Carl Johnson from Stephensons solicitors says calls by the independent review panel appointed by the FRC to increase Big Four fines is unlikely to alter perceptions within the accountancy profession.
An independent review of enforcement sanctions published by the Financial Reporting Council (FRC) has suggested that fines in excess of £10m may be appropriate in cases of seriously poor quality audit work by the Big Four.
The review panel report which was published in November states as follows:
“… if one of the Big 4 firms was guilty of seriously bad incompetence, in respect of the audit of a major public company, where the errors were measured in nine figures or more and there had in consequence been either widespread actual loss or the risk thereof, a financial penalty of £10 million or more (before any discount) could be appropriate as being;
(a) commensurate with the seriousness of the wrongdoing;
(b) a meaningful deterrent; and
(c) sufficient to meet the primary objectives sanctions.
That assumes that the failings did not involve dishonesty or conscious wrongdoing. If they did, the figure could be well above that.”
A fine in the region of £10m would be almost double the record fine issued by the FRC to date, namely the £5.1m fine imposed on PwC earlier this year for serious misconduct in relation to its 2011 audit of RSM Tenon.
Another of the Big Four firms, EY, was fined £2.75m in October for misconduct in relation to its 2012 audit of Tech Data Limited. This was reduced to £1.8m to account for mitigating features and settlement. Commentators have observed that, while both fines are headline grabbing, they represent comparatively small sums when compared to the turnover of the firms in question.
For example, earlier this year PwC UK announced a £3.59bn turnover for year-end June 2017; while the UK arm of EY announced that its turnover for year-end June 2017 was £2.15bn.
One rule for the Big Four, another for everyone else
In my experience it is a common complaint amongst practitioners who face enforcement action in relation to audit breaches that the Big Four and other larger practices do not face the same consequences, even in cases involving much more serious breaches.
Sole practitioners and small to medium size firms referred to ICAEW’s audit registration committee and ACCA’s admissions and licensing committee will routinely face the restriction, suspension or even removal of their audit certificates where they are found to have committed serious breaches of audit standards.
Such regulatory action can have a devastating effect on a practice’s turnover and will often threaten the viability of the business altogether. Fines imposed by the FRC, even those measured in the millions of pounds, do little to address these complaints when they represent a negligible fraction of a firm’s turnover.
In a smaller practice where, for example, audit work accounts for 40-50% of turnover, regulatory action by ICAEW or ACCA can represent an existential threat to the business. The same cannot be said of a Big Four firm facing a fine of £10m.
Perceptions within the profession and, perhaps the wider public, could be improved if the FRC made greater use of its other sanction powers in high profile cases involving larger firms. In addition to imposing regulatory penalties, the FRC also has the power to exclude or suspend individual practitioners; to impose restrictions on a firm’s audit certificate; and, in more serious cases, suspend or remove certification altogether.
The authors of the independent review do stress the importance of non-financial penalties and cite the enforcement action taken against Deloitte Brazil following its audit of Gol Linhas Aereas Inteligentes S.A as “a good example, in a very serious case, of the combination of financial and non-financial sanctions”.
In that case Deloitte Brazil agreed a wide ranging settlement with the Public Company Accounting Oversight Board (PCAOB) in the United States. This settlement included an $8m financial penalty; a restriction on accepting certain new audit clients; the appointment of an independent monitor to assess remedial action; and additional training for audit staff.
A willingness to impose similar sanctions in conjunction with multi-million pound fines may lead to a greater sense of fairness within the sector. It may lead to a perception that the Big Four are held to the same standards as smaller firms and, importantly, face the same consequences when audit standards are breached.
However in practice one has to question the likelihood of serious enforcement action being taken against a Big Four firm’s audit registration.
Given that 99% of FTSE 100 companies and 96% of FTSE 250 are audited by the Big Four firms, any regulatory action which seriously restricts a firm’s ability to carry out audit work could feasibly cause serious disruption both within the accountancy profession and the wider economy.
The independent review does raise these concerns and describes the question of precluding a large firm from carrying out audit work as ‘problematic’ and comments that such action may prejudicially affect the public and members/employees of the firm who are blameless in relation to the underlying misconduct.
Serious action to remove or curtail a firm’s ability to carry out audit work may also lead to challenges by firms whereas multi-million pound fines are more likely to be accepted as an operational cost of running a large audit practice.
In conclusion, it seems that the likely outcome of this independent review is that large firms will face larger fines; those fines will have little or no practical impact on the firms in question; and action to seriously restrict audit certification will continue to be a power exercised routinely against smaller practices, but sparingly against their much larger counterparts.
About Carl Johnson
Carl Johnson is a partner and regulatory solicitor at the national law firm, Stephensons. He specialises in professional misconduct and regulation law and acts for a wide range of regulated bodies, including accountancy firms.
Stephensons is a national, full service law firm with offices across the country. For more information, visit www.stephensons.co.uk or find us on Twitter and Facebook.