Local Audit and Accountability Bill [HL]

Baroness Hanham Excerpts

Wednesday 19th June 2013 Grand Committee

[Lord Palmer of Childs Hill]

My Lords, I will speak to these amendments, although sitting next to me is my noble friend Lord Tope, in whose name Amendment 14ZA stands. I hope the noble Lord, Lord McKenzie, will confirm that we have already dealt with the collaborative basis and the fact of buying centrally. Even I was a late adherent to this, but I think we agree that in one form or another that is the way to go forward, however it can be arranged, although there were numerous alternatives. As the noble Earl, Lord Lytton, has said, there are going to be significant savings, which is something that we cannot ignore.

I have one question about a sentence in Amendment 14ZA on the appointment of a new auditor, or the re-appointment of an existing auditor, to,

“audit its accounts for a financial year not later than 31 December in the preceding financial year”.

Both the Bill and the amendment say that that appointment should be made not later than 31 December in the preceding year. I cannot work this out in practical terms. Let us say that KPMG is the auditor of a local authority or group of local authorities; it has not finished its accounts and the accounts will not be signed off until, at the earliest, the end of January the following year. That company could be under notice, according to the amendments, that it may not be, or could not be, the auditor for the ensuing year. While KMPG is finishing off its audit—the accounts will not have been finished and signed off by the relevant person in the local authority, who in my local authority is me, so I am told; I have done it three years in a row—a new auditor, PricewaterhouseCoopers, perhaps, will have been appointed.

I worry about how that will affect the mindset of the auditor who is being replaced. Enshrining within the Bill that the auditor has to be appointed by 31 December within that year will cause moral, and sometimes practical, difficulties. Perhaps the Minister will take this issue back and consider whether the wording should be “could be appointed by 31 December” or “as soon as possible by that date”. I worry how the changeover, if there be a changeover, will affect the performance of the outgoing auditor.

[The Parliamentary Under-Secretary of State, Department for Communities and Local Government (Baroness Hanham)]

My Lords, I thank both noble Lords for these amendments, which take up the points that we made on Monday about the possibility of a centralised audit process for both larger and smaller authorities. As I understand it, the larger authorities will be run, more or less, by the LGA and the smaller authorities by the NALC. I made it quite clear that we were content to have discussions with the LGA and the NALC, to whom we are talking already, on the strict understanding that there could not be, in either case, mandatory schemes. The amendments brought forward today by the noble Lord, Lord McKenzie, and the noble Earl, Lord Lytton, are flexible enough to take account of that. As I said on Monday, we are willing to continue the discussions that are already taking place. I am sure that we can come back to this issue at a later stage if anyone feels that they are not going in the right direction.

Amendment 14BZA would specifically exclude bodies that opted into such an arrangement from the need to have an auditor panel. We agree with that. If there is a centralised system it is plainly not sensible for those who are being helped by it to have their own audit panel. However, it is essential that if they are appointing their own auditor, independently or in conjunction perhaps, with another authority, they have to have an audit panel. We have discussed the make-up of an audit panel and its independent membership, and they would be required to do that.

The noble Lord, Lord Palmer, raised the question of the date of appointment of auditors. The reason behind the auditor needing to be appointed by 31 December is to ensure that if for some reason the local authority fails to make an appointment, there is time for the Secretary of State in particular to take action under Clause 12, which allows him either to direct a body to appoint or make an appointment on behalf of the authority. We will discuss this later, but it will certainly apply to health authorities, and I understand that the situation is similar in local authorities. I hear very clearly what the noble Lord says about the auditors possibly lacking the enthusiasm to carry on if they are about to be replaced, but I think the audit bodies are pretty professional, and they would need to continue.

We will discuss the appointment of auditors when we reach the amendments that are a couple of groups further on, but I think those are the main points that have been raised. As I said, I hope that we shall be able to return to this matter at the next stage with some further ideas on how the centralised but not mandatory system might work.

I hope that with those explanations, and if I have covered the points that were made, the noble Lord will withdraw his amendment.

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[Lord Beecham]

Perhaps I might respond before the Minister replies, since we are in Committee. My preference would be for exclusion but as a fallback, at the very least, to have a proper tendering process, as I have explained.

