When it comes to the crunch

As the financial turmoil continues, there should be a serious scrutiny of who is responsible for safeguarding people's savings and investments.

As anxieties about the credit crunch and banking spread, attention should shift to the way banks and insurance companies are governed. Savers often stand to lose more money than shareholders. There should be a serious scrutiny of who is responsible for safeguarding their savings and investments.

Banks and insurance companies are managed by their board of directors. Some reassurance about their probity may be provided by audited financial statements, but the system does not privilege the interests of savers.

Savers in banks and insurance companies can lose their savings, investments and pensions, but unlike shareholders they do not have the statutory right to elect directors. The company law does not require directors to owe a "duty of care" to savers. They can't attend company AGMs, receive accounts, ask questions or table resolutions even though their savings may be wiped out by risky decisions made by directors.

The UK law requires that companies, including banks and insurance companies, should be run primarily for the benefit of their shareholders. So if directors invest in risky financial instruments and their gambles pay off, shareholders receive higher dividends and stock market appreciation of their shares. Directors receive fat cat salaries, but savers pick up measly returns. If the gamble fails and the company teeters on the edge of collapse then savers stand to lose their savings. Yet they have no voice in the way companies are governed.

Despite the risks, savers do not have any say in the appointment or removal of auditors. Following the House of Lords Caparo judgment, now part of the UK's Companies Act 2006, auditors do not owe a "duty of care" to any individual shareholder, creditor, or saver. In general, they only owe a "duty of care" to the company or shareholders collectively.

Might savers benefit from audit effort exerted for the protection of shareholders? There is bad news on that front as well. The economic incentives to deliver good audits have been diluted by a series of liability concessions for auditors. An EU study has recommended that to protect auditors, often from the folly of their actions, their liability should be "capped". With diminished liability auditors have little reason to be vigilant.

With the increasing complexity of financial transactions it is extremely doubtful that any multinational bank can be effectively audited. Even Nick Leeson, of the Barings fame, recently said that "the regulators, auditors and compliance officials are constantly playing catch-up" and can't really deal with corporate adventures, greed or misbehaviour.

Worried savers may seek some comfort from company audit reports, but they are in for a shock. Northern Rock's audit report, as the law requires, is addressed to the company or shareholders collectively. In case any saver or shareholder gets any idea of relying on the audit report to make any risk assessments, Northern Rock auditors PricewaterhouseCoopers have protected themselves with a customary disclaimer. It reads:

"This report, including the opinion, has been prepared for and only for the Company's members as a body in accordance with Section 235 of the Companies Act 1985 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing."

So published company accounts provide little comfort to savers.

The Financial Services Authority (FSA) is the ultimate regulator of the financial services industry. It can use taxpayer's monies to bail out distressed companies, but does not appoint their directors. Under law it can hold discussions with auditors about possible irregularities at entities regulated by it, but it does not appoint company auditors. Audit reports are not addressed to it and auditors don't owe a "duty of care" to it.

The current financial woes should encourage reforms of corporate governance. Savers at banks and insurance companies should elect directors and auditors. They should have the rights to receive information, question directors and auditors. Directors and auditors should owe a "duty of care" to savers. Their interests should not be subordinated to the interests of shareholders. Only democratisation of the financial industry holds out the possibility of durable reforms.