Local Audit and Accountability Bill [HL]

Lord Palmer of Childs Hill Excerpts

Wednesday 19th June 2013 Grand Committee

[The Earl of Lytton]

My Lords, I shall speak to Amendment 14ZAA and its co-runner Amendment 14BZA, both of which are in my name and that of the noble Lord, Lord Tope.

The principle behind these two amendments is relatively simple; they seek to allow for a measure of delegation of the duty to appoint an auditor so that the actual procurement of auditors and their formal appointment can be made by another body on behalf of the authority. The issue arises by virtue of Clause 7(1), which states:

“A relevant authority must appoint an auditor”.

This, if taken literally, could be taken to mean the direct appointment of a named auditor in person on an exclusive and non-transferrable basis. I am sure that it is not intended to be quite as tight as that. It is certainly felt by the LGA, and others who have briefed me on this matter, that this might prevent any appointment as authorised proxy by an external person or body.

In reality, a firm is appointed to the task and nominates one of its number, often a partner or director, to head up a small team to handle the matter. The appointment of an auditor, to use that singular term of art, and as a specific named individual, is in any event customarily carried out per pro the authority by this means. For instance, most small charities and similar bodies appoint a firm rather than an individual. In the realms of a collective appointment via a national or sector-led service, this becomes more important. A large consultancy firm bidding for a sector-led contract will ultimately make an appointment itself of the named auditor as overseer and signatory to the auditor’s report

The gist of Amendment 14ZAA is quite simply to provide for the procurement of an auditor by way of a duly authorised proxy, including a large firm, a sector body or other similar large concern dealing with possibly several authorities. It does not make this mandatory, simply an option.

Amendment 14BZA follows from this. If the procurement is by way of another body charged with meeting the requirements of the Bill and thus delegated from the authority, it is unnecessary, or should be unnecessary, to have an audit panel, because the oversight of the auditor is carried out in accordance with the relevant rules of engagement via the proxy. The authority always remains responsible for whatever measures it has put in place. The appointed procurer of the audit service must observe all the criteria in the Bill for that activity.

The LGA, as I said, provided a useful brief on this and it is worth picking out a few salient points. The amendments would be consonant with the authorities’ need to have flexibility to procure their audit nationally, or in some form of grouped manner. It would make collaborative audit procurement more attractive and produce, as we heard on the previous day of this Committee, the potential for significant savings. That would be to the direct benefit of local finance. Some of the reasons why this is so have already been rehearsed, including the Audit Commission’s own modelling and its calculated saving of between £205 million and £250 million over a five-year period.

The Government’s own impact assessment does not refute this. Indeed, it concedes that local appointment may not procure the level of savings secured by the Audit Commission during its last procurement round. It seems obvious to me that each authority procuring its own auditors on a recurring basis replicates a cost base. There is an opportunity to save money here.

I will not go into the other details that have been discussed before, save to say that I agree that local appointment does not necessarily increase competition or cut costs. I have no proof of this, but my hunch is probably that not many firms would undertake a municipal audit in the first place. In reality one is probably looking at one of the larger firms, a point that we have heard before. I register the point made by the Minister on Monday. A paraphrase of her words is that there will be no recreation of the Audit Commission by the back door, but if the reality of this Bill’s proposals is to create some form of suboptimal procurement with waste by duplication, I have to say that I am against that as a principle. I hope the Minister will feel that subject to any safeguards that might be necessary to eliminate the risk of a “son of” Audit Commission coming about, the principle is acceptable, in which case we can work out the detail as we go forward. I beg to move.

[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 Tope]

My Lords, I am slightly confused, because the group of amendments with which we are dealing is about the relationship between audit committees and auditor panels. The noble Lord, Lord McKenzie, as the mover of the amendments, will comment on that in a moment. However, I am quite sure that we will return to this issue, if only to seek clarification about the distinction and whether the two bodies should be, or have to be, separate. My noble friend Lord Wallace seemed almost to be saying that the auditor panel could in effect be a subcommittee of the audit committee. I do not think that that was quite what he meant, but maybe it was. We still need to clarify that role.

My confusion started when my noble friend went on to reply to Amendment 14BBA, which is not only in the name of the noble Earl, Lord Lytton, but in mine. That amendment has not been moved yet, so I am not quite sure whether we are dealing with it. If we are, and for the sake of preventing us from dealing with it later on—if and when it ever gets moved—perhaps I might say that the noble Earl is vastly more expert than me on the case of small bodies, such as parish councils and the like. However, the amendment comes from the Local Government Association, which represents primarily the larger authorities that do have these concerns. Personally, I have no great problem with majority independent members, but the LGA is concerned about it on a number of grounds.

