Over the last year, three key reports have been published on the future of the audit and accountancy professions. These reports together propose significant reforms to audit and the manner in which it is regulated, including the replacement of the Financial Reporting Council (the "FRC") with a new regulator with enhanced powers. While the reviews have focussed on audit, many of the recommendations similarly affect accountants who are not providing audit services. Similarly, one of the most eye catching recommendations, and one with a potentially enormous impact beyond the audit profession, is the proposal to extend the new regulator's disciplinary powers to company directors who are not accountants (and so not currently subject to the FRC’s enforcement jurisdiction).
In the December 2019 Queen's Speech, the Government promised to "develop proposals on company audit and corporate reporting, including a stronger regulator with all the powers necessary to reform the sector". Despite broadly accepting the reports’ recommendations, the Government might in this statement be taking a more limited approach than fully to implement all of the recommendations. In the interim, the regulatory burden on regulated firms and individuals has nevertheless increased significantly, with the FRC continuing to impose sanctions and levy fines at record levels.
In this paper we focus on the professional disciplinary implications of these reports, taking stock of the current position and assessing what the reforms might mean for regulated firms, individuals, and the wider business community. We note that none of the reports expressly consider how the recommendations proposed would comply with the rule of law and other public law principles. In circumstances where regulatory action can have serious implications for individuals and firms, we also consider below where current or proposed practice might conflict with the requirements of the rule of law and other public law principles.
1. Professional discipline currently As matters stand, the FRC is effectively the lead regulator for the audit and accountancy professions in the UK.1 It has responsibility for taking enforcement action in relation to audit firms and auditors under its Audit Enforcement Procedure ("AEP"), and, in public interest cases, for taking enforcement action against accountants and firms of accountants in relation to non-audit work (under the "Accountancy Scheme").2 At present, the FRC has no powers under these schemes to discipline those who are not accountants or auditors. There are notable differences between the AEP and the Accountancy Scheme (for instance the threshold for taking enforcement action is lower under the AEP), but at a high level they are both mechanisms by which regulated firms and individuals can be disciplined. Under both schemes, the FRC (incorporating its independent disciplinary tribunal) has the power to compel the provision of documents and information, make findings, and order sanctions against both firms and individuals. The FRC encourages settlement under both the AEP and Accountancy Scheme and offers discounts on sanctions where admissions are made at an early stage. Sanctions include reprimands, unlimited fines, and the potential to ban individuals from the profession for a period of time. These sanctions can be substantial – in one recent case, the sanctions included a fine for the audit firm of £10million, a fine for the audit partner of £500,000 (both of which were then discounted for early settlement), and an undertaking from the audit partner not to perform any audit work (or have his name on the register of statutory auditors) for 15 years. In this context it is worth noting that, despite proposing a number of significant amendments to the regulatory regime, the recent Kingman Report (to which we return below) found that there is no "shortfall in the severity of sanctions available".3 Decisions of the FRC in the enforcement context can be challenged by way of judicial review. This is an essential constitutional safeguard through which the courts can provide oversight of the regulator’s actions. In recent years, challenges have considered the legality of the FRC's guidance4 and the FRC's power to publish reports5 and settlement documents6 which criticise third parties. The courts have also recently dealt with the important question of whether the FRC can compel the provision of otherwise privileged documents.7 2. The reports It is fair to say that the FRC has been subject to significant public criticism in recent years, largely prompted by a number of corporate failures. In this context, in 2018 the Government commissioned three separate reviews of the audit profession: 1. The Independent Review of the FRC, by Sir John Kingman, which was published in December 2018 (the "Kingman Report"); 1 The FRC has a similar regulatory role in relation to actuaries. 2 Disciplinary action against accountants in non-public interest cases is taken by the professional bodies which sit under the FRC (eg ICAEW, ACCA, etc). 3 The Independent Review of the FRC, by Sir John Kingman, December 2018, at paragraph 2.59. 4 R (Baker Tilly UK Audit LLP) v Financial Reporting Council  EWCA Civ 406. Herbert Smith Freehills LLP acted for the FRC in this case. 5 R (Lewin) v Financial Reporting Council  EWHC 446 (Admin). 