Gerry Sutcliffe MP

Corporate Finance Faculty Annual Conference

As you may well be aware, we are planning to introduce a Bill that contains a number of important elements of our reform package.

But I do want to stress that legislation is only part of the story. There are limitations to what can and should be done by legislation just as there are limitations to what can and should be done by Government.
The Government alone cannot deliver the solutions that are needed to today's challenges - challenges highlighted so graphically by the corporate failures we have witnessed in recent years. So the theme of my speech today is the overall UK approach to strengthening the financial markets, through good governance and financial reporting.

There is no denying that financial markets have been badly shaken by corporate scandals. Worldwide we have seen apparently sound businesses plunge into crisis. In particular, Enron's collapse triggered a huge loss of faith in the market, with a consequent lowering of share prices and investment. Bad governance and inadequate auditing has, quite literally, cost the world billions of pounds.

Arising from this the questions we have asked are:

• What lessons can we learn from these scandals?
  
• And what do we need to do to prevent a similar situation over here?

I will start by taking you briefly through the process we have followed and the action that is being taken - action that will culminate in a new Bill - the Companies (Audit, Investigations and Community Enterprise) Bill. I will then turn to the "bigger picture" - and our main themes of:

• Principles not rules
  
• More active shareholder participation;
  
• Use of consensual codes and independent oversight where possible, legislation where necessary; and
  
• Longer term commitment to modernisation of whole company law

The priority reforms we will be introducing in the new Bill stem from a variety of reviews, consultations and other sources. They have not been plucked from thin air - one of the criticisms often made of the Sarbanes Oxley Act in the US, which we have no desire to emulate over here.

A very important element of our approach has been the work of the Co-ordinating Group on Audit and Accounting Issues, with which I am sure you are familiar. Peter Wyman was of course an observer on that Group, and the Government has agreed all 27 of its recommendations. Other important elements of the package include the review of the regulatory regime, the Higgs Review of non-Executive Directors, and the Smith review of the role of the audit committee.
And of course we have also taken into account the developments in the European Union, in the US and internationally.

So the Bill is the last part of the package of measures. It puts in place those elements which require primary legislation and underpins the action already taken, for example by the auditing profession in requiring rotation of audit partners, or by the City in revising the Combined Code and strengthening the role of audit committees.

So, what does the Bill do?

First, it strengthens enforcement of financial reporting requirements. This follows a key CGAA recommendation to strengthen and build on the work of the Financial Reporting Review Panel (FRRP).

This Panel is responsible for ensuring that major companies produce reliable accounts and the Bill will strengthen its role by:

• Giving the Panel a statutory power to require information from companies, instead of relying on a voluntary approach.
  
• Extending its remit to cover interim accounts as well as final accounts.
  
• And opening up an information gateway from the Inland Revenue to the Panel. Currently, if the Revenue uncovers any information about a company that shows that it may not be complying with its accounting requirements, they are prevented by law from revealing this information to the FRRP.

Second, the Bill will underpin our various non-legislative measures on auditor independence by requiring companies to publish a breakdown of the money they pay their auditors for non-audit work. This has become increasingly important, as we have seen a steady rise in the provision of non-audit services, which often accounts for more than the audit itself. This disclosure will inform shareholders and others about the work the auditors are doing and will enable them to make decisions about conflicts of interest.

Third, the Bill strengthens the independence of the regulatory regime. It will add to the requirements that bodies such as the ICAEW must already meet in order to be recognised as supervisory bodies for auditors. The new requirements are that they must participate in independent arrangements for:

• The setting of audit standards, including those relating to professional integrity and independence;
  
• The monitoring of major audits; and
  
• The investigation and disciplining of auditors in relation to public interest cases.

The Financial Reporting Council's (FRC) independence will be further strengthened by a new power to raise a levy from companies and the professional bodies. I hope we never have to use the levy - I would much prefer to see a continuation of the current voluntary arrangement for contributions to the FRC's costs. But we must remove any suggestion that either businesses or the profession could wield undue influence over the FRC by threatening to withhold funding. The levy power is to be matched with an extension to the Government's grant-making power, so that we can fund our share of the FRC's new remit.

