LIMITED LIABILITY PARTNERSHIPS
A COMMENT ON THE DTI CONSULTATION PAPER
LABOUR MP FOR NEWCASTLE CENTRAL
LABOUR MP FOR GREAT GRIMSBY
PROFESSOR OF ACCOUNTING
UNIVERSITY OF ESSEX
PROFESSOR OF ORGANIZATIONAL ANALYSIS
MANCHESTER SCHOOL OF MANAGEMENT, UMIST
We are pleased to comment upon the DTI’s consultation Paper titled, ‘Limited Liability Partnerships. Our views are summarised below. Further details are shown on the enclosed pages. We have no objection to our views being placed on the public record.
1. The LLP status should be made available in the UK.
2. In the interest of fairness and level playing fields, the LLP vehicle should be available to all businesses, not just accountants, lawyers and a select few.
3 We would want the UK version to be much superior to that enacted in Jersey. Our response notes that to secure concessions accountancy firms have used Jersey as a lever (paras 1-9).
4. For a considerable time, regulators have argued that partnership structures are inappropriate for major accountancy firms. Yet the DTI proposals ignore the issues (paras 10-13).
5. There is misplaced faith in professional regulation (paras 14-22). There should be no concession of LLP status to accountancy firms unless it is accompanied by effective and independent regulation.
6. A number of the DTI’s proposals are anti-competitive (paras 23-30).
7. LLPs should be required to apply the public accountability
requirements which are already applicable to limited liability companies.
Limitation on liability requires public accountability and there should
be no compromises (paras 31-50).
1. The Limited Liability Partnerships (LLP) legislation is primarily being devised to appease accountancy firms. It should be recalled that following considerable lobbying by accountancy firms and their trade associations, the Companies Act 1989 enabled accountancy firms to be incorporated as limited liability companies. The firms previously argued that partnership structures were very unwieldy for firms with numerous offices and hundreds of partners. They argued that a streamlined corporate structure with Boards of Directors would enable them to operate more efficiently and would also make it easier for them to raise finance through capital markets.
2. In the UK, traditionally, limited liability privileges have been accompanied by notions of public accountability. Therefore, limited liability companies (other than small and dormant companies) are required to place some selective information about their affairs on the public record.
3. Since the Companies Act 1989, a number of small and medium-sized firms have taken advantage of incorporation. This gives them exactly the same advantages and public accountability obligations as any other limited liability company. Amongst the larger firms, only KPMG Audit Plc has incorporated. Other major firms held back for three reasons:
Firstly, incorporation imposes public accountability. Generally, accountancy firms despite enjoying public monopolies (e.g. external audits, insolvency) have shunned public accountability. They are ultra secretive organisations even though the conduct of their operations affects the distribution of wealth, income and assessment of risks. Audits and insolvency practices affect the lives of investors, creditors, employees, bank depositors, pension scheme members and other stakeholders.
Secondly, incorporation may change the basis of their Schedule D Case I and II assessments. Expense deductibility may be harder as the test would be ‘wholly, exclusively and necessarily’ rather than the ‘wholly and exclusively’ which is applied to partnerships. Incorporation may also mean that the firms would have to pay corporation tax, nine months after the year end, rather than taking up to 21 months after the year end, as many unincorporated businesses do. Anyone else seeking incorporation and hence benefit of limited liability has to trade off tax perks and secrecy against the benefits of limited liability, but accountancy firms want secrecy without losing the perks.
Thirdly, the major firms do not just want vehicles which limit their liability and give them secrecy and tax advantages. They also want to further dilute (the Caparo judgement has already diluted) the rights of the injured parties against negligent auditors. Thus the LLP Bill they drafted for Jersey, ignored issues of public accountability and rights of stakeholders.
4. The government asked the Law Commission to consider the firms’ claim that they are somehow unfair victims of lawsuits (the firms remain silent on the losses suffered by ordinary people because auditors were negligent). The Law Commission rejected their claims for full proportional liability (full proportional liability is not implemented in any country, not even in states like Delaware). The US has a version of modified proportional liability. The principle of ‘contributory negligence’ was accepted by the House of Lords in 1995 and gives considerable protection to accountancy firms.