[Baroness Hanham]

My Lords, I thank the noble Lord, Lord Beecham, for raising this interesting point, but I am bound to say that I have the same scepticism about this as the noble Baroness, Lady Eaton, and my noble friend Lord Tope. It is scepticism about whether it is necessary.

The Bill currently requires local authorities or local bodies to make a new appointment every five years, as the noble Lord said. In most cases, this will require them to go through a full EU tendering process. We expect that most authorities would have that as a requirement, if not in their code of procedure then in their code of conduct. They will also have to go through the process with the independent auditor panel, which will have to manage the tendering process so that it is both independent and transparent. The independent auditor panel will also look regularly at the quality of the audit from the auditors currently doing the job. If they are not doing the job, it will not recommend that they are allowed to proceed. The Financial Reporting Council has ethical standards as well, and will require that key audit staff are rotated on a regular basis. The Government believe that the requirements for a maximum five-year term and the rotation of key staff provide sufficient assurances, along with the other measures on auditor appointment and removal, to safeguard auditor independence and the local bodies’ independence of view in taking on their auditors.

I know that there have been wider discussions about, for example, a recent Competition Commission report on the need for mandatory auditor rotation. However, we understand that the evidence that mandatory rotation supports improved auditor independence and auditor quality is inconclusive. Bearing in mind what my noble friend Lord Tope and the noble Baroness, Lady Eaton, said, sometimes there is benefit in the continuation of an auditor, not on a cosy basis but because of the mere fact that, particularly with bigger authorities, you have somebody who understands the processes and what has been happening during the past five years. In any event, I think it would be wrong to exclude them from being able to tender, to bring down the barricade and say, “No, you can’t do that”.

There is sufficient professional involvement to ensure that auditors are not reappointed where they are unsuitable, where they have not done the job properly or where the local body thinks that they could do with a change of auditor and makes that clear. I do not think we need to make it mandatory that they cannot go beyond five years; that would be too draconian. I am satisfied that we have the processes in place to ensure that a full appointments system takes place every five years. If the current auditors were seen to be the most successful, they should be able to be reappointed.

I hope that that explanation will satisfy the noble Lord, Lord Beecham, and that he will be able to withdraw the amendment.

[Lord Beecham]

My Lords, as the noble Baroness knows, I am not easily satisfied, and I am not completely satisfied by her reply, although I am grateful. In particular, there is still an issue about market share and the domination by large firms, which I fear will not be addressed by allowing the system outlined in the Bill. However, having heard the debate, of course I beg leave to withdraw the amendment.

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[Lord McKenzie of Luton]

My Lords, this amendment touches on something that my noble friend began to address in an earlier debate. It addresses paragraph 3 of Schedule 4, and the making of regulations about a health service bodies auditor panel. These regulations would enable the Secretary of State to determine whether any of the members of the health service bodies auditor panel must be independent and, if so, what proportion must be independent, as well as the definition of independent.

A health service body means a clinical commissioning group and special trustees for a hospital. These powers are subject to the negative procedure. The amendment would require there to be consultation with representatives of health service bodies before regulations are produced. This seems to be a significant paragraph to be dealt with by the negative procedure, particularly given the prescriptive nature of the constitution of auditor panels for other relevant authorities.

The Explanatory Note to the Bill, to which I referred earlier, states:

“The intention is that these panels will be the existing audit committees of health service bodies which will meet the independence requirements of best practice for central government audit committees”.

I took the opportunity to raise this in advance with the Bill team, and I had a helpful reply, which I have not had a chance to get my mind fully around yet. Perhaps the Minister might take the opportunity to put something on the record. If I understand the position, it is accepted that the audit committees of health service bodies, as currently constituted, which they are required to have under legislation, will serve as the auditor panels. In a sense, we have achieved for health service bodies what we have been seeking to achieve for local authorities. Therefore, it should not be too great a step to complete the journey. I should be grateful if the Minister would put something on the record generally about why there is this differentiation between health service bodies and local authorities. I beg to move.

[Baroness Hanham]

My Lords, the direct answer to the noble Lord is that there are different arrangements in the various bits of legislation. As he has said, the clinical commissioning groups have governance arrangements that say that their audit committees can carry out this duty. That is how it has been set up in the health service. The composition of the clinical commissioning groups and local authorities’ arrangements are different. I want to make it clear that where local authorities have audit committees with independent members on them, it is possible for them to appoint the panel from the audit committee as long as they use the independent members. The arrangements are not and do not have to be totally different from those available as regards the health service.

