The FSA has entered the vigorous debate on the role of auditors and actuaries in the recent fi nancial crisis. Although auditors escaped the blame during the immediate aftermath of the crisis, they are now facing severe scrutiny from regulators like the FSA. Two of the Big Four accountants are under AADB investigation connected with FSA client asset audits. Although the FSA already has draconian powers, it is seeking wider powers over accountants to enhance enforcement tools and improve regulatory compliance.
What powers does the FSA have?
As a part of its armoury for upholding its statutory objectives, the FSA has the power to disqualify auditors and actuaries who fail to comply with a duty imposed on them under the Financial Services and Markets Act 2000 (FSMA).1 The power granted by FSMA extends to disqualifying auditors in breach of duties imposed by the trust scheme rules.2 If an auditor or actuary provides a defi cient report to the FSA or fails to offer adequate assurance reporting on client assets, the FSA can disqualify the auditor or actuary from conducting such regulated work.
When deciding whether to exercise this power to disqualify and on the scope of any disqualifi cation, the FSA must take into account such factors as the nature and seriousness of any breach of rules and the effect of that breach, the action taken by the auditor or actuary to remedy the breach, the action taken by other professional bodies and the previous compliance record of the auditor or actuary.
Impact on auditors and actuaries
The FSA’s power to disqualify carries huge risks for auditors, actuaries and their clients. A disqualifi cation order is either made against the individual appointed by the fi rm or the audit fi rm itself and has the effect of banning the auditor or actuary from acting for any regulated fi rm or class of fi rms. Whatever order is made, the blow to reputations would do immeasurable harm.
FSA’s policy on disqualifying auditors and actuaries
The FSA has not exercised its powers to disqualify auditors or actuaries to date. Instead, the FSA has referred accountants to the AADB or the Institutes. In October 2010, the AADB announced investigations against the auditors of Lehman Brothers and JP Morgan Securities. We do not know whether or not these were instigated by the FSA but, in the JP Morgan case, the huge fi ne imposed on JP Morgan by the FSA for breaches of the Client Asset Rules (CASS) was widely publicised.3
In the wake of the banking crisis, auditors and actuaries have come under fi re over the value of their audits, which failed to identify the growing problems. The FSA’s discussion paper4 (published in June 2010) and its consultation paper5 (published in September) demonstrate a shift in the FSA’s view. In the discussion paper, the FSA raised concerns that auditors “portray a worrying lack of scepticism” when examining fi nancial accounting and disclosure which depend critically on management judgement.6
The FSA stressed the need for enhanced enforcement tools to make a fully calibrated response to the regulatory concerns in any given case. Further powers sought by the FSA would require amendments to FSMA, but could easily be introduced in the legislation to change the framework of fi nancial services regulation expected next year.7 The FSA believes the enhanced powers would make its monitoring and enforcement a more “credible deterrent” and help improve compliance.8 The package of new enforcement powers sought by the FSA includes:
- Public censure of the audit fi rm or relevant individual within the audit fi rm
- Financial penalties against the audit fi rm or the relevant individual within the audit fi rm
- Disqualifi cation of the audit fi rm or relevant individual within the audit fi rm from acting as the auditor of an authorised person or class of authorised person (either temporary or indefi nite).
Within its existing powers, the FSA’s drive to improve the quality and consistency of audit reports on client assets is evident in its consultation paper. It uncovered material failings and weaknesses of auditors’ reports that signifi ed a general defi ciency by auditors in applying the current requirements set out in the FSA Handbook (particularly CASS) and FSMA. It is proposed to amend the FSA Handbook to clarify the FSA’s expectations regarding the type of report and the applicability of auditing standards. These proposed sanctions and guidelines are attempts by the FSA to “better align auditors’ incentives with those of the regulators”.9
Will the FSA use their powers to disqualify?
There is further external pressure on the FSA to push through new powers to disqualify auditors and to provide a new model which incentivises auditors to co-operate with regulators. In the House of Lords Economic Affairs Committee’s inquiry into the audit profession, the inadequacy of the accounting rules on impairment, securitisation and contingent liabilities was raised as a signifi cant contributing factor to the banking crisis. Former Chancellor of the Exchequer Lord Lawson described auditors as “one of the dogs that didn’t bark”. Additionally, the EU green paper on audit policy10 published on 13 October 2010 considers a radical restructuring of the industry, with the creation of a new European Supervisory Authority and the dismantling of the dominance of the Big Four.
Whether and how the proposed new powers will fi t within the FSA’s structure is unknown. However, it is undeniable that the FSA will be keeping a closer watch on auditors and actuaries from now on. The fact that the FSA is seeking extended powers to disqualify auditors indicates its willingness to employ those powers and recognise their usefulness in pursuing its regulatory objectives.
Implications for FSA regulated fi rms
The FSA’s power to disqualify auditors and actuaries should not be taken lightly by unregulated accountancy fi rms, but the implications may be more signifi cant for fi rms that are fully regulated. Regulated fi rms have a fundamental obligation to take reasonable care to organise and control their affairs with adequate risk management systems.11 If an auditor or actuary in a fi rm which is regulated (even working within a practice area that is not itself directly regulated by the FSA) is disqualifi ed, the FSA may take this as an indication of risks in the whole of the fi rm’s business. The impact of the fi rm’s senior management and compliance culture cannot be ignored as an aspect which may lead to the breach of duty by the auditor. The FSA will fi nd it diffi cult to see how a fi rm could successfully introduce a culture of compliance in one part of a business without expecting the same approach elsewhere. Senior management should therefore take responsibility for ensuring that the entire business (including unregulated areas) operates in accordance with FSA expectations.
Regardless of whether the FSA will actually use its powers to disqualify auditors and actuaries, the fi nancial crisis has blown the role of auditors wide open and ignited a debate on the powers of the regulators to impose their will. Those used to reporting to the FSA about clients should make ready to explain themselves.