Holding the Public to Ransom
5. Whilst awaiting the Law Commission’s report, major firms and their trade associations (who act as public regulators under the Companies Act 1989, but have not called for any quid pro quo for stakeholders) approached Jersey to enact the LLP law. Price Waterhouse and Ernst & Young spent £1 million to draft the Jersey LLP law which gave the firms everything they wanted and contained no provisions relating to accountability and possible insolvency of the firms.
6. By using the Jersey LLP law as a lever, the firms are seeking to hold the British public and Parliament to ransom. They are threatening to move to Jersey unless they get what they want in the UK. However, such threats have little substance. In the event of a dispute, unless the plaintiffs have expressly agreed otherwise (which is inconceivable), the UK courts are likely to hear cases according to the statutory and common law of the UK. Any attempt by the firms to hide behind the Jersey structures, is likely to be constructed as a sham, since the firms will be continuing their normal business in the UK in the normal way. In addition, Inland Revenue is likely to recognise a move to Jersey as a cessation of a partnership business and commencement of a limited liability business. This will have profound consequences to the taxation of capital gains and income of the firms. The likelihood of a mass move to Jersey is virtually non-existent.
7. The whole purpose of the Jersey excursion was to blackmail the UK government and the public into giving liability concessions to firms. The LLP concessions are only the beginning. the firms will follow this with pressures for proportional liability. Should Parliament simply yield to such blackmail? What kind of a precedent will it set? Unless the government responds firmly, one likely development will be that the rich, the powerful and well-connected will be able to approach tin-pot states, indulge in DIY legislation and then use that to hold larger states to ransom. No democratic and civilised state can allow its public policymaking process to be hijacked by big business.
The bank-rolling of the Jersey LLP law is the first time in European history that private business has engaged in DIY legislation to give itself all the concessions that it desires. Any yielding to it creates a dangerous precedent. It will not be a one off exercise either as the firms want even more concessions on liability.
Should the government yield, a number of moral issues will also need to be raised. Following the 1990 Caparo judgement, the auditor liability to third parties has been severely diluted. Auditors do not owe any ‘duty of care’ to current or potential individual investors, creditors or stakeholders who relied upon audited financial statements. This is completely at odds with the intentions expressed where various laws (e.g. the Companies Act 1879, 1929, 1948, 1967, 1976 etc.) were enacted. Is it acceptable that the government and Parliament have done nothing to reverse the Caparo judgement and give real effect to the intentions of the Companies Acts, but are willing to bow down to the accounting lobby because it has been able to devise a way of holding the public and Parliament to ransom?
8. From press reports, it is clear that Ministers in the Conservative administration held meetings with the Big-six partners to hear their claims. But the same Ministers repeatedly ignored the plight of those suffering from the Caparo judgement. There have been no meetings with representatives of BCCI depositors to Maxwell pensioners to learn how they have suffered from auditor negligence and how they too could be given ‘rights’. Why?
9. There is no quid pro quo of any kind in the DTI consultation paper. Anyone buying a packet of sweets receives consumer rights; the product has to be fit for consumption, consumers have rights against the manufacturer and retailer of the product, producers have obligations to third parties etc. But the consumer rights revolution has not touched auditing. The normal market pressures for improving quality e.g. lawsuits, class actions etc. are missing in the auditing sector where the firms enjoy a statutory monopoly. It would be dangerous to concede what the firms want without a quid pro quo of proper regulation so that the public interest can be defended.
Are Partnership Structures Appropriate for Major Accountancy Firms?
10. The DTI consultation paper assumes that partnership structures are appropriate for accountancy firms. This needs to be questioned, especially accountancy firms themselves have argued, in the past, that such structures are unwieldy and inappropriate for them.
