Mr. Martin O’Neill MP
Chairman – Trade and Industry Select Committee
House of Commons
London SW1A OAA
12 August 1998
Dear Mr. O’Neill,
Limited Liability Partnerships
I understand that the Trade and Industry Select Committee is due to hold hearings and invite evidence on the topic of Limited Liability Partnerships (LLPs). May I suggest that amongst other things the Committee also consider the following matters:
1. No doubt, you are aware that major accountancy firms have orchestrated
much of the demand for LLPs. They claim that the present business vehicles
are unsuitable for them and that as a result their liability position is
adversely affected. The auditing industry has presented little public evidence
to support its claims. The enclosed monograph ‘Auditors: Holding the Public
to Ransom’ has examined the auditing industry’s case and finds little evidence
to support the industry’s assertions.
2. The proposed LLP legislation is part of a long-line of concessions
by successive governments to the auditing industry. For example,
(i). At the industry’s request, the Companies Act 1989 gave the auditing industry a right to trade through limited liability companies.
(ii). At the industry’s request, the government introduced Section 137 of the Companies Act 1989 (to amend Section 310 of the Companies Act 1985) and enabled companies (should they so wish) to buy insurance for auditors.
(iii) At the industry’s request, government also asked the Law Commission to investigate (report issued in 1996) the feasibility of replacing ‘joint and several liability’ with ‘proportional liability’.
Currently, LLPs are being proposed to offer further liability protections to auditors and the industry is also demanding further concessions, such as a financial ‘cap’ on its liabilities. The above concessions have been given (and demanded) in an environment in which the legal position (as exemplified by the House of Lords’ 1990 decision in Caparo Industries plc v Dickman & Others) is that auditors do not owe a ‘duty of care’ to any current or potential individual shareholder, creditor or any other stakeholder. They only owe a ‘duty of care’ to the company. So auditors could be negligent but individual stakeholders have no redress against them.
The social bargain of ‘external audit’ has been understood to be based upon a ‘duty of care’ to individual stakeholders and risk sharing arrangements. Statutory concessions, case law and further demands of the industry have significantly altered the terms of such a bargain. This has significant wealth distribution, risk sharing, consumer rights and consumer protection implications. One might also question whether the liability concessions given to the auditing industry also dilute economic incentives for good audits to auditing firms.
May I suggest that the Select Committee examine the LLP proposals in
its proper social context. For example, can the government really
deny the liability protection offered to accountants to other ‘producers’
of goods and services – e.g. doctors, dentists, architects, lawyers, food,
drink and medicine companies. What are the implications for consumer
protection. Whilst the auditing industry will advance its arguments, the
Committee should at the very least examine the implications of the proposed
legislation for audit consumers and the public generally.
3. Since all legislative reform and concessions have a wealth distribution
and risk sharing consequences, it is notable that the LLP proposals have
not been accompanied by any strengthening of the rights of audit stakeholders.
Despite the Caparo judgement, no government has urged the Law Commission
to investigate the plight of audit consumers.
4. The accountancy firms spent an estimated one million pounds to draft the Jersey LLP legislation and have used the same as a lever to secure concessions from the UK government. It is, perhaps, the first time that organised business interests have used smaller Western states to squeeze concessions from major Western states. Its implications for Western democracy should be considered. The Committee may find it helpful to invite evidence from those who objected to Jersey being used as a pawn.
5. The government’s LLP proposals (as indicated in the 1997 consultation paper) are anti-competition. For example, UK accountancy firms sell a variety of services ranging from audit, accountancy, audit, insolvency, tax, consultancy, executive recruitment, financial services and even printing T-shirts, badges and laying golf courses. In fact, accountancy and audit generate less than half of major firm income. Arthur Andersen receives less than 25% of their income from accounting and auditing. The government is proposing to make LLPs available to certain professionals, including accountants but not to their competitors. This does not make for level playing fields. It is difficult to see why the LLP status should not be available to almost everyone.
Under the government’s proposals, organisations such as KPMG will be able to give up their Plc status and re-register as LLPs, but the same privileges will not be available to those competing with KPMG. This does not seem to be equitable.
6. You may also be aware that a report prepared by US Senators Kerry and Brown investigating the BCCI audit failures (there is no such report in the UK) recommended that partnership structures are inappropriate (see chapter 10 of the report) for major accountancy firms. The investigators argued that the partnership structures enabled the firms to avoid national and international responsibilities and obstruct regulators. In its evidence, Price Waterhouse argued that it was not a global business was thus unwilling to provide the investigators with the UK files and working papers. The UK LLP proposals do not seem to consider the regulatory issues. Indeed, the UK government has never given any official response to the US report.
7. The question of taxation is also important and should be considered. Here comparisons with other organisations enjoying limited liability are important because LLPs will limit liability of some/all partners. In the UK, limited liability companies generally pay corporations tax within nine months of the year-end whilst partnerships can take anything up to twenty-one months. Expense deduction for partnerships is easier compared to that for limited liability companies.
Many professionals operating through partnership or sole trade vehicles currently are taxed on a ‘cash basis’, something which enables them to shuffle their tax liabilities and gain tax advantages of some £200 million. In contrast, companies are taxed on ‘accrual’’ basis. The question then is whether different business vehicles enjoying similar liability protections should really be taxed differently or not.
8. Insolvency of LLPs is an important issue. It is noticeable that the 1996 Jersey LLP Law contained virtually no provision for dealing with insolvency and thus could not be implemented. The Jersey States are due to deal with this in September 1998.
The proposed protection offered to UK stakeholders appears to be inadequate. In company law, there are restrictions on transfers of assets to shareholders as it is recognised that such transfers can reduce the company to a shell and severely disadvantage creditors. LLPs will not have shareholders but it is possible that the assets may easily be transferred by the management to the owners (who are the same parties), leaving behind a shell which is of no use to stakeholders. It is conceivable that any accountancy firm facing a massive negligence claim may well indulge in such transfers, at the first sign of litigation. As litigation takes long time, it will certainly have time to plan and execute such proposals.
The government has envisaged such a situation and is proposing a two year “clawback” i.e. requiring partners to hand back the amounts and assets taken from the firm in the two years preceding a named event (e.g. insolvency). But two years does not seem to be adequate.
It is conceivable that the soon to be published Draft Bill may clarify the above issues. The Draft Bill may also raise additional issues. I very much hope that you will bear the above issues in mind when scrutinising the government’s proposals. I would be happy to provide further written and/or oral evidence, should you consider that to be helpful.
Yours sincerely
Prem Sikka