I have pages of response to a question that the noble Lord has not asked. Is he reasonably happy that I have addressed the amendment? If not, I will give him the reams of pages that I have in response.

[Lord McKenzie of Luton]

Will the noble Baroness remind me of the question which I have not asked?

[Baroness Hanham]

I am tempted but I will not rise to that. If the noble Lord does not know what question he has not asked, I am not about to tell him what he might have asked.

[Lord McKenzie of Luton]

I shall ponder that response but I think that I would hang on to the basic point. It seems to me that the regulations that will flow from this provision will be, as has been said, a creation of the audit committees as the auditor panels. There will be only one body for health service bodies, which, in a sense, is the clarification that I was seeking as to what would flow from the broad powers set out in that paragraph. Obviously, there is a broader issue to which we will return about why that cannot be replicated for local authorities.

I am struggling to remember the question that I should have asked. Perhaps in the interim, I should beg leave to withdraw the amendment.

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[Lord McKenzie of Luton]

My Lords, I shall speak also to the other amendments in this group. The amendment would remove the requirement on the auditor panel to advise on the maintenance of an independent relationship with the local auditor. Indeed, it makes it discretionary. When I prepared for this debate, I could not for the life of me immediately recall why we tabled it. Obviously, the circumstances where a relevant authority ends up with an auditor panel and an audit committee, as we have discussed, would give rise to overlap and confusion, and possibly conflicting advice.

However, on reflection, we tabled it as a probe to establish a definition of “an independent relationship”. The Bill defines who is independent in establishing eligibility to serve on an audit panel and/or committee, but this definition does not appear to help in defining the parameters of an independent relationship between the relevant authority and its auditor. Is it proposed that guidance will be available, or is it expected that audit panels or audit committees will work that out for themselves? This issue is of particular relevance to the provision of other services by audit firms and how this is to be managed.

Amendment 14BJ would make a minor wording adjustment to advice related to liability limitation agreements. By referring to proposals for an authority to enter into such an agreement, it implies not that the proposal must have originated from the relevant authority but that it is more likely to have come from the audit firm.

Amendment 14BK would remove subsection (7), which seems superfluous. If subsection (6) requires the panel to advise on proposals for liability limitation agreements, why must there be the extra stricture for it to respond to requests for advice? It is not clear to me. I beg to move.

[Baroness Hanham]

My Lords, perhaps I may first deal with the description of “independent” which, I understand, will be a matter of consultation. There will be consultation on what “independent” means in health bodies and how it should be defined. We all need to be clear about what “independent” means, a point raised by the noble Lord, Lord Palmer, and others. This is in relation to health bodies, not local government bodies, but that consultation will be carried out. I hope that that is helpful.

On the main question about the auditor panel’s duty to advise on a proposal for an audit authority to enter into a liability limitation agreement, Amendment 14BJ would require that the panel should advise where there is a proposal for the authority to enter into such an agreement, rather than a proposal by the authority to do so. Amendment 14BK would remove the requirement that a panel must give advice on such a proposal if the authority asks for it. Amendment 14BE would require that an auditor panel “may” advise on auditor independence whereas the Bill currently states that a panel “must” advise on it.

The intention behind the amendments, to remind the noble Lord, relates to separate amendments that we had proposed to allow for a central body to appoint auditors on behalf of any relevant authority which had opted in to this structure. Where such arrangements applied, it would not be necessary for—I am sorry, something seems to have gone seriously wrong with my notes.

I will reply on the basis of the independent relationship but I am afraid that I am going to have to ask the noble Lord to come back on Report on this so that can I fulfil his right to a proper reply.

As to advising on the maintenance of the independent relationship, it is important that the panel maintains an ongoing oversight of the auditor’s relationship with the relevant local body. As in the company sector, this might include, for example, an annual assessment of the independence and objectivity of the auditor and setting policies for the provision of non-audit services.

The noble Lord asked about limited liability agreements. I ask him to raise the issue again. I shall certainly write to give him an answer. I apologise.

