Rise in FRC investigations
Somewhat surprisingly, in the immediate wake of the financial crisis in 2008, relatively few businesses went insolvent (largely as a result of historically low interest rates). As a result, there were perhaps not as many corporate scandals as one might expect following a period of economic decline. There was also a pause in the number of FRC investigations in 2010 and 2011, following concerns about the body’s independence, complex structure and time-consuming procedures. This resulted in considerable reform of its structure and powers in 2012.
However, since the new-look FRC was established in 2013 there has been a series of high profile scandals. The near collapse of the Co-op Bank and the Tesco accounting scandal dominated the headlines. In light of destabilising events like these, there has been a greater impetus for the FRC to take a more active role.
In 2013, the FRC identified investigative monitoring and disciplinary procedures as one of its major projects and increased the number of formal investigations that it announced from three in 2012 to nine in 2013. Meanwhile, the overall cost of running investigations has increased. The 2013-14 budget provisioned for a cost of £5m for this work, with the equivalent figure having increased to £7m in the budget for 2015-16.
Rise in fines
There has also been a parallel increase in the size of fines imposed by the FRC. In February 2013 the FRC published new Sanctions Guidance for members of its Disciplinary and Appeal Tribunal to refer to when considering the imposition of sanctions.
Before the Guidance came into effect the highest fine issued by the FRC was £1.4m in relation to reporting to the FCA on compliance with client asset rules. After the Guidance, the FRC issued a new highest fine of £14m – although this was later reduced on appeal to £3m (see boxed text).
Despite the FRC’s renewed vigour, its head count remains very small. Given this, some may question how it can realistically continue to achieve its regulatory objectives and expand its investigation work.
A look back at investigations launched in the past few years reveals the extent of the FRC’s backlog in cases. The majority of investigations conducted since 2011 are yet to be resolved and those with a final outcome have taken on average over one and a half years to reach a conclusion (with investigations ranging from six moths to three years and ten months).
The purpose of the FRC’s investigatory work is ultimately to increase audit quality. This begs the question – has the quality of audits increased as a result of the increase in FRC investigations? One helpful barometer is the FRC’s audit quality review. This annual review looks at around 90-100 audits conducted at firms by auditors including the Big Four.
The results for the reviews conducted in 2010-2014 are shown below. It is difficult to say decisively that quality is improving.
Click here to view the graph.
The FRC announced four investigations in 2015, a slight decrease on the six investigations announced in 2014. The trend had appeared to be an upward one pre-2015 with ever higher levies being imposed upon contributor companies and organisations. It will be interesting to see if 2015 is anomalous or indicative of a halt in pace for FRC investigation of individual firms with FRC activity instead focusing on reviews of the whole market.
One driver for the activity is political pressure as regulators and governments look to be visible in tackling corporate malpractice head-on. During 2015/2016, the implementation of the EU Audit Directive and Regulation and Competition Markets Authority recommendations requires the FRC to broaden the scope of its inspection work and responsibilities. The FRC says this will require it to expand some teams as its work widens to monitor audit quality.
On a national level, the PRA outlined that it wishes to take over aspects of the FRC’s role in its recent consultation paper (see article below). This would involve coordination of enforcement action by the two regulators where they have a mutual interest (whether involving auditors or actuaries) and could see them both take action in respect to the same set of facts.
The FRC’s Business Plan for 2015/2016 includes a focus upon achieving a consistently high standard of auditing, corporate reporting and enhancing the pace and effectiveness of its disciplinary function.
In light of this and the upward trends identified, firms should expect to remain under its scrutiny for the foreseeable future.
Record FRC fine slashed on appeal
- In September 2013, the FRC handed out their largest ever fine of £14m to Deloitte after conducting a six year-long investigation into the firm’s work for companies involved in MG Rover’s Phoenix arrangements and ultimate collapse. The FRC held that Deloitte had failed in its duty to avoid conflicts of interest by providing the businessmen leading the purchase of MG Rover from BMW with corporate finance advice whilst also acting as auditor for MG Rover. The FRC’s focus on Deloitte’s professional duty to “act in the public interest” was introduced the idea of accountancy firms being held to a far higher standard than previously thought to be the case. The widely accepted position prior to the FRC decision was that accountants’ duties centred on acting with integrity and in their client’s interests. Unsurprisingly, the far wider responsibility imposed by the FRC was of concern for firms of all sizes.
- Handed down in April 2015, the appeal tribunal decision significantly scaled back the FRC’s sanctions on Deloitte, overruling eight out of 13 findings that the FRC had made. Of particular significance was the tribunal ruling that the “public interest” concept is “vague and unhelpful” and that the reason the FRC’s fine was excessive was that the firm had not deliberately disregarded its duties. The welcome result for Deloitte was a reduction in the fine from £14m to £3m and a reversal of the three-year industry ban imposed on one of its partners.
- Although it has been confirmed that there is no general legal duty for firms to act in the public interest, firms may need to re-examine their compliance procedures in light of the increased consideration being given to whether such a duty should exist.