Auditors: EAC Report

Lord McFall of Alcluith Excerpts

Wednesday 14th March 2012 Grand Committee

[Lord McFall of Alcluith]

My Lords, I am delighted to contribute to this debate and congratulate the noble Lord, Lord MacGregor, and his colleagues on a very cogent report. When the auditors came before the Treasury Committee after the financial crisis in 2007 we concluded that they had done their job adequately in auditing, but that if these are the limits, what is the point of an audit? That question still haunts the audit profession to this day.

Progress has been made with accounting standards setters by the noble Baroness, Lady Hogg, and her colleagues and with the Sharman committee. However, the factors that led to the demise of RBS, HBOS and Northern Rock, such as the dependency on home sale markets funding in the case of Northern Rock, the high exposure to property in the case of HBOS and the very significant exposure to markets and businesses in the case of RBS, were all clear to accountants and auditors two or three years before the collapse. The problem was that no one paid any attention. The Bank of England and the FSA came before the Treasury Committee and said that they sent out warnings but nobody listened. There was no influence there and people were not talking to one another. That is the biggest issue in this financial crisis. The regulators were not talking to one another and there were black holes in between—that is the issue.

For the future, the question posed by McChesney Martin, the chairman of the Federal Reserve, is relevant: who will take the punch bowl away? We have to support the regulators and others to ensure that that is taken away. RBS was mentioned, where there was a 95 per cent shareholder endorsement. Where were the auditors? Where were the non-executives? How was corporate governance and risk organised? Abysmally—that is how. Auditors need to engage on a statutory basis with the FSA. It told us that it had six engagements with Northern Rock in the previous two years—four by telephone and two meetings with no minutes. If you had been secretary of your local community club or golf club, you would be thrown out at the AGM as a result of that.

That is the state we are in. We have to ensure an early warning system for the banks involved, which should involve a very measured risk profile. The problems were seen late. The issue with accounting is that it looks backwards and largely aims to reflect the transactions that have been committed to and not to affect future events. An audit will be effective only if it is underpinned by a thorough understanding of the business model. Auditors are close to the management, and they, above all, should have that understanding of the business model. That is why engagement is very important.

Simplicity of language is very important. One of the things that I regret not doing when I was in the other place was putting forward a 10-minute rule Bill to say that annual reports should be a maximum of 80 pages in length. When I was on the Treasury Committee, the HSBC report came to 500 pages. I challenged the main auditor to sit by a fire on a winter night with a nice good malt whisky and look at that report. I guaranteed that he would be asleep before he read it. Simplicity of language is hugely important. Given that we now have the Financial Policy Committee, that wider constituency should be used by auditors to report. I suggest an annual report from the FPC to Parliament to take these concerns into consideration.

I suggest the curriculum for auditors and accountants should be looked at. A result of the financial crisis was that the economics profession’s efficient-markets model was thrown out of the window. They have to look at that again. I think a wider constituency is important. I shall give my experience as an educationalist. I undertook a MBA part-time—three nights a week—at Strathclyde University. It was the best degree I undertook. Why? It was because everything was black and white and then went to grey as a result.

I shall give a six-point plan. Unlike the noble Lord, Lord Lawson, I know my place in this House. My six-point plan is: early warning; business model; wider engagement; education; corporate governance and risk; and culture and ethics.