Au­di­tors need to be called to ac­count, but can we rely on the watch­dog?

The Sunday Telegraph - Money & Business - - Business - Richard Bux­ton is head of UK eq­ui­ties and man­ager of the Old Mu­tual UK Al­pha Fund, Old Mu­tual Global In­vestors RICHARD BUX­TON

The Depart­ment for Busi­ness, En­ergy and In­dus­trial Strat­egy has an­nounced the terms of ref­er­ence for what will in­evitably be known as the King­man Re­view into the Fi­nan­cial Re­port­ing Coun­cil. The FRC, which de­scribes its mis­sion as “to pro­mote trans­parency and in­tegrity in busi­ness”, reg­u­lates ac­coun­tants, au­di­tors and ac­tu­ar­ies and op­er­ates the UK’S cor­po­rate gov­er­nance sys­tem.

Full dis­clo­sure – this also in­cludes over­sight of fund man­agers in the ex­er­cise of their stew­ard­ship of in­vest­ments, to iden­tify if we are gen­uinely en­gag­ing with com­pa­nies on gov­er­nance is­sues or merely pay­ing lip ser­vice. Ven­tur­ing to opine on the FRC’S work is fraught with po­ten­tial haz­ard for fund man­agers, but let us put that to one side.

Some com­men­ta­tors feel that this is symp­tomatic of a con­cern that the FRC’S re­mit is too wide, cre­at­ing ir­rec­on­cil­able con­flicts of in­ter­est. Es­tab­lish­ing stan­dards and over­see­ing their ap­pli­ca­tion may lead to sit­u­a­tions where it is re­luc­tant to crit­i­cise its own stan­dards, if they are less than per­fect.

For all the FRC’S brave words about chal­leng­ing com­pa­nies over con­cerns in their ac­counts, strong dis­ci­plinary ac­tion and pro­mot­ing con­fi­dence in an­nual re­ports, I strug­gle to name half a dozen clear ex­am­ples of reg­u­la­tory in­ter­ven­tion over com­pany re­port­ing. It may well take place be­hind closed doors, but if it is not highly vis­i­ble, where is the cen­sure to pro­mote con­fi­dence in the sys­tem?

For Car­il­lion’s au­di­tors to specif­i­cally high­light as ar­eas of po­ten­tial mis­state­ment recog­ni­tion of con­tract rev­enue and the sheer quan­tum of good­will on the bal­ance sheet and yet still sign off the ac­counts per­haps needs no fur­ther com­ment.

For many years in­vestors have been con­cerned that au­di­tors per­sist in re­fer­ring to the com­pa­nies they au­dit as their clients, whereas it is ac­tu­ally the share­hold­ers on whose be­half they work. We have all known the con­flicts of in­ter­est posed by the big four ac­coun­tancy firms, of­fer­ing losslead­ing au­dits in ex­change for lu­cra­tive con­sul­tancy work.

Where is the polic­ing of this or the chal­lenge by the FRC to share­hold­ers that they ac­tu­ally need to coun­te­nance a ma­te­rial rise in au­dit fees in or­der to en­sure a gen­uinely in­de­pen­dent view?

What is­sues like the col­lapse of Car­il­lion high­light is that in­vestors can rarely gain ex­ter­nal in­sights into the qual­ity of au­dit work to­day. The con­flicts of in­ter­est within the big four cre­ate the sus­pi­cion that many au­dited re­ports can­not pro­vide the con­fi­dence the FRC wishes to pro­vide – and the odd spec­tac­u­lar col­lapse can only sup­port these sus­pi­cions. The In­ter­na­tional Fo­rum of In­de­pen­dent Au­dit Reg­u­la­tors – of which the FRC is a mem­ber – re­cently pub­lished its sixth an­nual sur­vey of the six largest au­dit firms glob­ally. In a sam­ple size of 918 au­dits, a re­mark­able 40pc had at least one “find­ing” – use­fully de­fined as “a sig­nif­i­cant fail­ure to sat­isfy the re­quire­ments of au­dit­ing stan­dards”.

This does seem to con­firm fears that in­vestors are a long way from be­ing able to place their trust in com­pa­nies’ ac­counts. In­creas­ingly we will be ask­ing com­pa­nies more ques­tions about their au­di­tors and on whose be­half they think they are work­ing.

Au­dit com­mit­tees who sign off one year’s ac­counts, then sign off a sub­se­quent set in­volv­ing a ma­jor ex­er­cise in “kitchen-sink­ing” by an in­com­ing man­age­ment team, can ex­pect to face some ques­tion­ing.

And it will be in­ter­est­ing to see how the King­man Re­view does ex­am­ine the FRC’S gov­er­nance, when the sus­pi­cion of reg­u­la­tory cap­ture by for­mer mem­bers of big four firms work­ing at the FRC is quite high.

No one doubts the ben­e­fits of the FRC’S mis­sion, pro­mot­ing trans­parency and in­tegrity in busi­ness, gen­er­at­ing pub­lic trust and at­tract­ing in­vest­ment. But all those un­der the FRC’S over­sight – and the FRC them­selves – have work to do to move closer to re­al­is­ing those goals.

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