The record number of fines is the result of the conclusion of a number of long-standing cases, with audit firms slated for poor quality audit and lack of interrogation of accounts, with the majority of fines around the £5m mark. The regulator has also been under pressure following the Clarke report to issue higher fines for audit misconduct.

There was a near trebling in annual fines and sanctions from £15.5m in 2017/18 to £42.9m in 2018/19, as the FRC reacts to the recommendations of the Clarke review to issue far more punitive fines around the £10m mark to prove a real deterrent to audit firms. Even after discount, fines totalled £32m, despite heavier discounting of fines than in previous years. ‘The increase also reflects the serious nature of the misconduct and the size of the audit firms’, the FRC said.

The worst performing audit firm was KPMG, which was hit with £18.5m in fines before discounts (£15.25m), while individual audit partners at the firm were handed cumulative personal fines of some £525,000, although some of these were subsequently discounted. These fines related to audits for Quindell, Ted Baker, Equity Syndicate and Co-operative Bank.

PwC received the largest fine of £10m over the BHS audit, with the audit partner given a £500,000 fine, reduced to £325,000. The initial £10m fine was reduced to £6.5m but was still the largest ever fine given for misconduct in an audit, reflecting the severity of the audit failures.

Deloitte was landed with a £6.5m fine over the Serco audit, reduced to £4.2m, with a hefty £150,000 fine for the audit partner.

Grant Thornton, facing a number of major audit enquiries, was given a £4m (reduced to £3m) for the Nichols plc and University of Salford audit with three partners singled out for £60,000 personal fines.

Two smaller mid-tier firms were also given sanctions, with Baker Tilly (now RSM Group) fined £750,000 for the Tanfield Group audit with individual audit partners fined £65,000 each, while MRS (formerly Moore Stephens) was fined £825,000 (reduced to £455,000) with a £100,000 fine for the audit partner.

This comes after a series of major audit failures under investigation including Carillion and Patisserie Valerie as the audit profession comes under intense scrutiny for poor quality audits performed over a number of years, and efforts by the regulator to react more quickly to audit failure.

Over the year, 15 investigations opened and the aim is to conclude these more quickly, FRC said, unlike in recent years where some probes have taken five to eight years to resolve. However, there are still 41 open cases dating back to reviews of audits of financial statements relating to 2011 year ends.

The overall number is broadly similar to 2017/18 when 14 investigations opened.

Major investigations were launched into a number of Grant Thornton audits, including Patisserie Valerie and Interserve, Deloitte over SIG financial statements, and KPMG for the Conviviality audit while the Carillion probe was extended to look back at transactions between Carillion plc ad Wipro Ltd for year end 31 December 2013.

Audit partners have also been hit with £1.6m in personal fines, significantly up from only £500,000 in 2017/18, illustrating a shift in personal responsibility.

At the same time, the regulator has come down hard on individual firms, issuing more non-financial sanctions, rising from 11 in 2017/18 to 38 in 2018/2019. These include requiring firms to change audit practice and closer oversight by the regulator, as well as some firms such as Grant Thornton being put into ‘special measures’ with a warning that it must improve its audit performance significantly. A lack of scepticism and independence were repeatedly flagged as problematic with the poorest audits.

On reaching the decision on the size of fines, FRC said: ‘Financial sanctions also take into account the size and financial resources of the audit firms. Of the nine sanctions imposed on audit firms, six related to Big Four firms. Whilst there is no set mathematical formula (which was rejected by the Clarke report) the turnover of the firm, its revenue and profit per partner are all measures which may be taken into account in determining a proportionate financial sanction.’

This is the first time the FRC has issued a detailed report on its enforcement activity, setting out the status of current investigations and detailing the fines levied over the last 12 months. It also highlights role of non-financial sanctions such as exclusions and ongoing monitoring to address misconduct and improve behaviour.

In 2018/19, horizon scanning activities, where the FRC identifies issues requiring investigation, accounted for 25 (over 54%) of the enquiries opened compared to 14 (27%) in 2017/18. Of the 25 cases identified in 2018/19, the majority (17 or 68%) were from London Stock Exchange RNS updates related to errors in prior year financial statements.

The review shows that progress has been made in concluding legacy cases, while the enforcement team has been bolstered with additional staff. The FRC said ‘resourcing has increased significantly, with further growth planned, and processes have been streamlined. These changes are beginning to show results’.

Fiona Czerniawska, director of Source Global Research, said: ‘Higher fines and tougher enforcement procedures will naturally lead to a greater focus on quality by all audit firms, but we mustn’t forget that the majority of audit work is of a high quality. There’s a danger that the approach being taken by the government and regulators to audit quality is one-dimensional. Management teams provide data and context to the financial audit, and the government should consider what more can be done to ensure that they fulfil their obligations.’

The regulator also said that more cases were being resolved using the constructive engagement process, which involves close dialogue with firms. This was used in 19 cases involving errors in financial statements which led to subsequent restatements. This approach was used where the errors were not deemed to be of fundamental importance to the measurement of the underlying financial performance of the entity or where the underlying accounting issues were highly technical.

Elizabeth Barrett, the FRC’s executive counsel said: ‘The clarity and accuracy of financial reporting is of critical importance to us all. The significant increase in the number, range and severity of sanctions sends a clear message that where behaviour falls short of what is required, we will hold those responsible to account.

‘Improved behaviour by those we regulate requires recognition that where failures occur their root causes must be identified, effectively addressed and reported to us. Where such co-operation occurs due credit will be given; where it does not, consequences will be severe.’

The detailed 76-page review provides a baseline for measuring future enforcement performance as the FRC is overhauled and restructured as a more robust regulator - the Audit, Reporting and Governance Authority (ARGA).

The FRC is going through a period of upheaval with changes in senior management have been made to lead the transition with the appointment of current HMRC chief, Jon Thompson, as chief executive to replace outgoing Stephen Haddrill from October. John Dingemans has also been appointed as chairman, a maximum three-day a week job, as Sir Win Bischoff steps down.

Report by Sara White | 31-07-2019

FRC Audit Enforcement Report 2019