6 Tavata Investments v Financial Reporting Council  EWHC 1662 (Admin). 7 The Financial Reporting Council Limited v Sports Direct International Plc  EWHC 2284 (Ch). We note that this case has been heard by the Court of Appeal and judgment is awaited. // 3 2. The Competition and Markets Authority's study of competition in the audit market, which was published in April 2019 (the "CMA Report"); and 3. The Independent Review into the quality and effectiveness of audit, by Sir Donald Brydon, which was published in December 2019 (the "Brydon Report"). These reports contain a large number of wide-ranging recommendations. Below we focus on those recommendations likely to have the most significant effect on those subject to the regulator's professional discipline regime. In addition to these reports, in 2019 the House of Commons Business, Energy and Industrial Strategy Committee produced a report entitled "the Future of Audit" (the "BEIS Report"). While this report did contain a number of its own recommendations, to a large part it focussed on the recommendations proposed in the Kingman Report, which it endorsed, and the ongoing work of the CMA and Sir Donald Brydon. The Government has since issued consultation papers on the recommendations proposed in both the Kingman Report and the CMA Report. Both consultations have now closed but the Government has not yet published its response. The Government has not yet issued a consultation paper on the Brydon Report. 3. The Rule of Law and public law principles As with any regulatory system, the consequences of disciplinary proceedings are often significant for the firms and individuals involved. The sanctions applied (financial and otherwise) can be onerous and the reputational consequences severe – in many cases, disciplinary action can signal the effective end of individuals' professional careers. This can occur both where conduct is viewed as particularly culpable (for instance cases of dishonesty) but also where the failings simply reflect a poor quality of work. Material adverse consequences can also arise from the simple fact of an investigation, even if ultimately no findings are made or sanctions applied. For instance the costs and management time involved in properly responding to an investigation can be substantial and, if the fact of an investigation becomes well known, reputational damage can occur before any findings are made. In these circumstances, it is critical that any disciplinary framework is designed and operated in a manner which is consistent with public law principles and the rule of law. In particular, the following rule of law principles can be considered in this context and link into the grounds for judicial review.8 a. Legality: In addition to including a transparent, accountable and democratic process for enacting law, this principle covers the expectation that powers of public authorities are defined by law and that they act within those powers. Decisions of public authorities (such as regulators) which offend this principle can be challenged by way of judicial review, as can delegated legislation. b. Legal certainty: Key elements of this principle are that laws are accessible, foreseeable (ie, that they are proclaimed in advance of their implementation), formulated in a sufficiently clear and precise manner, stable, and (generally) not retroactive. This principle encompasses the protection of legitimate expectations, a freestanding public law principle which can be a ground for challenging decisions by way of judicial review. It also covers the principle of “res judicata” (ie, that appeals are final once determined) and the prohibition against double jeopardy. 8 These principles draw on the Rule of Law checklist adopted by the Venice Commission in 2016. // 4 c. Prevention of abuse of powers: This principle requires that abuse of discretionary powers, such as acting in an irrational manner or failing to give reasons where reasons are required, must be controlled by judicial review. The principle of preventing “abuse of power” supports a wide range of grounds for judicial review, including where a public body has acted for an improper purpose, acted unreasonably, or, in some instances, acted disproportionately. d. Access to justice: Importantly, this principle encompasses the right of individuals to receive a fair trial, which includes having effective access to courts, in certain circumstances the availability of appeal procedures, and equality of arms (by which we mean that there should be a fair balance between the opportunities available to the different parties to disputes). Decisions or procedures which contravene this principle can be challenged by way of judicial review. This links to a broader concept under public law of procedural fairness, which encompasses challenges based on inadequate consultations, bias, and rights to make representations or be heard at an oral hearing. e. Equality: This principle requires equal treatment and prohibits discrimination. A key element of this principle is that effective remedies are available to challenge actions which violate the principle of equality. In addition to common law grounds of judicial review which are available to challenge infringements of these principles, the European Convention on Human Rights (the "ECHR"), which is incorporated into domestic law by the