First, the LGA quite rightly makes the point about the professional integrity of auditors, which the noble Baroness, Lady Eaton, has already made, as has the noble Lord, Lord True, and others, and which I think we all accept. They are already fully regulated, quite rightly and properly, and therefore the perception of independence is, in a sense, already covered to a considerable extent by the regulation.

Secondly, there is the rather more important, practical problem of whether in some areas it will be possible to find a significant number of truly independent people. That does not mean somebody elected to the council as being independent of a political party; it means somebody who is truly independent of the council in a way that is defined in the schedule. In some areas, it may not be possible to find sufficient people of relevant experience. That does not mean that they have a professional qualification necessarily, but that they have relevant experience and are also able and willing to put in the necessary time to serve on this. That may be less of a concern in some London boroughs that many of us know. However, I can well see that in more rural areas or smaller district councils, it may well be quite a significant difficulty. That is part of the concern that the LGA was raising and which we need to include in this debate, whichever amendment we are debating at this moment.

[Lord Palmer of Childs Hill]

Since we are not sure which amendment it is, perhaps the Committee will forgive me if I say just a word, having come in late on this section. I hope it will. I want to pick up on what the noble Lord, Lord Beecham, said about close friends. I feel that whatever legislation these Houses of Parliament pass should not be capable of ridicule. That must surely be paramount in people’s minds. Can one imagine the situation in which people vehemently deny that they are a close friend: “I am not a close friend, let me on it.”? It is quite nonsense. The idea of having to justify not being a close friend is capable of being ridiculed.

We are not putting these words into the Bill; we are trying to say that the relationship of someone in this position should not be such that they could influence the person on the panel. Imagine a court trying to decide whether this person was a close friend when they were denying it. Mr Saatchi and his wife might have problems saying whether they were close friends, given that he put his hands around her throat—he has been cautioned, so I think I can say that. It really is a worry. As I say, I understand what the Bill is trying to do and it is absolutely right to do so. However, to pick up on what the noble Lord, Lord Beecham, has said, the words are unfortunate.

[Lord McKenzie of Luton]

My Lords, I thank all noble Lords who have contributed to what was a wide-ranging debate in the event. I also thank the Minister for his reply, but I am bound to say that I do not feel reassured by it. There are two sorts of issues flowing through this debate. One is whether, as the amendment proposes, the audit committee could not take unto itself the role of the auditor panel. Then there is the separate but obviously related issue of composition, whether it is of the audit committee or the auditor panel, and whether that should be independent as defined, quite apart from the definition.

The noble Lord, Lord Wallace, asserted that 80% of local authorities have audit committees. I accept that. I know that it is not currently mandatory, but it is certainly encouraged and there has been a substantial development of them. Their role is not limited to internal audit, controls and processes. That is part of their role, but the CIPFA guidance makes clear that part of their role is reviewing the financial statements, the external auditor’s opinion, and reports to members, so they should already have an engagement with the external auditors and be able to take a view on how they should proceed.

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[Lord Wallace of Saltaire]

My Lords, we are willing to look at that as well and I will write to the noble Lord. After all, we are talking about panels that may consist of two independents and one member of the audit committee. We are not talking about a vast number of people to be found outside. However, my understanding is that “independent” will exclude close political friendship. My experience of close political friendship also tends to mean close personal friendship, but we could discuss that in the bar or on another occasion.

[Lord Palmer of Childs Hill]

My Lords, perhaps I can come back on that because I am probably the only person in your Lordships’ House who is a chairman of an audit committee. The present situation in many audit committees, of which mine is one, where the chairman is a member of an opposition party, which I am, gives an incredible independence. You are not part of the ruling party and when we were in power we did the same the other way round.

As the noble Lord mentioned, we already have two independent members, which is very good. However, the trouble is that if you appoint an independent chairman or chairwoman of the committee, that person could well have a political affiliation. Therefore, when the controlling party in that local authority was looking for an independent chair of that committee or panel, not unnaturally it would look to people whom they know or know of. The current situation where the person is of an opposition party, where that is relevant, seems to get over that point because that person is not a close political friend. I just wanted to pick up that point from my personal experience as something to think about that when we are considering this point.