11. During the disciplinary hearings against Coopers & Lybrand partners for violating ethical guidelines (for which they were fined the princely sum of £1,000), their defence was that the partnership affairs were so complex that they did not have any easy way of knowing that the firm had already acted as auditors and advisors to Polly Peck, its subsidiaries and officials (for further details see Mitchell, A, Puxty, T., Sikka, P. And Willmott, H. ‘Ethical Statements as Smokescreens for Sectional Interests: The Case of the UK Accountancy Profession", Journal of Business Ethics, Vol. 13, No. 1, 1994, pages 39-51)
12. The Joint Disciplinary Scheme’s 1996 inquiry into the audits of The International Signal and Control Group Plc (part of Ferranti) noted that though the company was audited by Peat Marwick Mitchell (now KPMG), part of the audit was actually conducted by the firm’s American firm. The regulators state that “very considerable difficulties were experienced in gaining such access” and that the UK investigators were “not permitted to photocopy relevant material on any of the American firm’s files, rendering extensive note-taking necessary”.
13. The 1992 US Senate’s report on the closure of BCCI (John Kerry and Hank Brown, ‘The BCCI Affair’, Washington, US Printing Office) and the role of its auditors (some seven years after the BCCI debacle, there is still not report on the role of the UK audits) argued that partnerships structures for accountancy firms are not appropriate. It is recalled that in this case Price Waterhouse (who advertise themselves as ‘international’, ‘global’, ‘multinational’ business) suddenly argued that various national practices are separate entities (in which case all their advertising is misleading). Price Waterhouse (UK) refused to honour the subpoenas issued by the US Senate. The Senators made three recommendations (see chapter 10 of the report). Firstly, that a condition of licensing to operate in a country (say USA or UK) be that the firm be required to respond to any subpoenas issued by the host country and produce the evidence requested, regardless of where the affiliated entity is located. Secondly, the firms could be persuaded (voluntarily or through legislation, if necessary) to devise schemes and procedures (say a world wide Memorandum of Association), which bind all other members (e.g. firms in UK, USA etc.). Thus if Price Waterhouse (UK) is subpoenaed by a House of Commons Select Committee and is required to produce documents possessed by any of its affiliates, it will have to provide that information, subject to the laws of the jurisdictions (as modified by any treaty with the UK) in which the firm operates. Thirdly, legislation (say in the UK) could require that only UK based firms (or their affiliates who agree to the requirements of the UK regulators) could audit a UK based or UK registered entity.
The LLP proposals give no consideration to the appropriateness of a partnership structure for major accountancy firms or to the regulatory problems caused by such structures
Misplaced Faith in Professional Regulation
14. The Consultation paper continues to encourage the belief that professional regulation (e.g. of auditors under the Companies Act 1989) offers adequate public assurance. This is questionable. The idea that professional bodies can make the rules, collect subscriptions from their members, lobby for giant firms (as on auditor liability), discipline them and effectively defend the ‘public interest’ is unacceptable.
We all know how professional bodies have a history of opposing reforms (see the paper by Puxty, T., Sikka, P. And Willmott, H. ‘(Re)Forming the Circle: Education, Ethics and Accountancy Practices’, Accounting Education, Vol. 3, No. 1, 1994, pages 77-92). The ACCA and ICAEW submissions to the DTI on auditor liability do not contain even one idea for advancing consumer rights.
15. The professional bodies were formed to protect and advance the interests of their members. None of the accountancy professional bodies owes (under statute, ethical code of any bye-law) a ‘duty of care’ to the public.
16. The public has no ‘right of appeal’ against any decisions made by the RSBs. Even the so called Ombudsmen are appointed and remunerated by them. There is no independence. None of the RSBs has compensated stakeholders who have suffered losses due to the actions of auditors authorised by them.
17. The professional bodies do not compensate anyone who might have suffered as a result of their negligence. How many people can really afford to go to the courts?
18. To date, we know nothing about the audits of BCCI, Polly Peck, Levitt, Coloroll, Maxwell, Wickes, Morgan Grenfell, Barings, Queens Moat Houses, Homes Assured, MTM and many others. In short, regulation by accountancy trade associations is ineffective and unacceptable.
