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Legal experts are expressing skepticism about the potential improvement in audit quality following the record fines imposed on audit firms by the UK's Financial Reporting Council (FRC) in the last fiscal year. The FRC's July enforcement review revealed 19 cases resolved, with financial sanctions totaling £40.5 million ($51.6 million). This included a then-record £20 million ($24 million) penalty against KPMG for dishonesty related to audits of Carillion and Regenersis, a figure surpassed in October when KPMG was assessed a £26.5 million ($32 million) fine, before reductions, for its broader Carillion failings.
Richard Burger, a partner in law firm WilmerHale’s investigations practice, commented, "It does demonstrate that the enforcement function of the FRC is more robust and better resourced." He said higher financial penalties are likely in the future because the revenue of the corporates involved and/or audit fees charged are also rising.
“Fines are increasing and tolerance for breaches of audit standards is low,” noted Julie Matheson, accounting regulatory partner at law firm Kingsley Napley. She added, “Although the FRC’s drive is to increase competition in the audit market, the regulatory outcomes that we are seeing may have a chilling effect on those firms considering whether to tender for the audits of PIEs because they will need to consider whether to take the risk of an adverse finding by the FRC and a resultant significant fine.”
Fines typically result from investigations begun many years ago and so are not necessarily representative of current audit practices. As such, auditors are likely to continue working as they do because their failings are deemed to be “historic,” said one expert who declined to be named.
Paul Brehony, partner at law firm Signature Litigation, said the FRC’s track record sends out “mixed messages.” He said the Big Four are firmly in the FRC’s sights. Across the regulator’s current portfolio of 38 open investigations, he said, 32 relate to audit work. Of new investigations opened last year, 24 relate to Big Four firms, with integrity failings and going concern issues remaining in the spotlight.
“Any findings in either respect could very well result in significant, headline-grabbing fines,” said Brehony.
He said the FRC is trying to establish that it expects audit firms to be “proactively cooperative” and focused on “constructive engagement,” while self-reporting “remains encouraged and incentivized by significant financial discounts.”
The publication of the latest corporate governance code on Monday will fuel the FRC’s hopes companies do more to improve their reporting around financial and nonfinancial risks. Investors have raised concerns that poor audit work was exacerbated by a lack of proper disclosure by executives in several instances of recent governance failures.
Among the limited number of changes to the code, the board is no longer responsible just for establishing the risk management and internal control framework but also for maintaining and reviewing the effectiveness of it.
Under a new provision, boards should provide in the annual report:
A description of how they have monitored and reviewed the effectiveness of the framework;
A declaration of effectiveness of the material controls, including financial, operational, reporting, and compliance controls; and
A description of any material controls which have not operated effectively, as well as what actions were taken or proposed to improve them.
Executives also must provide details of any action taken to address previously reported issues.
By fLEXI tEAM
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