FRC calls for rewrite of Companies Act to improve audit

The head of the audit regulator, the Financial Reporting Council (FRC), is calling for a significant overhaul of the 2006 Companies Act as a way to reform the audit market, raise standards and restore public confidence in audit firms, which MPs described as 'tantalising'

Questioned by MPs on the Business, Energy and Industrial Strategy (BEIS) Committee about failures on the part of the country’s largest professional institute and the audit regulator to control the Big Four auditors and ensure quality standards in audit, FRC chief executive Stephen Haddrill was asked what changes to legislation would make a real impact on the audit profession.

In a surprise admission, the head of the audit regulator, a body whose own future is threatened following calls for the creation of a new regulatory body with statutory powers following the Kingman Review, said the best option would be for a radical overhaul of the Companies Act.

MPs described Haddrill’s comments as ‘tantalising’, asking what he would like to see the legislation looking like, if there was to be significant reform.

Haddrill said: ‘If you take the Kingman report, and CMA [Competition and Markets Authority] and potentially Sir Donald Brydon’s report, what we need to construct is an integrated and coherent package to reviews the Companies Act and sets out a new strategic framework for expectations of audit, the expectations of directors in relation to reporting, what standards they [auditors] are going to meet, whether there should be a Sarbanes-Oxley overlay and the expectations of the regulator.’

He stopped short of calling for a rewrite of the Companies Act, stating: ‘This would not mean redoing the Companies Act as that would take 10 years, but it does need to be thought through as a single package.’

While the representative from Association of Chartered Certified Accountants (ACCA) did not go so far, there was clearly strong support for radical reform of the current audit structure and perceived lack of regulatory oversight, while the dominance of the Big Four audit firms was clearly a cause for concern.

Maggie McGhee, executive director, governance at ACCA said: ‘We have reviewed all of the proposals against quality and not considered cost. We have seen the CMA reports and that did not see a reduction in audit costs were down because of retendering.

‘We believe audits should be fairly priced, audit committee chairs are pivotal as are investors. In terms of separation of firms want to make sure it is not just on paper, and that is why we have particularly focused on the cooling off period between completing the audit and then when firms can sell on non-audit services which would be banned when firm is handling audit.’

The future of the audit regulator is up in the air due to the Kingman review, which proposes setting up a new body, tentatively called the Auditing, Reporting and Governance Authority (ARGA), with statutory powers to directly regulate major audit firms and make use of a stronger enforcement regime. It would also cover directors who are not members of professional bodies.

On Kingman, Haddrill said: ‘I think there are a couple of areas where we need a bit of clarity going forward, for example, the new regulator being there for investors, but there has been a lot of work done around the last couple of years to meet the interests of wider society and investors, that must be built out.’

When pressed about Big Four conflict on the FRC board, Haddrill said: ‘It is necessary for the regulatory board to have some serious accounting experience on it; there should be one or two at most [ex Big Four partners], and also there has got to be a clear cooling off period – three years at least, moving towards five years. But you do need someone that is technically strong.’

MPs questioned outgoing Haddrill on what his successor could learn following a challenging decade since the crash in 2008.

‘What I would say to my successor is that there a number of things that are practice in the profession,’ said Haddrill. ‘The auditor is clearly responsible for pursuing fraud but there is a mythology which has grown up where the auditor says it is not going to find it… we [the auditors] are not really on the hook for that, but the public expectation has shifted.

‘It will be important to think about where is the public interest, and where is it going to be? I think I should have had more foresight after the crash,’ he added.

This issue around conflicts of interest was flagged by MPs, with criticism of the FRC’s reluctance to investigate the KPMG audit of HBOS and its apparently soft approach to audit quality inspection reports at companies like Carillion where signs of financial instability were seemingly overlooked. It was also exercised about the AssetCo audit judgment, handed down this week, which saw a £12m damages bill for mid-tier firm Grant Thornton over ‘flagrant’ audit failures.

When MPs asked ‘how do you make changes in the market and separate audit and non-audit services, Izza responded that the audit profession and firms ‘now have to move – that the rubicon has been passed’, and if there is a radical shake-up of the audit profession, splitting up the Big Four firms will be ‘inevitable’.

Haddrill held back on the breakup of the firms, clearly not convinced that this approach was inevitable, putting pressure on audit committees to really take audit quality inspection reports more seriously.

An earlier joint BEIS/DWP joint committee report into the collapse of Carillion heavily criticised FRC and described it as a toothless regulator, an issue once again raised at today’s hearing.

MPs said the FRC’s work should contribute to avoid major causes of corporate failure and asked why the FRC did not do more to avert corporate disasters.

Haddrill said: ‘It is very difficult for a regulator whose powers are focused on achieving audit quality across the piece to intervene.’

This was not sufficient for MPs, who asked whether Haddrill seriously was arguing that ‘the effectiveness [of the regulator] was limited by lack of powers?’.

‘Absolutely – we get the report and accounts, ask the company a lot of questions but do not have the ability to send someone into the company to check this out,’ Haddrill said.

The FRC was asked to report back as soon as possible on how many audits the regulator looked at in the last five years where companies did not depreciate goodwill and what action you took to deal with the issue.

Report by Sara White

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