19. In most of the cases where the DTI inspectors’ reports criticised major auditing firms, the Joint disciplinary Scheme (JDS) has done its customary whitewash (see Sikka, P. and Willmott, H. ‘Illuminating the State-Profession Relationship: Accountants Acting as Department of Trade and Industry Investigators’, Critical Perspectives on Accounting,, Vol. 6, No. 4, 1995, pages 341-369).
20. The ICAEW even failed to maintain a proper register of the partners for Coopers & Lybrand.
21. The professional regulation of auditors is concerned with compliance with auditor regulations. It is not concerned with ‘quality’ of audits. Audit failures continue to make headlines in newspapers. They have all been the result of failures which are institutionalised in auditing standards. Such standards are the result of the politics of auditing in which firms, their patrons and accountancy trade associations are major players.
22. On numerous occasions, the reports of the Financial Reporting Review Panel (FRRP) have concluded that published company accounts were defective, yet the auditors had given an unqualified audit opinion. The FRRP’s comments amount to a second opinion. It is concerned with the quality of audit opinion given. None of the auditors criticised by the FRRP have been disciplined. The usual disciplinary whitewash has ensued.
Anti-Competitive Nature of the Proposals
23. Currently, three broad categories of business vehicles are available in the UK i.e. sole traders, partnerships (including limited partnerships) and limited liability companies. They are generally available to almost everyone regardless of the business sector, wealth, age etc.
24. The LLP proposal marks a sharp departure from the above principle. Under the DTI proposals, the LLP structure would be available only to those businesses which have a designated professional regulator (e.g. accountants, lawyers, architects etc.). Its considerable privileges on secrecy and liability are not being extended to other businesses. Why not?
25. The LLP proposals are based on the mistaken view that the main business of accountancy firms is auditing and/or insolvency. From what little information the firms allow to fall into the public domain, it is evident that more than 50% of their income is derived from tax, consultancy, executive recruitment and many other categories of non-reserved business. This aspect of the business is not subject to any professional regulation, nor covered by any monitoring arrangements. By extending LLP status to the entire business, the firms would be given advantages which are not available to other businesses operating in consultancy, executive recruitment and other sectors. The LLP proposals are anti-competitive and do not create level playing fields for other businesses.
Under the DTI’s proposals, the LLP status would not be extended to competitors of major accountancy firms who may be selling consultancy etc.. They can only limit their liability through incorporation under the Companies Acts. This route requires fuller disclosure and in most cases an external audit. In contrast, the concessions offered to accountancy firms under the LLP route require less disclosures. Why this built-in discrimination against other businesses?
26. Accountancy firms are predatory and have been expanding aggressively in the field of consultancy. If the LLP status is given to accountancy firms, would it also be given to their acquisitions. Currently, CSL is a consultancy subsidiary of Deloitte & Touche. Would a LLP status granted to Deloitte & Touche also apply to CSL? Would Andersen Consulting enjoy and LLP status just because Arthur Andersen have acquired one? The RSBs have no jurisdiction over the consultancy parts even if they do not trade separately. So how will the LLP status apply? Would it only apply to the auditing parts?
27. The LLP proposals, as drafted, are not durable. They ignore the trends which are emerging. For example, in Scandinavian countries, some banks (e.g. American Express) have begun to enter the audit market and offer one stop shopping. Should the same happen in the UK (perhaps with a specially created offshoot), the legislation would be faced with a dilemma. Should American Express be given LLP privileges and thereby allowed to dilute its public accountability? If American Express is to be forced to create a separate offshoot to compartmentalise audit business, will the accountancy firms be required to do the same?
28. Under the LLP proposals, companies such as KPMG Audit Plc could re-register as LLPs, but the same privileges are not available to other limited companies.