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[Lord McKenzie of Luton]

I would simply urge the Minister to give some encouragement to the noble Lord, Lord True, who has raised a very important point, as he did at earlier stages in our deliberations. I hope that the Minister can help him at least a bit.

[Baroness Hanham]

My Lords, I thank my noble friend for having introduced this amendment because it opens up the relationship that exists between local authorities and health authorities, particularly in relation to what is required of scrutiny. As my noble friend has said, the primary care trusts and the clinical commissioning groups have now come into being, while the local authorities still have a health scrutiny role since that changeover. If I may, I will refer to the duties in the health scrutiny regulations as I go through what I have got to say.

Failure to comply with a duty under the health regulations will place the relevant body in breach of its statutory duty and render it at risk of a legal challenge. The regulations provide that the local authority can require attendance of a member or employee of a relevant health service provider or commissioner to answer such questions as appear to the authority to be necessary for discharging its health scrutiny functions. It is the duty of that member or employee to comply. The regulations also require a health service commissioner or provider to provide a local authority with such information about the planning, provision and operation of health services in the area of the authority as the authority reasonably requires in order to discharge its health scrutiny functions. To focus particularly on attendance, if a local authority was to require the attendance of members of a clinical commissioning group, it could do so under the health scrutiny regulations.

On employers’ actions, we would expect employers to take the appropriate steps to ensure that the relevant member or employee complied with the local authority’s requirements. It would be highly unlikely that an NHS body, as a public authority, would refuse to take action to ensure that its members or employees complied with a request from a local authority. I think that these provisions are part and parcel of the health service legislation which recently passed through Parliament. The emphasis put on this since the noble Lord’s problem arose may have changed.

Any refusal would not be in line with the duty of co-operation that applies as between the National Health Service and local authorities. Section 82 of the National Health Service Act 2006 imposes a duty of co-operation between National Health Service bodies and local authorities and requires them, in exercising their respective functions, to co-operate with one another in order to secure and advance the health and welfare of the people of England and Wales.

As regards the attendance of particular individuals, identification of the appropriate member or employee to attend may depend on the type of scrutiny review being undertaken and its aims. To take a theoretical case, where the local authority has required attendance of a particular individual—let us say the accountable officer of a clinical commissioning group—and it is not practical for that individual to attend, or if that individual is not the most suitable person to attend, we would expect the clinical commissioning group to suggest another relevant individual. In such situations, both the local authority and the commissioning group or provider, as the case may be, will be expected to co-operate with each other to agree on a suitable person for attendance and, in doing so, to act reasonably.

Therefore, in the interpretation of the health scrutiny regulations and on the basis of the duty of co-operation contained in the National Health Service Act 2006, there are existing principles that guide how the National Health Service and local authorities conduct themselves in relation to the discharge of the local authority’s health scrutiny function.

We share my noble friend’s desire to ensure that everything works as it should in the future and, although we feel that the duties and powers already in place are correct, we believe that we can take further action to ensure that the responsibilities on NHS organisations and local authorities are clear. We shall shortly be publishing updated guidance to support the health scrutiny regulations and to emphasise these responsibilities. If my noble friend would find it helpful, I know that the Department of Health would be happy to work with him on the development of this guidance.

I appreciate that this was very much an individual case to which my noble friend brought our attention, but it flows widely across the health scrutiny role. I hope that I have reassured my noble friend that there are requirements on people to come, that the health authority can require them to come and that they are truly expected to appear. I know that that was not the situation that he described but the regulations are there. If my noble friend is willing to give his experience and help to the Department of Health, I know that it will be very willing to take it up. With that, I hope that he may feel that he has enough to enable him to withdraw the amendment.

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[Baroness Hanham]

My Lords, this goes back to what we were discussing when we were talking about local authorities. If the clinical commissioning group has not appointed an auditor by December and has no reasonable expectation of employing one by the end of March, the Commissioning Board will have to notify the Secretary of State and he, NHS England or the commissioning group will have to ensure that an auditor is appointed. There is no question that the clinical commissioning group should not have an auditor in place at the beginning of the financial year.

[Lord Palmer of Childs Hill]

Perhaps I may ask the Minister for clarification. The Bill states:

“by the end of 25 March in the financial year preceding the financial year to which the accounts to be audited relate”.

