The Treasury Committee’s inquiry into the failure of HBOS and the role of regulators was heavily critical of the FRC’s role and in particular its decision not to launch an immediate inquiry into KPMG’s auditing of the bank in 2007 and 2008, in the run-up to the crisis. 

It said the FRC’s decision not to go ahead, taken in 2013 and well before the completion of the final HBOS report, was ‘a serious mistake’ as it meant the auditing of the bank had escaped scrutiny.

While pressure from Parliament and the committee did result in the FRC opening an inquiry in June 2016, this was described as a ‘very tardy response’ which ‘appears to be as inexplicable as it is unacceptable’.

FRC has now, at the committee’s request, published a report outlining its actions in respect of investigating KPMG.

The FRC report states: ‘While much work was undertaken in the period between 2009 and 2013, we were not sufficiently proactive in making enquiries in relation to the HBOS audit and relied too heavily on the work of the FSA and the FCA/PRA and on the information provided by them.

‘The FSA was the lead regulator in relation to the banks but it was not right to regard them as the lead regulator in relation to audit. We should have adopted a more proactive role and acted more quickly.’

In a letter to the committee accompanying the report, FRC chief executive Stephen Haddrill said: ‘We were concerned that the limitations in our powers to secure information from companies meant it was sensible to await the conclusions of the financial services regulators which had full access to information and whose conclusions would enable us to focus our own work better.

‘However, these other investigations took much longer than initially expected and, therefore, a substantial gap in inquiries in relation to audit opened up while the FSA and FCA/PRA work was underway.

‘FRC investigations should be undertaken in parallel so that there is no unnecessary delay in reaching conclusions, and so our evidence can be fed into other inquiries if appropriate.’

The FRC also says that, at the time, the definition of misconduct, which was the evidential threshold for taking action against auditors under its accountancy scheme, was high and did not necessarily allow for holding auditors to account for poor quality audits. This has now changed with the introduction of the new audit enforcement procedure.

However, Haddrill said in the letter: ‘The old test remains in being in relation to cases involving accountant members of the professional accountancy bodies. We are reviewing this with the bodies as they need to agree to participate in any new arrangements. It is our view that accountants in public interest roles should be subject to a similar threshold of accountability as auditors now are to protect the public interest. We would appreciate your support for this and, if necessary, legislation.’

In the report, the regulator also concedes that it could have done more to explain why and how it came to its decision with regard to HBOS.

The report states: ‘Public interest in and criticism of the outcome of our enquiries and investigation has highlighted a concern that we do not sufficiently explain the reasons for our decisions to close cases. In future, where there is a clear public interest to do so and subject to any applicable legal restraints, we will publish a summary of our reasons for closing an investigation.’

Following the report's publication, the Treasury Committee confirmed it would call the FRC to give further evidence in the New Year.

Committee chair Nicky Morgan said: 'This long-awaited report rightly acknowledges that the FRC should have been more ‘proactive’ in investigating KMPG’s audit of HBOS. It was only through pressure from the Treasury Committee that the FRC decided to act.

‘As Mr Haddrill says, the report sets out the lessons that the FRC has learned for the future. We will be calling the FRC to give evidence in the New Year to discuss whether their conclusions go far enough.’

In a statement following the FRC report's publication, KPMG said: 'Over the last nine years the FRC, PRA and FCA have examined the events that led to the failure of HBOS in detail. Throughout this process, we have maintained that our work met the applicable audit standards of the time. The FRC’s report clearly shows we considered the risks facing the bank, including liquidity and loan loss provisions and reported our concerns to those charged with governance at HBoS.

'As the FRC’s report notes, the intensification of the financial crisis in late 2008 was not foreseen by market participants. The Bank of England continued to forecast positive GDP growth until August 2008, while HBoS reported pre-tax profits of £5.5bn in its 2007 financial statements and continued to raise capital in the wholesale markets well into 2008.

'The PRA and FCA’s report into “The failure of HBOS plc”, published in November 2015, states that during the period from September 2007 to February 2008 “HBoS appeared to be weathering the early storm reasonably well following steps taken in August 2007 to renew its wholesale funding. At that time, the possibility that HBOS would fail still appeared extremely remote.” The sudden escalation of the crisis in the final quarter of 2008 affected many financial institutions, of which HBOS was one.

'The collapse of HBOS has served to underline the persistent and widening gap between what society expects of an audit and what an audit has been designed to do.

'It is clear with the benefit of hindsight that there were lessons to be learned regarding how banks operate and how the profession audits financial institutions. While the profession has risen to and responded to this challenge, questions over the scope of audit remain. We are committed to working with the FRC and our peers to listen to these concerns and redefine the remit and purpose of audit, to ensure it better serves investors, business and the public at large.' 

The report on the FRC’s enquiries and investigation of KPMG’s 2007 and 2008 audits of HBOS is here.

Stephen Haddrill’s letter to the Treasury select committee is here.

Report by Pat Sweet