section 453C'.

No. 24, in page 29, line 32, at end insert—

'(9) The Secretary of State may on the written request of the inspector or investigator—

(a) if satisfied that it is necessary for the purpose mentioned in subsection 1(b) extend for a period which he may specify beyond the initial 30 days the period of authorisation under subsection 1(a); or

(b) extend the number of consecutive days during which the inspector or investigator may remain on the relevant premises.

(10) There shall be no limit on the number of extensions which may be requested of or granted by the Secretary of State under subsection (9).'.

No. 14, in page 30, line 7, at end insert—

'(c) the grounds for his belief that entry onto the company's premises will and that remaining thereon for a period will be necessary to materially assist him in the exercise of his functions under this Part,'.

No. 15, in page 30, line 42, at end insert—

' "453 C Entry into residential premises

(1) A justice of the peace may issue a warrant under section 453A(3A) if satisfied on information on oath given by or on behalf of the inspector or investigator authorised under section 453A(3A) that there are reasonable grounds for believing that access to any premises falling within section 453A(3A) will materially assist the inspector or investigator in the exercise of his functions under this Part.

(2) A warrant under section 453A(3A) may authorise the inspector or investigator, accompanied by a constable and any persons thought appropriate under section 453A(4) and any other constables—

(a) to enter the premises, and

(b) to remain there for such period as the inspector or investigator thinks necessary, or for such period as the warrant may provide, for the purpose mentioned in subsection 453A(1)(b).

(3) A warrant may be issued under section 453A(3A) subject to conditions.

(4) Sections 448(5) and 448(9) shall apply to the issue of a warrant under section 453A(3A) as they apply to the issue of a warrant under section 448(1).".'.

No. 16, in page 59, line 31, in schedule 2, at end insert—

'(d) any person accompanying an inspector or investigator pursuant to section 453A(3A).'.

Government amendments Nos. 17 and 18.

We now come to the guts of the Opposition's concerns about the Bill: investigations and the powers of investigators. I draw the attention of the House to amendments Nos. 1 and 20, in which we argue that the Secretary of State must have "good reason".

Clause 21 reformulates section 447 of the Companies Act 1985 and excludes the requirement under that section for the Secretary of State to act only if he thinks there is good reason to do so. The amendments propose alternative forms of words but which have the same intention: to maintain in section 447 an express requirement for the Secretary of State to act only where it appears to him or her that there is good reason to do so.

Amendment No. 1 adopts the form of words found in section 167(1) of the Financial Services and Markets Act 2000, which provides for the Financial Services Authority's power to appoint persons to carry out general investigations. Amendment No. 20 retains the form of words in section 447 of the 1985 Act. A similar amendment was proposed and defeated in the other place on 22 March and was proposed and debated in the Standing Committee on 16 September. I subsequently withdrew it, to give the House an opportunity of considering the proposal further today.

The Government's answer throughout has been doggedly to maintain that those words are superfluous and add nothing to the requirements imposed by general administrative law. In Committee, the Minister suggested further reasons for the Government's refusal to adopt such an amendment. First, she suggested that there is a thorough approach to vetting complaints that give rise to investigations under section 447 of the 1985 Act, which will not change if those words are omitted. Secondly, she suggested that the courts have never given any special meaning to the words, which she described as

"a somewhat antiquated expression with no transparent, obvious and precise meaning."

Thirdly, as a consequence of the second point, she said that the phrase

"could, over time, produce a result that we do not want to achieve by narrowing or widening the circumstances in which the power can be used." ."—[Official Report, Standing Committee A, 16 September 2004; c. 89.]

I am sorry to tell the Minister that neither my colleagues nor I found those arguments remotely convincing. There are compelling answers to those points and strong, positive reasons to accept one or other of the amendments.

I challenge the Minister's assurance that the approach to vetting will not change if the words are omitted. That is dangerous speculation on her part. In fact, the thorough and admirable vetting procedures to which she referred that are carried out in practice by the Secretary of State's officials at the companies investigation branch of the Department of Trade and Industry have come about precisely because section 447 of the 1985 Act has hitherto contained the words.

The officials who carry out the vetting procedures will have at the forefront of their minds at every stage these questions: "Is there good reason to take the step that I am contemplating? What is that good reason? How do I express it? Can I justify it if challenged?" That is why the vetting procedures have evolved in the way that they have. No one can assert with confidence that rigour will be maintained in the future, as it has been in the past, if those important words simply vanish from the lexicon of that section, new and challenging situations develop or budgetary constraints begin to bite on the Department's budget. The words are not surplus. The discipline imposed on officials by the inclusion of explicit words of limitation in a section under the authority of which they propose to act is a powerful, positive justification for adopting the amendment.