[Lord Tope]

My Lords, I think that we are trying to achieve the same thing here and therefore further discussion will be helpful. I pick up on the Minister’s example of an auditor panel that has two independent members, in the terms defined thus far, and a member from the audit commission. Whether they are friends by any definition, they could easily be members of the same political party. In a slightly different context, we said earlier that all of us are concerned that that should not happen in terms of elected members, with a majority party having a majority on the committee or sometimes even all the places on the committee. If we are talking about a small auditor panel, with the three members suggested, it is possible—this is not in the realms of fantasy in some areas of the country—that all three could be members of a political party. That does not necessarily imply a conspiracy or corruption; that is merely how it is in that area.

Thanks to the noble Lord, Lord True, we have moved to an area to which we may have to give greater thought if we are to achieve the objectives we all share.

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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.

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[Lord McKenzie of Luton]

My Lords, in seeking that Clause 14 should not stand part of the Bill, I should say that this is a probing measure to seek government assurances about the appropriateness of facilitating the limitation of local auditor liability arrangements. The impact assessment and other documentation records that the Audit Commission currently provides an indemnity to audit firms for certain aspects of their work. This is, presumably, their statutory audit function. It also appears that it covers irrecoverable legal costs. We are told that the indemnity has been used only twice over the past five years and that auditors have faced legal action four times over a five-year period. Perhaps the Minister will let us know the amounts involved in the use of the indemnity and how much was paid.

What benefits ensue from limited liability arrangements which relieve auditors of liability in respect of negligence, default or breach of trust when conducting an audit? What are the benefits of that? The limitation of auditors’ liability has been permitted under the Companies Acts since 2008, although reports suggest that there has been little take-up. I am indebted in this regard to a Mr James Herbert, who is a corporate partner in a law firm who wrote an interesting article in Accountancy Age back in 2009. I took the opportunity of speaking to him to see whether the view he expressed then had changed. It had not.

Part of the reason for little take-up of those arrangements is attributed to issues with the SEC prohibiting UK companies registered with them from entering into those arrangements. Under the Companies Acts, any limitation must be fair and reasonable. A separate agreement is reached for each year and each agreement must be approved by shareholders. On the face of it, there is no reason why auditors should be protected from the consequences of their negligence or default in the public or private sectors. However, one of the public policy objectives was to enhance competition in the UK audit market and to address concerns about auditor concentration. As we have discussed before, the big four have deep pockets, are better able to bear the risks and have more clout with professional indemnity insurers. There are concerns that the smaller and mid-tier firms have been least able to benefit from the agreements.

Another reason for allowing such agreements might be its impact on the price of an audit. If the risk on the audit firm is less, the cost of the audit should go down. However, it is difficult to gauge whether there will be any real downward pressure on fees in the public sector, particularly given the infrequent calls on the commission’s indemnity. We can see some merit in allowing limitation of liability agreements if tightly regulated and if they can be demonstrated to help to open up the markets and put downward pressure on fees. However, we are sceptical that they will deliver that outcome. Perhaps the Minister can say when we might see a draft of the proposed regulations referred to in Clause 14 or what else might be provided in the key elements in the regulations. How do the Government propose to monitor and assess the effects of the clause?

I emphasise that in my discussions with that particular lawyer, it appeared that limitation of liability agreements have simply not taken off, certainly not in the private sector, so one wonders about the merits of introducing them to the public sector.

We might wish to return to the matter on Report, but it seems to me that, at the very least, there may be an argument for a sunset clause on the provisions, or at least a very clear process of assessment so that one can see whether what should be the benefits—downward pressure on audit fees and an opening up of the market to smaller firms—is actually achieved. We remain sceptical.

[Lord Palmer of Childs Hill]

We have already mentioned that the number of accountancy firms capable of carrying out these audits is quite small—five to seven, probably. The maximum would be 13, and most of those would probably not achieve those audits. All of those in the top echelon of firms of audits are now limited liability partnerships. The days of my times in practice when we were personally liable have, for the large firms that we are considering, long departed.

I ask my noble friend: if there is a liability, where should it rest? Should it rest at the end with the Government as a short-stop? Should we say, at the end of the day, if things go sour, the Government will pick up the liability? Bearing in mind that no partner of one of those firms would be personally liable, and that they are firms of great size with considerable power, I wonder whether they should not bear that liability.

We had the example within the corporate sector of Arthur Andersen, which messed up on an audit—not a local authority audit but a public audit—and that ended with the demise of that firm. Are we trying to say that, in terms of local or public health authorities, these firms should have this protection, or are we saying that these are the professionals and they must do their audits, work correctly and cover themselves? We are not talking about anyone being responsible for fraud or errors within local authorities or the health service; we are talking about them not having carried out their work properly to an extent where they can cover themselves. I ask the Minister to reconsider whether the liability should ultimately rest with the Government, or whether it should rest with these five to seven very large limited liability concerns.