Since 2014 the FRC have published a Sanctions Guidance, setting out the approach Tribunals should take when determining sanctions imposed under the Accountancy Scheme. An updated version of the existing FRC Sanctions Guidance takes effect on 1 June 2018 with a number of material amendments. The FRC has announced that the Guidance is intended to implement the recommendations of the Independent Sanctions Review. Please click here to read DACB's article on the Sanctions Review.
As discussed at our recent seminar, the FRC is under pressure from politicians and press commentators to adopt a more aggressive approach to audit investigations and, in particular, to sanctions. Most recently, politicians have been demanding that a break up of the Big Four be considered. We are concerned that such pressures may influence how the new guidance is applied by the FRC when recommending sanctions to a Tribunal, or when negotiating settlement with firms under investigation.
Watchdog or bloodhound?
The role of the auditor is often misunderstood or misdescribed in the press. The auditor's primary role is not to sniff out fraud and malpractice. Rather, it is tasked with testing and confirming the reliability of a company's financial statements and unless there are obvious "red flags", fraud may well remain uncovered. The public do not understand this, nor the fact that the role of auditor would have to change with audit fees significantly increasing if the role of the auditor is to change from watchdog to a bloodhound.
On this subject, we are concerned on behalf of accountants and auditors who face investigations in the future that the FRC does not overreact to public criticisms. There has been a change in the FRC's self-described aims in applying sanctions under the Scheme. Hitherto, the FRC aimed at "promoting high quality corporate governance and reporting to foster investment". The FRC has now adopted a more general mission – of promoting "transparency and integrity in business" as a whole. It remains to be seen whether this is mere window dressing, or evidence of a more fundamental shift by the FRC towards aligning itself with the users of audit reports and distancing itself from those who it regulates.
Precedent no longer a constraint
The new guidance states that Tribunals "should not feel constrained" by precedent when imposing sanctions.
This clears the way for potentially higher fines, with precedent playing a less part in a Tribunal's consideration of the level of sanctions to impose. On behalf of the profession, we are concerned about this on two fronts. First, the regulated should have some certainty around the sanctions they face for misconduct; we warn that unwarranted fear of higher sanctions will have unintended negative consequences. It is also a matter of fairness; we hope we are not entering a period when the objective of achieving fairness for those under investigation is downgraded in a rush to see tougher regulation.
The downgrading of deterrence as a reason for imposing sanctions
Interestingly, the new guidance de-emphasises the role of deterrence. It has re-ordered the list of reasons for imposing sanctions, with promoting public confidence in the accountancy profession and the quality of corporate reporting now appearing above deterrence, which has moved from first to last in the list.
The report from the Independent Review of sanctions which recommended this change explained that in their view, this was a significant amendment and reflected a fundamental shift in approach.
Downgrading deterrence as a reason for sanction could in theory cut both ways. A lower sanction or lesser fine might be considered if deterrence is not the primary aim, particularly on large audit firms for whom smaller fines will never be seen as an effective deterrent. We suspect the reality is that the direction of travel will be one way with higher fines being imposed, justified on the grounds that they are appropriate to maintain public / press confidence in the profession. Nevertheless, it will be interesting to see how a Tribunal deals with submissions on this.
Sanction with no fine
The new guidance suggests a fine may not be necessary where the 'sanctions package' achieves the desired end without one. Remediation and whether the proposed sanction is likely to lead to improvements in relation to matters identified in the disciplinary proceedings are matters for a Tribunal to take into account. A 'sanctions package' might include conditions, such as requiring firms to amend their processes and internal guidance to ensure adherence to ethical standards. It will be interesting to see how, or whether, the FRC are open to agreeing a sanctions package without a fine. This firm, along with other contributors to the consultation process in the Independent Review, argued that fines were not always appropriate where misconduct was not intentional. With 'deterrence' no longer the primary reason given by the guidance for imposing sanctions, it is now just possible a Tribunal could be persuaded for lesser examples of misconduct to impose sanctions without an accompanying fine.
There is a potentially important change in emphasis when assessing aggravating and mitigating factors and their impact on the level of sanction and fines. The new guidance emphasises a Tribunal will impose harsher penalties on firms failing to promptly remediate breaches. Conversely, swift corrective action will be rewarded.
