The replacement of the Financial Reporting Council (FRC) by the Audit, Reporting and Governance Authority (ARGA) as the UK’s new audit regulator should lead to a change in approach to audits and investigations of auditors. But will the UK’s economic reality neutralise any such change?

A spate of audit failures in the past few years led to widespread calls for change in both the audit process and the way in which auditors were regulated.

These in turn led to the “Kingman Review”, the “Brydon Review” and the Competition & Market Authority’s review, which all proposed major changes. Most significantly, the Kingman Review recommended the creation a new audit regulator - ARGA. Understandably distracted by other matters, however, the Government has not yet brought forward the legislation required to create ARGA.

"Does the Government want to create an enforcement heavy environment?"

The widespread commentary on the future of audit enforcement is highly cynical as to whether enforcement will become any stricter and, if it does, whether it will have the desired effect. There may be some truth to this. Given the economic pressures caused by COVID-19 and Brexit, does the Government want to create an enforcement heavy environment? It certainly has not yet shown appetite to bring in the new regulator. In audit and other areas (such as financial services regulation), there may well be a political preference for regulators to take a lighter touch approach to enforcement in the near future.

"How can the Government square the circle of ensuring auditors are held accountable for corporate collapses they should have seen coming, while not reducing the corporate attraction of the UK?"

Yet the audit failures keep coming and keep causing problems for the Government. The FRC’s recent Annual Enforcement Review identified insufficient audit evidence and a lack of professional scepticism as two of the key underlying reasons for recurring audit failures. These and other reasons (such as “Insufficient involvement of the audit partner and over-delegation to junior members of the team”) point to a need to reform the audit culture. The threat of enforcement is a key mechanism to effect such change. How, therefore, can the Government square the circle of ensuring auditors are held accountable for corporate collapses they should have seen coming, while not reducing the corporate attraction of the UK?

Firstly, the assumption that stronger audit enforcement would make the UK a less attractive place to run a business must be challenged. There is an idealistic response and a cynical response. Idealistically, stronger audit enforcement will mean better audits and more confidence in UK plc. This would make the UK a more attractive place to run a business. Cynically, stronger audit enforcement will not be the determining factor when it comes to an assessment of the UK’s attractiveness by UK plc.

"The assumption that stronger audit enforcement would make the UK a less attractive place to run a business must be challenged."

Secondly, the reaction of the UK’s financial services regulators after the global financial crisis may provide a blueprint for audit reform. In the aftermath of the financial crisis, there was a surge of public pressure (fuelled by the media and politicians) to ensure that senior managers working in financial services would be held personally accountable for failings in the future. In this regard, the Senior Managers and Certification Regime has been widely viewed as successfully driving a culture change in financial services. It is easy to see the attractiveness of this approach. Corporates have a tendency to shrug off fines as the cost of doing business. Individuals are far less able to shrug them off as it puts their careers and financial security on the line. As it stands, the FRC can only take enforcement action against directors who are also accountants. The Kingman Review, however, recommended that ARGA be given the powers to take enforcement action against non-accountant directors too. In terms of auditors themselves, the FRC already seeks to hold individuals to account and regularly takes disciplinary action against individuals. However, in comparison to cases taken by the FCA and PRA, its enforcement regime is comparatively lightweight (both in terms of volume of cases and severity of outcomes). If, however, the FRC or ARGA is looking to send a strong message that there is now a new approach to audit enforcement and there needs to be a culture change, then focussing on obtaining stronger outcomes against individuals conducting or overseeing audits (including members of the audit firm’s senior management) may be the way they choose to go.

CONCLUSION

"Changes to the audit environment are inevitable following a number of high profile failures."

Despite the current economic uncertainty facing the UK, changes to the audit environment are inevitable following a number of high profile failures. History shows us that crises give rise to new approaches to regulation and enforcement. How and when ARGA moves forward is still to be determined, but don’t be surprised if there is a stronger approach to enforcement, and a focus on targeting senior individuals to drive cultural change.

Everyone should welcome steps to avoid the audit failures of the past. This may mean that firms need to be ready for a different (possibly stricter) approach to audits from their auditors and increased personal liability on directors for any reporting or audit failures.