The revised Sanctions Policy follows the publication in November 2017 of the report of the independent review commissioned by the FRC into its sanctions policies. That review was led by former Court of Appeal Judge Sir Christopher Clarke and heard a wide range of submissions from interested parties before publishing its final report and recommendations (a link to our article on the key recommendations of the Clarke Review can be found here).
In this article, we summarise and comment on the key changes under the new Sanctions Policy from the existing 2016 Sanctions Guidance under the Audit Enforcement Procedure ("AEP").
Key changes under the revised Sanctions Policy
1. Discretion as to penalties – use of financial and non-financial penalties
- A key part of the Clarke Report's recommendations was that greater attention should be given than has been the case in the past to the use of non-financial penalties, particularly in circumstances where the AEP applies the low hurdle of a breach of a Relevant Requirement which include failings that would not constitute Misconduct under the Accountancy Scheme. In this regard the new Sanctions Policy sets out that:
- "…Decision Makers should consider whether, and, if so, to what extent, the sanctions proposed would be likely to lead to improvements in respect of the matters which give rise to the proceedings and in the quality of work of the Statutory Auditor or Statutory Audit Firm concerned."
- "Decision Makers should also consider whether the sanction or combination of sanctions, financial and/or non-financial, achieve the objectives of the Audit Enforcement Procedure. There may be circumstances where the objectives can be achieved without a financial penalty." [Emphasis added]
2. Level of financial penalties
- Whilst the FRC press release announcing the new Sanctions Policy refers to the implementation of the Clarke proposals which included the much reported suggestion of imposing financial penalties of £10 million or more (before any discount) on the large audit firms in cases of seriously bad incompetence in respect of the audit of a major public company (where there has been no dishonesty), this is not explicitly contained in the formal Policy.
- Indeed, the Sanctions Policy is silent as to the level of financial penalties and appears to accept the Clarke Report suggestion that it would not be appropriate to impose a tariff based or strict guideline system of financial penalties but instead to retain flexibility to impose an appropriate financial sanction where warranted.
- In determining the appropriate financial sanction, the Policy makes clear that whilst Decision Makers may have regard to sanctions imposed in other cases, they must "determine the sanction which they think appropriate on the facts and circumstances of the case before them and should not feel constrained by the sanctions imposed (or not imposed) in earlier cases to impose a sanction which they do not think appropriate."
3. Co-operation discount: Need for 'Exceptional Cooperation'
- Where previously a Statutory Auditor or Statutory Audit Firm could expect cooperation with the FRC's investigation to be taken into account as a mitigating factor, in one of the more surprising changes, particularly in light of the Clarke Report's proposals (see below), the new Policy sets out that "In order for cooperation to be considered as a mitigating factor at the point of determining appropriate sanction it will therefore be necessary for the Statutory Auditors and Statutory Audit Firms to have provided an exceptional level of cooperation."[Emphasis added]
- The Policy gives two (non-exhaustive) examples of what 'exceptional cooperation' might include:
- self-reporting "any facts and/or matters which may constitute an allegation of a breach of the Relevant Requirements"; or
- volunteering information or documentation not specifically requested but which "may assist the investigation".
- Conversely, the Policy includes a (non-exhaustive) list of examples of behaviour which would be considered an aggravating factor at the point of determining appropriate sanction:
- incomplete provision of documents and information in response to Notices and requests;
- failure to provide adequate explanation of information provided;
- failure to comply with deadlines specified in Notices under the Audit Enforcement Procedure and other written requests;
- failure to prepare properly for interviews conducted under the Audit Enforcement Procedure (including failure to review material provided by the Executive Counsel in advance of such interviews); and
- failure to conduct an adequate search for documents and information.
The Policy goes on to make clear that "the examples [above]…are merely illustrative and that the relevant Decision Maker will consider the overall level of co-operation provided during the course of the investigation and enforcement process at the point of determining sanction."
- A key proposal in the Clarke Report was that discounts to any financial penalty of up to 50% should be introduced in cases where there is no dishonesty or want of integrity; where the firm had reported itself to the FRC; had shown insight into what went wrong; had carried out all necessary remedial measures speedily; and had co-operated fully at every stage and had agreed the facts and its liability very early on. The Policy is silent as to whether such a level of discount can be expected in the event of an 'exceptional level of cooperation'.