There is also potentially interesting clarification of the relevance of prior breaches to the level of sanction. The new guidance states that previous breaches of the standards will no longer automatically be an aggravating factor. It is worth quoting in full: “The more serious and/or similar the previous Misconduct or breach, the greater the aggravating factor. The fact that a sanction has previously been imposed will not automatically be regarded as a significant aggravating factor. Much will depend on the degree of similarity, the time that has elapsed since the earlier sanction was imposed, the changes that have taken place since then, and the response (or lack of it) to any previous finding or sanction imposed”. In theory, a breach in one business area or office should not necessarily be imputed to others when the Tribunal is considering a previous sanction as an aggravating factor justifying a higher fine.
Mitigation and cooperation
Cooperating with an FRC investigation will no longer be a mitigating factor unless a respondent shows 'exceptional' levels of cooperation. Simply complying with the FRC's requests, no matter how onerous, is unlikely to be enough. To meet this threshold, we believe the FRC is looking for respondents to self-report, and / or volunteer information that has not been requested.
The FRC has changed its guidance on what discounts will apply for settlement at different stages in proceedings. There are now five stages rather than three, and the FRC is more prescriptive as to discounts, with greater ability to apply pressure in favour of (very) early settlement. There is one very important change – the 'Stage 1' discount of 20-35% is now available only for settlement achieved up to 28 days after delivery of a Proposed Formal Complaint (PFC) to the respondents. Previously, Stage 1 discounts were available for settlements achieved up to the delivery of a Formal Complaint to the Conduct Committee. The window for the more generous level of discount available under Stage 1 is considerably narrower than before and effectively requires wholesale, and almost immediate, acceptance of the content of a PFC. This could lead to unjust results where the PFC contains significant factual inaccuracies, or where some of the assumptions on which allegations are based are not well founded. It does not seem fair in these circumstances to deny a respondent the opportunity to benefit from the higher levels of discount available under Stage 1 before the respondent has had an opportunity to comment on the PFC and draw such matters to the FRC’s attention; however, that is the practical effect of this change. Settlement within Stage 2 allows discounts of between 10-20% where settlement is achieved up to and including delivery of a Formal Complaint.
However, there is an important change which favours respondents. The current guidance states that the FRC should only apply discounts at the higher end of the allowed range where the respondent admits substantially all of the heads of complaint. The Independent Review pointed out this did not seem an appropriate limitation to impose when the heads of complaint might include unjustified allegations. A respondent should not be penalised for failing to admit an unjustified allegation. Moreover, an agreed settlement reflects terms which both the FRC and a respondent consider appropriate. Under the new guidance, the Tribunal has an open-ended discretion to determine the level of discount.
We are pleased to see that the new guidance requires a Tribunal to take into account sanctions imposed by another regulator. The old guidance recommended the opposite, namely that a Tribunal should ignore such sanctions. This of course might lead to 'double jeopardy' for accountants facing investigation from more than one regulator.
This is a particularly challenging time for the audit profession and also its independent regulator, the FRC. Political and media pressure for change in the manner in which audits are conducted and regulated has probably never been stronger, nor so ill-informed. In truth, auditors in the UK generally do a very good job, but positive news stories do not sell well.
Higher fines and harsher sanctions will of course change behaviours, but not necessarily for the better, particularly if we witness a drain of accountancy talent with a generation of graduates put off becoming auditors due to the increasingly harsh regulatory environment. The new sanctions guidance has some important changes, we hope that the FRC implements them wisely with such considerations in mind, and is not influenced by unwarranted criticism levelled at it by politicians and the press.
Whether regulatory fines issued by the FRC are capable of being insured under an accountant's professional indemnity insurance policy is likely to be of considerable interest to both insurers and insureds alike in the current climate of increasing regulation. Under English law, it is not possible to insure against fines arising out of deliberate wrongdoing, illegality or 'morally reprehensible' actions on public policy grounds but it may be possible to insure against regulatory fines where the breach was innocent or there has been a lesser degree of culpability. The FRC has not objected to firms insuring against such fines and penalties in principle, and this leaves the door open for insurers to decide whether to cover regulatory fines, pending a decision on the point.