Human Rights Act 1998, provides another means to protect the rights of those affected by adverse decisions. The ECHR encompasses a number of the principles outlined above, for instance the right to a fair trial is protected by Article 6. Importantly, challenges based on a breach of the ECHR can be brought against primary legislation (whereas other judicial review challenges cannot).9 4. Key recommendations for professional discipline In this section we discuss the recommendations made in the three reports (Kingman, CMA and Brydon) which are likely to have the greatest effect on those firms and individuals who are subject – or who are proposed to be subject – to the regulator's disciplinary functions. We also raise a number of questions about the compatibility of the proposed reforms with the rule of law and other public law principles. The Kingman Report From the perspective of firms and individuals who are subject to the FRC's disciplinary functions, the key points arising from the Kingman Report are as follows: - The replacement of the FRC with a new regulator, the Audit Reporting and Governance Authority (the "ARGA"), which is to be given clear statutory powers and objectives. 10 This differs from the current position, whereby the FRC's regulatory function under the Accountancy Scheme does not have statutory backing but rather is a voluntary agreement. While in practice we do not anticipate the transition to the new regulator itself making a material difference to the operation of its enforcement functions, the detail of its objectives and duties are likely to be central to any public law challenges brought against decisions of the ARGA in due course. Indeed any action by the ARGA which exceeds, or is not taken in 9 Challenges to primary legislation can also currently be brought on the basis of breaches of EU law but the position is expected to change as a result of Brexit. 10 Chapter 1. // 5 furtherance of, its statutory powers and objectives could be challenged on the basis that it contravenes the principle of legality. For that reason it is important that stakeholders pay close attention to exactly how this part of the statute is expressed (and, if appropriate, make representations as to its content at the formative stage). As to the current proposal for the ARGA's objectives (which is endorsed by the consultation paper on the Kingman Report), we note the express duty on the ARGA to act in a manner which "is proportionate". We consider this a helpful inclusion which we envisage may be relied on by any firms or individuals who seek to challenge what they might perceive to be oppressive decisions by the ARGA. – The regime for approving and registering firms conducting audits of public interest entities should be undertaken by the ARGA, which should be given a range of possible sanctions. 11 The question of approval and registration of auditors for future audits is analytically distinct from the question of discipline for past conduct. However, they are linked in that both can involve the consideration of aspects of quality and conduct. The proposals for approval and registration of firms conducting audits of public interest entities would be a departure from the current position, whereby those functions are undertaken by the professional accountancy bodies (eg ICAEW and ACCA). Although the proposal does not recommend amending the rules for approving and registering firms (save that it recommends increasing the range of sanctions available), if implemented this change to the regime would likely lead to increased public and Parliamentary focus on the procedure, which might in turn lead to a higher likelihood of sanctions being imposed. In accordance with the principle of legal certainty, it will be important that those subject to this regime have clarity on the sanctions which can be applied and the circumstances in which they will be imposed. Separately, from the perspective of accountancy bodies such as ICAEW and ACCA, this recommendation is significant as it would entail a marked reduction to their role. – That the board of the ARGA and Parliament monitor enforcement performance, with the ARGA regularly appearing before the BEIS Select Committee. 12 In practical terms, we consider that the increased scrutiny on the regulator proposed by this recommendation is likely to mean that it will seek to avoid any criticism that it is taking a "soft" or overly consensual approach. This may mean, for instance, that the ARGA continues the trajectory recently set by the FRC of increasing the level of sanctions imposed on firms and individuals. From the perspective of the rule of law, however, political or public pressure (as distinct from any role that the public interest has based on the wording of the disciplinary scheme) is not a relevant consideration for the regulator in deciding which sanctions to impose (or the level of those sanctions). Decisions which are made on the basis of such outside influences are liable to be challenged on the basis that they are an abuse of power. Conceivably reliance on such factors could result in the sanctions applied in identical cases being markedly different depending on the varying level of political pressure present from time to time. In circumstances where a failure to treat like cases alike can be characterised as unreasonable, this would not be a proper approach to the exercise of a regulator’s discretion in relation to sanctions. 