- Whilst the discretion to consider the overall level of co-operation provided during the investigation at the point of determining sanction is welcome, the suggestion in the new Policy that an 'exceptional' level of co-operation is required to merit any discount is concerning particularly in the context of the examples set out in the Policy as aggravating factors for consideration on the level of penalty. For instance, whilst it is important that the Regulator receives documentation in a timely manner, a common complaint by audit firms and their advisors with regard to FRC Notices under the AEP is that they frequently seek to impose unrealistic, arbitrary and often unnecessary deadlines for the delivery up of (often) vast swathes of documentation. Often such requests for documents go back many years and require lengthy and expensive trawls and reviews of large quantities of documents (in part to avoid providing unnecessary quantities of irrelevant and unresponsive documents). It would be regrettable if a failure to meet an unrealistic and unreasonable timescale for delivery up of documents, particularly where reasonable requests for a realistic timescale have been made, in any way places an audit firm at risk of an aggravated level of financial penalty.
4. Settlement Discounts
- The new Policy amends both the periods during which a discount for early settlement would be applicable and the available discount range for each period (subject to a broad discretion).
- "Stage 1" is extended from the date of Executive Counsel's Decision Notice to 28 days after that date.The maximum discount for settlement in this period remains 35%, but the minimum discount drops from 25% to 20%.
- "Stage 2" is extended from the date of Enforcement Committee's Decision Notice to 28 days after that date.The range of discount available for settlement in this period reduces from 15% - 25% to 10% - 15%.
- "Stage 3", and a new "Stage 4" covers the period after Stage 2.If settlement is agreed in this period then there may be a reduction of up to 10%, unless it is within 28 days of a hearing, in which case the discount drops to a maximum discount of 5%.
- There is no reduction available following commencement of a hearing ("Stage 5").
- The existing Sanctions Guidelines regarding partial admissions is expanded to specifically include circumstances where the facts and liability are agreed, but not the level of financial penalty or the appropriate discount.In these circumstances, the new Policy provides that "such discount as is thought appropriate having regard to all the circumstances and in particular the time when that was agreed" should be allowed.
- The Clarke Report noted that the "FRC Enforcement Division was strongly of the view that ranges of percentage discounts should be reviewed to ensure that there are far greater incentives for early settlement." The Report went to on to propose that the discount for an early settlement should ordinarily be 35% (as opposed to a range of up to 35%).Regrettably, whilst the period for acceptance of such offers has sensibly been extended, no increased incentives have been made to the settlement regime despite the submissions of the FRC's Executive Counsel and the member firms – and the strong recommendations of the Clarke Report.
5. Threshold for a Severe Reprimand
- The threshold at which a Severe Reprimand may be appropriate will no longer be solely for cases of misconduct, but where there has been a breach of the Relevant Requirements "of a serious nature".
6. Exclusion for dishonesty
- In circumstances where a Statutory Auditor has been found to have been dishonest: the recommendation should normally be that (s)he be excluded for at least 10 years.
7. Previous Sanctions
- The fact that a sanction has previously been imposed will no longer automatically be regarded as a significant aggravating factor when considering the appropriate sanction. The factors to take into account when assessing the relevance of a previous sanction are 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.
The FRC has retained its wide discretion to determine the appropriate sanction(s) in any particular set of circumstances with the guidance contained in the new Sanctions Policy remaining advisory only and not binding on Decision Makers (albeit Decision Makers are required to explain the reasons for any departure from the guidance contained in the Policy). As such there are relatively few substantive changes to the 2016 sanctions guidelines.
Whilst consideration of whether non-financial sanctions may alone be appropriate – particularly in circumstances where there has been an inadvertent and minor breach of a Relevant Requirement – is welcome; the two substantive changes to the Policy/Guidance to the discounts to any financial penalty (1) for cooperation; and (2) in the event of settlement appear to reject (or at least move in the opposite direction to) the Clarke review's recommendations and encouragement of greater incentives for both. It may be that in the current hostile political environment where the FRC itself is under increasing public pressure, explicit revisions to the Sanctions Policy to allow for discounts on financial penalties imposed on auditors has been considered bad politics.