29. In its attempts to appease the accounting lobby, the DTI has overlooked the privileges already enjoyed by accountancy firms. Accountancy firms already enjoy statutory monopolies. Therefore, it is desirable that they should be publicly accountable and required to publish information about their affairs. The reduced public accountability requirements proposed by the LLP proposals do not fit any notion of a stakeholder economy or accountability.
Some Specific Issues
We take specific issue with some comments and proposals contained in the DTI Consultative Paper.
30. Page 1, para 1: says that it “may be impossible for partners to know all other partners and their work in a modern partnership ...”. This raises a number of questions. Are we to understand that individuals are admitted to partnerships without any evaluation of their contribution and input? Parternships do not seem to have any difficulty in sharing the fees and income generated by partners. It seems that only the issues to accountability helps partners to develop collective amnesia. It is perfectly possible for accountancy firms to develop information systems to provide the appropriate information. Carried to its logic, directors of multinational companies could also deny liability and put in claims for concessions by arguing that they do not know other directors.
31. Page 1, para 3: The maintenance of a competitive and up-to-date legal environment should not preclude public accountability.
32. Page 4, para 2.3: The proposals to grant limited liability and all the partnership perks, disadvantage competitors of accountancy firms.
33. Page 5: Since firms are being given limited liability, it is desirable that they be obliged to meet all the accountability provisions required by the Companies Acts i.e. should not be exempt from the Companies Acts disclosure requirements.
34. Page 5, para 2.9 states that “it is not intended to reproduce share capital maintenance requirements of company law since those complex provisions presuppose a form of capitalisation ......”. It should be recalled that many of these provisions are aimed at creditor protection i.e. share capital has been looked as a kind of a reserve fund, out of which creditors could be paid in the event of insolvency. Besides, directors are required to ensure that business does not trade whilst insolvent. Such matters cannot be operationalised without maintenance of capital. As the LLPs are being subjected to similar insolvency requirements, they too need to be subjected to capital maintenance requirements.
35. Page 6, para 2.10: As indicated above, professional regulation does not apply to the entire accountancy firm. Therefore, the proposal to grant LLP status to the entire accountancy firms and deny it to others is anti-competitive.
Within the scope of their consultation document, the ‘clawback’ procedures are inadequate. The period should be at least ‘six’ years and thus bringing it in line with the requirements of the Limitation Act.
36. Pages 7 and 8: The basic proposals appear to be reasonable. However, we do not believe that matters of enforcement should rest with the present bodies responsible for regulating auditing firms. They have not been able to reconcile their trade association and regulatory roles.
37. Page 8, para 3.8: Limited liability companies are required to file Memorandum of Association yet there appears to be no equivalent requirement for LLPs. Why?
38. Page 8, paras 3.9 and 3.10: We believe that all LLPs (and limited companies) should be required to file information within 90 days of the year end thus ensuring that it is timely.
39. Page 9, para 3.11. The absence of the salary disclosure would make it difficult to enforce the ‘clawback’ proposals. Besides, accountancy firm partners are taking advantage of a public monopoly (audit, insolvency). It is difficult to see why they should be exempt from such disclosures whilst their rivals form consultancy companies would be required to reveal the same. We recommend that the salaries, pensions etc. of partners should revealed on exactly the same basis as applicable to limited liability companies.
40. We do not believe that the disclosure proposals are adequate. Without disclosure of remuneration and work-in-progress, LLP accounts cannot be said to show a ‘true and fair’ view (see questions 1-3 in Volume 2 of the consultation paper), at least not in the way it is understood at present.
41. Page 9, Additional Safeguards; We are sympathetic to the DTI’s dilemma and believe that the Jersey approach is unsatisfactory. We believe that the LLPs should be treated in exactly the same way as any other limited liability company and be subjected to the provisions of capital maintenance etc. Indemnity insurance should provide the additional safeguard. After this, any excess may fall upon individual partners, depending upon their level of guilt, if any.
42. Page 10, para 3.16: As a matter of equity, if LLP status is to be made available, it should available to all, not just a select few who have managed to hold the government to ransom. Within this framework, various regulators (e.g. financial services), could devise rules for protecting the public.