So, if the relevant year is to 31 December 2012, as I understand it, the auditor will have to be in place by 25 March 2011 because that is the financial year preceding the financial year to which the accounts to be audited relate. Is that right? I would have thought it should be in the financial year to which the accounts to be audited relate, not the preceding year. This is bringing the date incredibly far forward and I wonder whether I have misunderstood it. Perhaps my noble friend the Minister can elucidate.

[Baroness Hanham]

My Lords, I have misled the Committee, for which I apologise. As the noble Lord said, it is the preceding year. If the clinical commissioning group fails to appoint an auditor in the preceding year at the end of March, the Commissioning Board will have to notify the Secretary of State. This gives time for an auditor to put in place the provisions for the following year. The Secretary of State has to be notified by the commissioning board by 25 March that the clinical commissioning group has failed to appoint an auditor. The provisions are intended to ensure that a clinical commissioning group has a local auditor in place in a way that is consistent with their respective roles. I agree with the noble Lord that nine months seems a long time to get someone in place.

[Lord McKenzie of Luton]

I thank the Minister. I am going to have to read the record on that. The potential discrepancy that I was probing was the difference between using the 25 March and the financial year preceding it. As I understand it, if the financial year ends 31 December 2014, it would be the 25 March 2013 that would count. However, the difference is between the 25 March for the clinical commissioning groups and 31 December for the relevant authority’s appointment date. Why is it 31 December in the preceding year for the relevant authority and 25 March for clinical commissioning groups? I am happy to receive a follow-up letter if that is easier. I beg leave to withdraw the amendment.

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[Baroness Hanham]

My Lords, perhaps I can pick up the questions as I go along. However, it would probably be helpful if I gave the justification for the clause and then we could look at the impact.

As in the companies sector, auditors appointed under the Bill will, by agreement with the audited authority, be able to limit the extent of their liability to the body in relation to negligence or breach of duty or trust. This clause gives the Secretary of State powers to place restrictions on such agreements to ensure that they are reasonable and proportionate.

The decision to allow liability limitation agreements in the companies sector was made following extensive consultation. Such agreements aim to ensure that auditors are not held liable for consequences beyond their control and responsibility. Under the joint and several liability principle in UK law, auditors may be held liable for damages beyond that for which they are directly responsible. The Financial Reporting Council has welcomed provision for such agreements.

Clause 14 mirrors the Companies Act 2006 by providing that any such “liability limitation agreement” must comply with certain conditions. The purpose of this clause is to ensure that the agreements do not unreasonably limit the auditor’s liability and are entered into transparently. Without such a provision, there would be no limits on an auditor limiting their liability and nothing to stop them removing all liability completely. As I said, it is right that auditors are held responsible for their actions in a fair way.

Subsection (2) requires that:

“A liability limitation agreement must comply with regulations made by the Secretary of State”.

Such regulations may address the duration of an agreement or the amount to which it may limit the auditor’s liability, or require it to contain, or not contain, certain provisions. Under subsection (5), regulations may provide that any limited liability agreement not complying with regulations is void or has effect only in so far as it complies with them. In the interests of transparency, subsection (6) allows the Secretary of State to make regulations requiring the disclosure of any such agreement. Subsection (7) excludes compliant agreements from wider provisions in the Unfair Contract Terms Act 1977, which set out similar but more general provision and conditions around limitation of liability.

With regard to the amounts of money involved, perhaps I may write to the noble Lord. I think that the amounts are very small but I will provide them to the noble Lord. As the Bill proceeds, there will be further details on the various matters that have been raised. We will, as with all new legislation, be undertaking a review of monitoring to see what the situation is.

With regard to the point raised by the noble Lord, Lord Palmer, about who should pick up the liability, the Bill includes provisions that enable auditors to recover the costs of their time in exercising their functions from the body being audited. It does not replicate the Audit Commission’s indemnity scheme, which covers the costs of auditors taking or defending legal action. We believe that it is appropriate for private companies to bear the risks and costs of that. We do not believe that it would unduly deter auditors from exercising their functions. The Audit Commission has rarely indemnified its suppliers. On the noble Lord’s question as to whether the Government should pick up liability, the answer would be no. With that, I urge that the clause remains part of the Bill.