As most of you will know, the FRC is currently expanding to take on the functions of the Accountancy Foundation, resulting in a single independent regulator. I envisage that bodies such as the Institute will meet the new recognition requirements by participating in arrangements established under the new FRC - that is, the Auditing Practices Board, the Audit Inspection Unit and the Accountancy Investigation and Discipline Board.

And, as you know, we propose to delegate the Secretary of State's functions in relation to recognising supervisory bodies to the FRC's new Professional Oversight Board for Accountancy, which will also take over the role of the old Review Board in overseeing self-regulation of accountancy. Aside from technical changes to the existing delegation power, these structural changes do not require legislation. They are, nevertheless, important elements in our efforts to strengthen and clarify the regulatory regime.

Finally, on the audit side, the Bill will also strengthen auditors' powers to obtain information when they are auditing companies. This will help auditors to do their job of verifying companies' accounts more effectively. Directors will also be required to give a statement that they have provided all relevant information necessary for a successful audit. In doing so, they will have to carefully consider what information is actually required.

The Bill will also introduce a new form of company, the community interest company, to provide a ready made form of company for social enterprises which want to use their assets and profits to benefit a community. These are typically dynamic businesses, which apply entrepreneurial drive for a social purpose. They can bring excluded groups into the labour market and raise skills and employability. This was a widely supported recommendation of the Strategy Unit's report on the voluntary sector and we want to implement it as quickly as possible.

And finally, it will also strengthen the powers of the DTI's own company inspectors who suspect malpractice in companies. This will mean that all those who do business with companies have greater protection against the careless, incompetent and downright fraudulent who abuse the company form.

But as I remarked at the start of this speech, legislation is only one part of the picture. A lot of important work on the "post-Enron" agenda is being taken forward elsewhere. For example, on auditor independence, you may have seen that the Auditing Practices Board has just published draft ethical standards covering auditor objectivity, integrity and independence. These are an important part of the jigsaw and I would urge anyone with an interest to take part in that consultation exercise.

And, only a fortnight ago, Jacqui Smith co-hosted the launch of the ICAEW's register for non-executive directors. This register responds to the recommendations of the Higgs Report on Non-Executive Directors and to the Tyson Report on the Recruitment and Development of Non-Executive Directors.

It offers a practical tool to business users and will benefit business by broadening the talent pool of directors and increasing diversity on boards. It was also a good example of Government and Industry working together on these issues.

And we have already made a start on the issue of executive pay.

The public, quite rightly, is outraged when it sees the directors responsible for massive corporate failures walk away with huge pay-offs, while employees were losing their jobs and investors their pensions. Rather than dictating corporate pay, we acted to put information and power where it should belong - in the hands of shareholders. By requiring companies to publish full details and hold annual shareholder votes on executive pay, we have made company directors properly accountable to those whose interests they are meant to represent.

And by empowering people to make their own views heard, and consulting widely on what further (self-regulatory or government) action is needed, we are reinforcing a change in public and corporate attitudes towards payment for failure.

Such an approach is already delivering real change in the boardroom.

But having made this and other changes to the corporate governance framework, I am aware that some companies have expressed a fear that, with new and more demanding standards of corporate governance - and ever more complex markets - too many investors will resort to 'box-ticking' instead of taking the trouble to understand the firm properly - and make a sound judgement on the board's explanations. As Patricia Hewitt said recently, good governance is not - and must not become - an exercise in box-ticking. Good governance is about the creation of a productive and profitable market economy.

Active owners take time and the trouble to understand the company's strategy and strengths, to make sure the right management is in place, and to support the delivery of sustainable long-term value. Active owners are what a progressive economy needs.

This is just one reason why we are currently considering what other elements of company law need changing following the fundamental Company Law Review. As our work develops we will continue to consult with you, to hear your views and discuss key areas and legislative proposals. I am sure you recognise it will be very important to get this right, but also that it will take time to get right.

While difficult to quantify, we believe these measures will result in higher quality accounts and improved audits; and that we stand a better chance of catching a potential UK Enron before damage is done. I hope you will agree that we are taking the necessary steps to restore market confidence and integrity in business and the professions.