The criticism of the words "good reason" by the Minister as "antiquated" and lacking transparency or precise meaning was rather surprising. The same so-called antiquated and precise phrase has been incorporated in the parallel section 167 of Financial Services and Markets Act 2000—legislation enacted by the Government in the past four years. Something that happened four years ago is surely not yet to be relegated to antiquity, even if four years certainly feels like a very long time under this Government. The words were included because they have a real context.

The Government have not suggested that developments in administrative law have now made redundant words that were, by necessary implication, considered essential and not superfluous in 2000. The Minister conceded on two occasions in Committee—I draw her attention to columns 88 and 102—that the Secretary of State will have to give sound reasons for using the powers. She is right: let the clause say so expressly to stand as a reminder and a check.

The Government argue that the words have not been judicially defined and may later be construed as unexpectedly to narrow or, indeed, widen the powers intended, but they are missing the bigger picture. It may be that the words have never been subjected to judicial interpretation because their plain and natural meaning is clear enough. For example, where wording that contains the notion of reasonableness has been considered, the courts have recognised the fact that what is or is not reasonable will depend on the facts in any case. It is plain beyond argument that a similar approach will attach to any consideration of what is or is not a good reason to act.

The Minister makes the criticism that the phrase is not precisely defined, but that dodges the real question that it is incumbent on the Government to introduce legislation that precisely defines the powers and discretions given to Ministers and their officials. Even without attempting to pre-empt any judicial interpretation, I suggest that the more obvious and more serious risk of unexpected and undesirable consequences of interpretation springs from the Government's refusal to incorporate the words suggested in the amendment. The reason is plain to see: the requirement for good reason to act appears in other closely analogous provisions in other Acts and, crucially, in similar provisions in the Companies Act 1985.

Leaving such words out of proposed new section 447 of the Companies Act 1985 represents a great risk. The courts will be induced to conclude that Parliament's intention was for the provision to confer far wider executive power or discretion on the Secretary of State than that enjoyed under analogous provisions that are expressly constrained by the "good reason" requirement. If that is the Government's intention, let that be expressed, exposed to debate and set out in the Bill. The power should not be expanded on by stealth.

I shall cite the analogous provisions to which I referred. First, under the heading "Appointment of persons to carry out general investigations", section 167(1) of the Financial Services and Markets Act 2000—as enacted by the Government—which is the exact counterpart to section 447 of the Companies Act 1985, states:

"If it appears to the Authority or the Secretary of State . . . that there is good reason for doing so, the investigating authority may appoint one or more competent persons to conduct an investigation on its behalf".

Secondly, section 442 of the Companies Act 1985 confers powers on the Secretary of State to appoint inspectors to report on company ownership. It states:

"Where it appears to the Secretary of State that there is good reason to do so, he may appoint one or more competent inspectors".

Thirdly, section 444 of the 1985 Act confers powers on the Secretary of State to obtain information as to those interested in shares. It states:

"If it appears to the Secretary of State that there is good reason to investigate the ownership of any shares in or debentures of a company and that it is unnecessary to appoint inspectors for the purpose, he may require any person"—

and so on.

The Government seem to rely on general administrative law as the bedrock of the limitations on the Secretary of State's powers, but administrative law is a fluid discipline and the legislature has no control on its development. By leaving out the words "good reason", yet not inserting any other words of limitation, the Government are denying themselves and the legislature a voice in defining the scope of law. They are replacing bedrock with shifting sands, and more importantly they are failing to address the fundamental question of the intended effective limit on the Secretary of State's powers. It is worth remembering that if words are interpreted as narrowing the power that Parliament intends to confer, the remedy is in our own hands. However, if a power is conferred by statute that is far wider than that intended, it creates a licence for future abuse.

There is a further compelling and positive reason to include such words in new section 447. They would act as a signpost to not only officials, but a lay person or company director who was the object of the exercise of the powers. The corollary of the Government's position is that an onus will be placed on an individual either to have knowledge of, or to obtain legal advice on, the complex area of administrative law. It is right that legislation should be internally comprehensible to the man in the street as well as practitioners at the administrative Bar, so it would be unfair to pass legislation that would impose such a burden. Given that the Executive could subject companies and individuals to intrusive action, the Bill should plainly set out the Secretary of State's obligation to act for good reason.

Amendments Nos. 12 and 15, which address relevant premises, characterise the amendments that I have tabled to clauses 23 and 24. Those clauses will insert new sections 453A, 453B and 453C in the 1985 Act, thus conferring on inspectors and investigators the entirely new power to require entry to, and to remain on, relevant premises. Relevant premises are defined in proposed new section 453A(3) as

"premises which the inspector or investigator believe are used (wholly or partly) for the purposes of the company's business."

The provision will broaden for the first time the powers of inspectors and investigators by permitting them to enter into and remain on domestic and residential premises. Section 448 of the 1985 Act provides that investigators and inspectors must obtain a warrant before they are able to enter any premises.