11 Recommendations 15 and 16. 12 Recommendation 32. // 6 – That the regulator revisits its publication policy in relation to concluded cases which result in undertakings. 13 Subsequent to the publication of the Kingman Report, the FRC issued an updated Publication Policy for each of the AEP and the Accountancy Scheme (in September 2019 and November 2019 respectively). This is part of a trend towards increased transparency in relation to enforcement decisions, which we expect that the FRC (and the ARGA) will seek to continue. However, that is not to say that the regulator can make publication decisions in its sole discretion – it must comply with public law principles otherwise it will be open to aggrieved individuals and firms to seek to challenge such decisions. A particular concern for individuals and firms is the broad discretion in both the AEP and Accountancy Scheme publication policies for the regulator to choose to publicise matters such as the commencement of an investigation (which, as we mention above, could have material adverse effects on persons who are named). From a public law perspective, we have a number of observations on this discretion: Helpfully the current policies do set out a number of factors to be taken into account by the regulator when deciding whether to publish such information. A failure properly to consider such factors would give grounds to challenge the regulator's decision. The current policies both set out the general position that firms and individuals will be given an opportunity to comment on the proposed terms of the publication. As a matter of procedural fairness, this expectation is important and a failure to comply with it could give rise to grounds for judicial review. Similarly, as a matter of public law, the regulator must conscientiously take into account representations that are made. The current policies do not include a requirement for the regulator to give reasons for the exercise of its discretion to publish material. As a matter of procedural fairness, and in order to prevent the abuse of the regulator’s discretion, we consider that in appropriate circumstances a court might nevertheless require the regulator to give reasons for its decision. From the perspective of regulated firms and individuals, it would be helpful if subsequent iterations of the publication policies (which we expect to be revised when the ARGA is established) contain an express expectation that the regulator will give reasons for any discretionary decision which it makes in this context. – The international reach of the regulator’s statutory audit enforcement action should be extended, on a risk-based basis. 14 In the consultation paper on the Kingman Report, the Government noted that, "The proposal to extend the reach of the regulator's enforcement internationally will need careful consideration to ensure that it can be effective and proportionate in the UK". On that basis the Government committed to reflecting further on this recommendation. We note that UK statutes do not usually have extra-territorial effect (though they can expressly be drafted to have such effect) and agree with the Government that there are legal and practical difficulties with this recommendation which would need to be considered carefully if it is to be taken forward. Particular concerns with extra-territoriality include the difficulty in designing and operating enforcement mechanisms, together with the possible infringement of the rule of law prohibition against double jeopardy in circumstances where overseas regulators also have jurisdiction. Clearly this is an important issue from the perspective of audit firms' activities. If taken forward, this recommendation could represent a dramatic 13 Recommendation 33. 14 Recommendation 34. // 7 increase in the regulatory reach of the ARGA. As a matter of legal certainty, it is critical that the limits of the regulator’s jurisdiction are closely defined and that legislation or guidance stipulates the matters which should inform any discretion which the regulator is afforded. – Discontinuing the Accountancy Scheme and instead bringing enforcement action against accountants in relation to public interest entities (as to which the Kingman Report proposes widening the scope of what is a "public interest entity")15 on a statutory basis.16 This would encompass a lower threshold for bringing enforcement action against accountants than currently exists and for that reason should be of significant note for accountants and firms conducting non-audit work. Currently the threshold for enforcement action for accountants (whether in relation to public interest entities or otherwise) is "misconduct", which is defined as conduct which "falls significantly short of the standards reasonably to be expected". On the other hand, the threshold under the AEP is a breach of a "relevant requirement". This is a lower standard, which could involve strict liability in certain circumstances. From the perspective of the rule of law we have two observations on this proposal. First, legal certainty requires that the definition of “public interest entities” continues to be clearly defined. Given the consequences of designating an organisation as a “public interest entity”, it would be problematic if the legislation left any room for doubt as to the scope of the concept. Second, any broadening of this concept should occur in a manner which is foreseeable and not retroactive. For instance there would be an issue if the principle was broadened in such a manner that an accountant’s prior work in organisations which are subsequently defined as “public interest entities” was brought within the scope of the new disciplinary regime. – Otherwise, the FRC's oversight of the accountancy profession should continue. 