43. Page 11: As indicated above, the availability of the LLP status to some firms (e.g. accountancy firms) only would be construed as an anti-competitive measure. If it is to be made available, then subject to safeguards it should be available to all. The fact that professional or other regulators exist does not of itself justify discrimination in favour of accountancy firms. Banks and Building Societies also have designated regulators. Are they to be granted the LLP privileges?
Most of the published accounting research does not support the claims that accountancy bodies have adequate disciplinary and ethical arrangements. The rules may convey one message, but the outcomes do not support the claims.
Overall, in response to Question 8, we do not believe that regulation by professional bodies (or trade associations) should be a necessary condition for LLP status.
44. Pages 12 and 13, ‘Clawback’: the time limit should be six years rather two years.
Page 14, para 3.32; the period should be six years.
45. Page 17, Question 20: LLPs should be available not only to firms of all sizes but all UK entrepreneurs. None should be exempt from insolvency and other safeguards.
46. Page 21: The LLP status should not be conditional upon regulation by a supervisory body. The inappropriateness of this proposal has been mentioned earlier
Proposed Accounting Requirements
47. LLPs should be required to produce group and consolidated accounts
48. As a matter of principle, we believe that LLPs should be subjected to the disclosure requirements applicable under the Companies Acts. They should not be exempt from any major disclosures. Instead of a directors’ report, they should be required to produce a ‘Review’. Emolument of partners, in suitable categories (say between £50,000 -£55,000 and thereafter in £5,000 intervals) should be disclosed. These disclosures provide information to creditors.
49. Applicability of Sections 238 & 239: It is conceivable that some debenture holders may have a right to receive accounts.
50. Section 241: The legislation should state that all partners shall have an equal entitlement to receive annual accounts. This will provide additional safeguard, in case the partnership deed is deficient.
51. As a matter of principle, the Financial Reporting Review Panel (FRRP) should be able to examine the accounts of large LLPs. Such accounts are aimed at informing creditors, consumers, regulatory bodies and other stakeholders and therefore need to be credible.
52. We agree (page 5, Volume 2 of the paper) that small and medium company exemptions should not be made available to LLPs.
53 Page 6, profit and loss account formats: We agree that format 2 appears to be most appropriate. What prevents the UK from developing a format more suitable for LLPs?
54. We believe that in the interest of public accountability and even-handedness with those not operating through a LLP structure, the requirements of Schedule 6 should apply to LLPs.
55. Page 11, Volume 2: LLPs should show profit/loss before taxation and withdrawals. LLP figure could be constructed from the tax levied upon individual partners. This figure can give some indication of the LLP’s (which will be legal persons) contribution to taxation and society generally. Besides, firms will also receive dividends and will be in a position to reclaim tax credits (ACT) etc.
56. All invoices, stationery, letter heads etc. should clearly state that an organisation is a LLP. The organisation’s registration number and registered office should be clearly stated (as for a limited company).
Accountants and their activities have been publicly privileged. They enjoy statutory monopolies (e.g. insolvency, external audits). However, they prefer secrecy and avoid public accountability. This was the prime reason for their Jersey excursion.
The major accountancy firms have been in the front-line demanding LLP. They have sought to hold the British public and Parliament to ransom. We believe that special businesses entities should not be created just for their benefit. In line with previous practices, all forms of business vehicles should be universally available. This provides level playing fields for all concerned.
Currently, there are few safeguards to bring accountancy firms
to account. The present regulatory bodies have done little to bring the
firms to account, check their excesses, conflicts of interests or defend
the public interest. The extension of the LLP privileges to accountancy
firms should be accompanied by an independent, statute-based regulator.
The government has already recognised the need for this in financial services
and other sectors. Too many regulators results in waste, duplication and
ineffective regulation. The auditing and insolvency industries need to
be regulated by an independent regulator. Only an independent regulator
(rather than numerous overlapping RSBs and RPB) can advance and defend
the public interest.
20 May 1997