Emile Woolf - Qualified audit reports: please don't show them to the FRRP

Proposals to encourage auditors to pass qualified reports to the FRRP are not in the public interest, argues Emile Woolf.

In June, the Financial Reporting Review Panel (FRRP) published a consultation paper called Proposal to Encourage Voluntary Disclosure of Qualified Audit Reports. The text makes it clear, however, that it is the auditor rather than the company that is being 'encouraged' to make voluntary disclosure - promptly, ahead of public filings, directly to the FRRP. If implemented, it will apply to auditors of public companies (even if unlisted); private companies which do not qualify as small or medium-sized; and private companies in groups that do not so qualify.

It is, of course, only a consultation paper - but when the Financial Reporting Council or one of its committees gets a 'good idea' that might save it some work or enhance its already awesome powers, implementation tends to follow, especially when the Treasury is persuaded that the idea is indeed a good one. Let us, however, take a closer look.

If the FRRP is not being disingenuous in its choice of words, 'voluntary' must be taken to mean … well, voluntary. That implies by definition that some auditors will oblige the FRRP and some will not. Already we foresee an inconsistency in practice which is inherently unsatisfactory.

A little thought therefore shows that 'voluntary' will not work, so it is not surprising that the paper's final paragraph declares ominously that if the FRRP cannot rely on a voluntary referral mechanism 'it would then need to consider whether there were legal powers it could use to obtain the same information'. Which puts a rather more sinister slant on the FRRP's use of the verb 'to encourage'.

Breaching confidentiality

Contractual privity between auditors and client companies, which includes the obligation to respect confidentiality, may legally be put aside in only a small number of well-defined instances, such as probability of material and pervasive fraud in which management may be implicated (ISA 240); circumstances of non-compliance that give rise to a right/duty to report in the public interest to financial sector regulators (ISA 250); or in the context of money laundering regulations (Proceeds of Crime Act 2003).

The FRRP's proposed initiative, however, pays no heed to considerations that govern the above exceptions. How can it be in the public interest for a panel with little coal-face experience of sensitive auditing issues to encourage auditors to breach confidentiality by passing them qualified reports ahead of all other entitled entities - shareholders, stock exchange, Companies House?

The FRRP's declared objective is to agree 'corrective action' promptly so that markets and user decisions can be promptly informed, and it says that this depends on it being made aware of qualified opinions as soon as possible. In reality, any fair investigation process by the FRRP would be completed long after the accounts, and the qualified audit report, have already become public knowledge.

In the inexorable tide of barely comprehensible accounting rules, the potential for technical dispute is unprecedented. Yet the FRRP harbours the simplistic notion that the issue of a qualified opinion should trigger corrective action that it is somehow more competent to carry out than the auditors themselves.

Serving the public interest

What if there is genuine disagreement between auditors and directors on a particularly complex accounting issue? What if crucial audit evidence is genuinely unavailable through no fault of the directors, and the auditors are therefore unable to form an opinion? On what basis will the auditors be expected to form their own judgment on whether to volunteer disclosure to the FRRP irrespective of the client's views on the subject? What will disclosure do for client relations, and is the consequential attrition really in the public interest?

Given the proposal's immense potential for generating conflict it would, if implemented, risk compromising independence by influencing the audit opinion: auditors will be under great pressure to find a way to justify a clean opinion when a qualification would otherwise have been given. Again, hardly in the public interest.

Indeed, objectively viewed, the FRRP's proposal is actually in no one's interest - except maybe the FRRP.

Emile Woolf is head of Kingston Smith LLP's forensic accounting services, specialising in professional negligence and valuation claims. He is also a director of the Hyperion Insurance Group. The views expressed in this article are those of the author.

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