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The FRC: A story of dismal decline

13th Mar 2019
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Failure to punish those responsible for a series of high-profile accounting blunders ultimately sealed the fate of the Financial Reporting Council (FRC), industry experts believe, and there is little optimism its replacement will fare better unless major change occurs.

On Monday, the government said it will dismantle the FRC in place of a new body with wider legal powers, billed the Audit, Reporting and Governance Authority (ARGA).

“After the recent auditing scandals it's actually no surprise that this is happening,” said Tony Margaritelli, chairman of the Institute of Certified Practising Accountants (ICPA). “The FRC have failed in their duty to oversee and to act when necessary in a meaningful way. I am not saying their work is easy, far from it, but the lack of action and in fact reaction has been tangible. Let's hope the new body looks very closely at ethics for starters.”

Kingman delivers knockout

The government has acted on the findings of an independent review it commissioned in August 2018 by Sir John Kingman into the FRC’s effectiveness. Kingman stated the watchdog should be scrapped immediately in favour of an independent statutory regulator with “the interests of consumers of financial information, not producers” at its heart.

In his 83 recommendations, Kingman said the replacement should be accountable to parliament, and have clarity of purpose and mission, something the FRC lacked.

New leadership would be a certainty, as FRC chairman Stephen Haddrill jumped before he could be pushed, announcing in October 2018 he would go after almost a decade in charge.

Kingman’s findings were published on the same day as the outcome of an equally damning concurrent probe by the Competition and Markets Authority (CMA) into the effectiveness of the wider audit sector.

A month earlier, in November, the department of business, energy and industrial strategy (BEIS) announced a swingeing review into the future of audit would begin once both the Kingman and CMA reviews were complete, hinting the FRC’s days were numbered.

It marks a dismal end for the watchdog, which was formed in 1990 from the bones of six separate accounting, auditing and actuary standards bodies to strengthen corporate governance standards in the UK and the Republic of Ireland.

High-profile failures

One major scandal is unfortunate, several proved careless on the watch of the FRC, which has overseen the failure of two enormous firms in HBOS and Carillion, the almost-failure of eatery Patisserie Valerie, and significant accounting debacles at Tesco and Rolls-Royce.

BEIS select committee chairwoman Rachel Reeves said singled out misleading audits at BHS, Carillion, and at Patisserie Valerie as showing accounts bearing “closer resemblance to works of fiction than an accurate reflection of the true financial performance of the business”.

It is arguable the FRC never recovered from the damage to its reputation caused by the fallout from the collapse of lender HBOS, however.

KPMG had audited the accounts of the bank, and given it a clean bill of health just before it had to be rescued by Lloyds at the height of the 2008 financial crisis, and went on to accumulate losses of £46bn from its corporate division. The FRC later in 2013 reviewed KPMG’s accounting of HBOS and cleared the professional services giant of any wrongdoing.

It emerged that many of the individuals due to probe the failure for the regulator were ex-KPMG employees, prompting fury from MPs who said the regulator was unfit for purpose.

The FRC muddled through, despite mounting criticism, until the construction and services business Carillion went under in January 2018. MP’s slammed the role of KPMG, PricewaterhouseCoopers, EY and Deloitte, and said they all were complicit in Carillion’s liquidation.

The firms were accused of “feasting on what was soon to become a carcass”, as their enquiries revealed that the quartet had charged £71.6m for work relating to Carillion in the ten years leading up to its financial collapse.

Fingers were again pointed at the FRC, which was described as “feeble and timid” by MPs, who eventually triggered multiple reviews into the regulator, its relationship with larger accountancy firms, and overall the state of audit.

Not confident

Accounting and auditing experts said they are not optimistic a replacement regulator will clean up festering problems such as wide-scale conflicts of interest, or ramp up enforcement activity as a deterrent.  

“The enhanced powers given to the new body are suggestive of a marginal improvement, whereas what is really needed is a more radical shake-up,” said Professor Crawford Spence, Vice Dean, Corporate Relations, at King’s Business School. “There is nothing in the new remit about ensuring auditor independence, which is really the elephant in the room here.”

The FRC’s termination had been telegraphed by the sector for some time given the several ongoing reviews, and Spence said he found both to be a let-down and lacklustre given the importance of their context.

“Ensuring auditor independence is a much bigger issue that would effectively require other changes to corporate governance in the UK, namely a more active and engaged investor community,” Spence told AccountingWEB. “Until auditors work directly for investors and other stakeholders rather than their own clients, it is difficult to see how audit can be anything more than ceremonial.”

The government has promised to alleviate these concerns, ensuring the new regulator will be able to directly regulate the biggest audit firms, slap greater sanctions on cases of corporate failure, and demand rapid explanations from companies in the event of wrongdoing.

Some accountants have already flagged concerns regarding the fees they may face to pay for the new regulator, which they say is not a welcome prospect bearing in mind existing subscriptions with several chartered accounting associations.

Chief evangelist at IRIS software Steve Cox also asks whether the new watchdog might herald a tsunami of new rules and regulations, “leading to more anguish for accountants, who have already faced much change lately, not least with Making Tax Digital”.

Replies (6)

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Chris M
By mr. mischief
13th Mar 2019 18:09

We need to be throwing dodgy auditors in prison and confiscating their personal wealth, ditto dodgy directors of failed companies. There should be a prima facie assumption that an audit was dodgy if it fails within 6 months of a clean audit report.

Unless and until measures like this come in, I will continue to act on the basis that every auditor is a chocolate fireguard. As I have said before, if we are not going to take really strong action then we should simply scrap auditing totally.

Then every investor knows it is the wild West out there, whereas at present only experienced ones like myself know that.

Thanks (4)
By mkowl
14th Mar 2019 10:01

My only reaction is thankfully I have finally extricated myself from the world of audit. Very little empathy for the regulators as frankly one of their ilk have shown very little empathy to my firm in the last few months.

Thanks (0)
By matthewleitch
14th Mar 2019 10:13

The partners of the biggest firms are very rich people. That's their big driver. They push audit work down to keep their wealth up. They keep clients happy to keep their wealth up.

Now, if the penalty for a failed audit was that the partners personally responsible for the audit lost nearly all their personal wealth and could not insure against that, then I think we would have a powerful incentive that is cheaper than prison.

The amount of wealth a responsible partner was left with could be a fixed amount, so partners in smaller firms who are not so wealthy would have less to lose.

Thanks (1)
By tedbuck
14th Mar 2019 14:14

Matthew has a point, but...........
When all the partners in the BIG 4 look at their potential liability won't they decide not to Audit?

Being realistic there is really no way in the world that an audit can be bombproof so why on earth would they do it?

I know, he said, brainwave/light bulb moment, why don't we have a Government Audit department? At least all the incompetence would be in one place then!

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Replying to tedbuck:
By matthewleitch
14th Mar 2019 14:33

If those rich audit partners did decide to get out of auditing then they would be replaced by people willing to accept a rather less comfortable lifestyle. They really are very comfortably well off.

Thanks (0)
By matthewleitch
14th Mar 2019 14:43

And it might be possible to vary the level of wealth to which audit partners are reduced by audit failures, gradually lowering it over time to control the number that decide early retirement is a good option.

It's a bit like TV news readers on the BBC. Right now they are paid far, far more than is necessary but it's hard to get anyone to make the mental adjustment necessary. They could pay newsreaders nothing and there would still be a queue of young TV hopefuls wanting to have a week of exposure.

Thanks (1)