FRC sketches out initial views on audit sanctions for auditors and directors

The Financial Reporting Council (FRC) has set out its preliminary interpretation of the sanctions regime under the government’s proposed audit reforms and plans to hire new staff to strengthen its director oversight programme

The government is planning a major overhaul of the audit market with the introduction of a new sanctions regime which for the first time will extend beyond auditors and firms to directors of the largest listed companies.

In a webinar on the future sanctions regime for directors and accountants under reform proposals, Elizabeth Barrett, executive counsel of the FRC, said: ‘Sir John Kingman recommended an effective enforcement regime holding company directors to account for financial reporting. The government looked at existing enforcement regimes and concluded that the existing regimes would not be effective. They agreed that the new regulator would be given new regulatory powers and these could be exercised whether or not the director was a member of one of the professional bodies.’

The government proposals would extend the remit of the regulator, when it becomes the Audit Regulatory and Governance Authority (ARGA), which is likely to start operating under a new statutory basis from April 2023.

David Johnson, senior lawyer in the FRC enforcement division, said: ‘Company directors are primarily responsible for the truth and fairness of accounts. FRC has no direct powers to enforce those responsibilities. The government intends to legislate to give ARGA the powers to sanction public interest entity (PIE) directors.

‘The government intention is that the new obligations will cover corporate reporting and company audits. It will give ARGA the ability to issue a temporary prohibition to an individual from acting as a director of a PIE. Use of these powers will need to be coordinated with existing enforcement regimes.

‘It will not replace existing powers – ARGA powers are intended to work in tandem with the Financial Conduct Authority (FCA) and Serious Fraud Office. There will be a memorandum of understanding with the FCA setting out the separate responsibilities and how the two regulators will work together.

‘The look and feel of the new regime should be similar to the audit enforcement procedure. Where new statutory duties for directors are introduced ARGA should be able to enforce those duties under the new directors’ regime. Within scope is a duty to approve accounts only if give fair and true view, but this is not set out in the Companies Act 2006, so this will be a new statutory responsibility.’

Johnson also said that the consultation document states that ‘directors need to provide adequate accounts’, stressing that this needs clear definition, while directors also need to act with ‘honesty and integrity’.

The proposals call for a more robust enforcement regime although it is likely that the full extent of sanctions will reflect the current level of penalties.

Barrett said: ‘The idea of a new enforcement regime will give rise to interest in terms of its scope and range. It would give the regulator the powers to investigate whether there has been a breach, and the regime would provide a graduated range of civil sanctions and the government stressed that the regulator would have to issue sanctions in a proportionate manner.’

The current enforcement regime comprises the FRC accounting scheme, a voluntary scheme between professional bodies including the ICAEW, ICAS, ACCA and ICAS, and the FRC. Investigatory powers apply only to member firms and the initial FRC review of the current regime found powers lacked effectiveness and the regulator needed to be given new powers in line with regulatory auditors rules.

The major change in the current proposals include the introduction of a statutory scheme.

‘The government is looking at replacing voluntary arrangements with a statutory scheme,’ said Barrett. ‘A very important element of investigations is that there should be alignment with test for action with professional accountants. It has to be a matter in the public interest and the misconduct test will be replaced – there will be a new holistic framework that applies to the audit of financial statements.

‘The government intention is to restrict the new powers to members of professional accounting bodies but in order to avoid regulatory arbitrage or gaps in the future, this matter is going to be kept under review.’

It is also worth noting that the reach of the regulator’s future powers will also be reviewed.

Johnson said: ‘In order to ensure that the regulator’s powers remain effective, there are two options in the consultation document, one by giving secretary of state a power to compel persons providing accountancy services to PIEs to be a member of a professional accountancy body. Option 2 proposes  extending covered services to anyone providing audit services to PIEs.’

There are also proposed changes to the code of ethics for auditors and accountants, replacing the existing codes overseen by professional institutes.

