Multimillion pound fines could reduce competition in audit market

Accountancy firms and institutes have raised concerns that if the Financial Reporting Council (FRC) continues to impose growing fines for audit misconduct it could result in a lack of competition, as firms may leave or avoid the listed markets due to a higher level of risk, reports Amy Austin

The Big Four audit firms, ICAEW and a handful of mid-tier firms were among the 29 respondents to the FRC’s independent sanctions review, chaired by former Court of Appeal Judge Sir Christopher Clarke, who provided recommendations for improvements to the FRC sanctions regime and voiced concerns to the regulator regarding growing fines in the audit market.

A major concern that was raised was if the FRC continues to raise sanctions as it has been doing recently, with PwC holding the record after being fined £5.1m for its RSM Tenon audit, it could lead to a lack of competition in the audit market.

The FTSE 350 audit market is currently dominated by the Big Four but the risk of receiving large fines could be deterring mid-tier firms from entering this market. In its response to the FRC’s sanctions review, Moore Stephens said: ‘Firms may decide that they wish to leave, or not enter this market on the basis of the perceived higher level of risk.’

PwC agreed saying: ‘Whilst large financial sanctions generate headlines, we would also caution against unintended consequences including dis-incentivising mid-tier firms from growing their audit practices and possibly reducing choice of auditors for clients who are perceived as higher risk.’

PwC warned the FRC about raising fines further stating that this action could damage the public confidence in audit, restrict competition and choice in the audit market, damage accountancy as a profession and career choice, and impact on audit quality.

It is not only firms that voiced this concern as accounting institutes are also worried that this could become a trend. The ICAEW said: ‘Market exit from what is already a narrow market would become a real possibility for one or more firms including the Big Four.

‘The setting of fines in our view should be linked solely to the audit operation of a firm and be a discomfort but not terminal to its trading position.’

Deloitte warned the FRC about rising fines further, commenting: ‘We believe that financial penalties are already very high and increasing them further is likely to have unintended consequences, making a partner role less appealing to current and future generations of auditors, weakening the attractiveness of the profession and potentially reducing competition in the audit market.’

‘We believe sanctions should be better targeted, more proportionate, enforce remedial action and, where applicable, be aligned with sanctions for company directors.’

Non-financial sanctions

Audit firms believe there should be more focus on non-financial sanctions to change auditor behaviours rather than to simply punish it.

Grant Thornton, in its recommendations says the regulator should put more emphasis on changing behaviour enabling people to learn from their mistakes, use more non-financial sanctions and promote good behaviour.

PwC suggests: ‘Tribunals and decision-makers should consider making greater use of other non-financial sanctions penalties that are available, for example an undertaking requiring that staff in a member firm are subject to mandatory training and also that any such undertakings imposed by the FRC should be actively monitored.’

In its response the AAT said: ‘ The regulatory objectives are supported by having the full range of financial and non-financial sanctions available that are more likely to deter members of the accountancy profession from committing misconduct.

‘For example, a member of a member firm may not change their behaviour by the application of a fine whereas, given the more substantive implications, they are likely to take exclusion rather more seriously.’

Severity of fines

The majority of respondents said that they do not think that the FRC’s fines are too low however, a group of legal chairs, including the Rt Hon Sir Stanley Burton from One Essex Court, believe that the general level of financial sanctions is too low saying that they are out of proportion to sanctions imposed by other regulators, such as the Financial Conduct Authority (FCA).

The AAT did not comment when questioned about the severity of fines.

A response submitted by the FRC’s enforcement division said: ‘We are strongly of the view that the time periods and the ranges of percentage discounts should be reviewed to ensure that there are far great incentives for early settlement.’

RSM said that ‘there is a risk of assuming firstly that sanction should be principally financial in nature and secondly that the higher the financial sanctions the more effective the regulatory system’.

According to the FRC sanctions guidance, ‘the primary purpose of imposing sanctions for acts of misconduct is not to punish, but to protect the public and wider interest’.

The sanctions report found that the irreducible minimum for any financial penalty will, in many cases, be an order for the waiver or repayment of the relevant fees, unless for any reason that is impractical or inappropriate, eg, where the client has ceased to exist, or has acted in a dishonest manner, or been complicit in the wrongdoing or otherwise culpable. Any value received by the client from the services should also be taken in to account.

Such a fine would be commensurate with the seriousness of the wrongdoing, act as a meaningful deterrent, and be sufficient to meet the primary objectives of sanctions. It also assumes that the failings did not involve dishonesty or conscious wrongdoing. If they did, the figure could be well above that.

Background information

Sanctions Review Responses.

Independent review of the Financial Reporting Council’s Enforcement Procedures Sanctions.

Further reading

FTSE 100: Auditors Survey 2017

FTSE 250 Auditors Survey 2017: sting in the tail as audit fees rise

Report by Amy Austin

Amy Austin |Reporter, Accountancy Daily [2016-2019]

Amy Austin was reporter, Accountancy Daily and Accountancy magazine, published by ...

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