[Lord McKenzie of Luton]

My Lords, I am grateful to the Minister for that response. I think that we understand a bit better that the regulations will broadly follow the Companies Acts requirements and what flows from that. I found her response confusing in some respects. We are talking about something that is not beyond the control of the auditors. These arrangements are predicated on a breach in respect of any negligence, default, breach of duty or breach of trust occurring in the course of the audit of accounts, so it is a failure of an audit firm which triggers them. The noble Lord, Lord Palmer, raised a very important point. If there is a breach or damages and if that is not to be visited on the auditor, or what is to be visited on them is restricted, who bears the cost of the rest? I do not think we understand that from the Minister’s response.

I thought that the public policy issue about this was partly to do with making sure that another big four company did not go under. The ramifications of those four big beasts going down to three would be significant over a whole range of areas, as we learnt from the demise of Arthur Andersen because of Enron. I thought that a key point was to make it easier for smaller firms to enter the market because their risks were, in a sense, capped. There is no great evidence to suggest that that has happened in the private sector. We do not yet know whether it will happen in the public sector, but if it does not, that raises the question: why have these agreements in the first place? All they do is to protect audit firms. Why? These are sophisticated organisations. They have excellent training programmes, generally recruit very good staff and have been around the block a few times. If they mess up, should they not bear the consequences? If not, the question of the noble Lord, Lord Palmer, is absolutely right: who should? Part of the rationale may be that it would produce downward pressure on audit fees, but that is difficult to justify, particularly if the use of the commission’s indemnity was pretty restricted.

We may return to that issue, perhaps in terms of a sunset clause, if these things are to continue. I hope that the same arrangements as in the private sector, where I think they have to be annual contracts, will persist in the public sector in so far as they are used at all. I hope that guidance is given to firms when faced with such a request from their auditors as to how they should respond. We have probably taken this as far as we can this afternoon, but for us it is an outstanding issue to which, one way or another, we will wish to return.

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[Lord True]

My Lords, the noble Lord makes an extremely important point which in certain circumstances could touch on issues of public accountability, although referred to on another matter. It may well be that he could be satisfied in that Clause 16(3)(d), at the top of page 12, allows a regulation-making power in relation to,

“the role of the relevant authority’s auditor panel or … supervisory body”.

On this issue of a right of audience, or a right to make representations, my noble friend might well be able in discussion to consider including the point which the noble Lord has raised. It is a significant one and he is right to refer to Companies Act procedures. Perhaps it could be clarified whether it is potentially encompassed in that area, which might help some of us on the Committee.

[Baroness Hanham]

My Lords, Amendment 14E would add to the regulation-making powers under Clause 16(1)(b), which relate to the circumstances of an auditor being removed, as the noble Lord said, by a local public body before their term of office expires. It would enable regulations giving local auditors the right to make representations to the authority’s auditor panel or to the auditors’ “recognised supervisory body” in those circumstances. The noble Lord asked what would happen if it was the Audit Commission; as we have already said, that commission will have an interim body between it being abolished in 2015 and when this changes. That will be a responsible transfer, which is the main thing.

We are sympathetic to the intention of this amendment, which is to ensure proper scrutiny of the removal of an auditor. However, as the noble Lord suspected, we consider this amendment to be unnecessary. Subsection (3)(c) already provides a regulation-making power about,

“the steps that may be taken by the local auditor in connection with the local auditor’s removal from that office”.

As set out in our consultation paper on the draft Bill last year, we intend by regulations to enable the auditor to respond to a relevant authority’s notice of intention to remove them, with that response to be considered by the relevant authority’s auditor panel. So the auditor panel now has a role in overseeing that in an independent way.

The auditor panel would then be required to advise the authority on the proposal to remove the auditor. In light of the auditor’s response, we intend that the authority’s final decision to remove the auditor would be subject to that advice. As with appointment, we intend that where a body does not follow the audit panel’s advice it would need to publish the reasons for not doing so. We also intend to require that the recognised supervisory body is notified of a removal. Therefore, we do not consider that it is necessary to include this additional wording in the Bill. We think that there are enough safeguards in it. With that explanation, I hope that the noble Lord will feel able to withdraw his amendment.