‘The government proposes to give the regulator the power to establish a standardised code of ethics with which members of the chartered bodies – individual members or firms - would be required to comply and which would be enforceable by the regulator using its new powers,’ Barrett said. ‘It would cover the exiting fundamental principles including integrity and confidentiality.

‘The government considers that the regulator’s powers should apply to breaches of ethics in public interest regardless of whether the individual or firm is engaged by a public interest entity. The definition of PIE is also being reviewed by the government.

The test for liability would be the civil test and the regime would provide a graduated range of sanctions taking into account matters such as seriousness and risk.

‘The government has concluded that the range of sanctions under the voluntary scheme is sufficient ranging from reprimands, existing powers to repay fees and also financial sanctions, and at the extreme range the ability to exclude accountants from professional bodies or to provide services to PIEs,’ Barrett added.

With the provisional launch date of ARGA set for 2023, it is unlikely that draft legislation will be issued before early 2022.

There are still a number of issues to clarify about the future sanctions regime and the FRC was unable to confirm whether the powers of enforcement would be retrospective and cover ongoing investigations.

Barrett said: ‘The whole issue of timing of implementation is under review – there is a section in the consultation document which addresses when any proposals should be introduced. The new regulator would be set up first, then there are some options about phasing in proposals.’

What are implications of directors for companies that are not PIEs?

‘There are a number of moving parts, the definition of PIE is being consulted on and is up for debate itself, but we are talking about substantial companies not SMEs,’ Johnson said.

There is still a lack of clarity about the future appeals process, but there is likely to be a similar framework to the existing appeal system.

Barrett said: ‘We need first of all to receive the responses to the consultation and then depending on government  decisions, we will need to do a great deal of work in relation to the procedure and the creation of the relevant requirements in respect of which any powers over accountants and auditors would be applied. Those procedural requirements would set out the threshold test and any appeal mechanisms.

‘The existing audit enforcement procedure was introduced in 2016 and at the time we said it would be reviewed after it was implemented. The current thinking is that there will be revisions to the procedure and a consultation is likely to be issued later this year. One thing that would probably make sense is that there would be a single procedural framework that would apply to all individuals operating in the financial reporting space including auditors, accountants and directors.

How proportionate will the regulator be when taking action?

‘We have a published sanctions policy which explains all the factors taken into account, including mitigation. The sanctions policy does take into account the resources of the individual and the entity and I would expect that to continue. The record sanction to date imposed by the FRC is £15m,’ said Barrett.

‘There are instances where we have already reduced fines in cases where issues around financial resources,’ added Johnson.

There are questions about how the new rules will affect professional bodies.

‘There are a lot of moving parts and we are still trying to scope out the framework,’ said Johnson. ‘They will still have powers over their members and will be able to extend member requirements. Where it is a public interest case, the FRC has the power to take that case on and would envisage that is how the new regime will operate.’

The extension of enforcement powers are also likely to put pressure on existing resources at the FRC and it will be looking to beef up its director enforcement capability.

‘One of the things that FRC has done from beginning of January is to streamline its governance processes and as part of that has removed various committees and panels, and has established five committees of the board. In parallel it has established special advisers to provide advice to committees and to the executive, and also established an advisory panel with individuals with experience on audit committees and auditors. We would expect that to continue,’ said Barrett.

‘There are three important stages – the consultation process, the commentary and the legislation approved by the Houses of Parliament to bring in scope of regulations, second, to give scope of powers to ARGA and third and very important, the new regulator will have to operationalise its resources so it can hit the ground running and have all the powers – there is a need for ongoing growth in numbers and to focus on and expand the scope of expertise that is available within the regulator.’

The FRC is running a series of webinars on the audit reform consultation, focusing on different aspects of the proposals and will also host a series of roundtables split by different stakeholder groups including companies and boards, investors, auditors, firms and professional bodies, and lawyers. These will kick off from the end of April and will run for five weeks.

The audit reform consultation closes for comment on 8 July.

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