17 Taken together with the recommendation discussed immediately above, this proposal seems to suggest that the regulator's oversight of the accountancy profession should continue as per the Accountancy Scheme, save where accountants act in relation to public interest entities (who will be subject to an AEP-type regime). On its face, this would mean that there would be a different test for bringing enforcement action against accountants depending on whether they were advising a public interest entity or not. This might lead to rather arbitrary results and, if carried forward, would suggest a two tier profession (or at least a two tier professional conduct regime). While such a result is possible, in practice the ultimate result might be that the threshold for bringing enforcement action against all accountants (whether in relation to public interest entities or not) will be lowered to that currently applied to auditors under the AEP. We note that in the consultation paper on the Kingman Report the Government commits to considering this proposal further. – The scope of the regulator's enforcement powers should be extended to company directors (of public interest entities) who are not accountants/auditors. Such 15 The consultation on the Kingman Report says that the Government would consult on proposals to review the definition of “public interest entities, as per recommendation 18 of the Kingman Report, "this year" (ie in 2019). We are not aware that such consultation has yet been published. 16 Recommendation 35. 17 Recommendation 39. // 8 directors should be held individually accountable in relation to auditing and corporate reporting against a set of relevant requirements. 18 This is an eye-catching and controversial recommendation which has been widely criticised, not least on the basis that the proposal does not adequately take into account the existing enforcement framework for company directors (or the role of the courts in relation to company law). While analysing the detail of this recommendation is beyond the scope of this paper, we consider that the proposal gives rise to a number of rule of law concerns, including in relation to double jeopardy and legal certainty. For now, however, we note that this recommendation has not yet been taken forward by the Government. Instead the consultation paper on the Kingman report states the following: "Changes to this regime will require primary legislation and will require careful consideration of how any new policies interact with the existing enforcement framework". – A duty should be introduced for auditors to report viability or other serious concerns. 19 While the Kingman Report does not say this expressly, the implication is that there would be disciplinary consequences for auditors were they to fail to report such concerns. If that is the case, it will be essential that the expectations on auditors are clearly set out. For instance it will important to understand, as a matter of legal certainty, what would be classified as a "serious concern" and whether it is an objective or subjective test (eg would the requirement only cover auditors who in fact had such concerns but did not report them, or would it also catch auditors who in fact did not have such concerns but ought to have done so). We note that the consultation on the Kingman Report does not include proposals for how to take this forward, but rather says that the Government will work with the FRC to develop a framework and will consult in due course. – The ARGA should be able to require rapid explanations from companies about concerns held by the regulator. 20 As with the proposal discussed above about increasing the regulator's reach to company directors, analysing this recommendation is beyond the scope of this paper. We would, however, note that, at present, neither the Kingman Report nor the consultation paper provide details on how this proposal would work (for instance what is meant by “explanation” or the consequences of a failure to comply with a request from the regulator). Any legislation on this issue would need to provide sufficient detail and clarity on these issues. In addition the process adopted by the regulator for requiring explanations would need to comply with public law principles (eg giving companies adequate time to respond to requests). – That all of the functions of the ARGA should be subject to the Freedom of Information Act 2000 ("FOIA"). 21 This would be a significant extension to the current position – at present, the FOIA does not apply to the FRC's disciplinary functions against auditors and accountants. From the perspective of firms and individuals regulated by the FRC (and their clients), this proposed extension to FOIA is of potential concern given the possibility it introduces of the disclosure