The Financial Reporting Council (FRC) published its first Annual Enforcement Review in July 2019. Below is a brief summary of some of the key themes arising from the review and some practical reminders for firms in light of the current regulatory environment.

Increase in investigations

A general theme arising from the review is the increase in the number of referrals and concluded cases. In particular, the review notes that since the introduction of the Audit Enforcement Procedure, which has a lower threshold for opening investigations and taking enforcement action than the Accountancy Scheme, there has been an increase in the number of cases referred by the Audit Quality Review team to the Case Examiner to be considered for investigation.

The report also notes that there was a significant increase in the number of concluded cases in 2018–2019 in comparison to previous years (13 cases were concluded in 2018–2019 as opposed to nine in both 2017–2018 and 2016–2017). Of the 13 cases concluded in 2018–2019, one was closed with no further action, eight were closed after reaching a settlement and four were determined by the tribunal.

Increase in financial sanctions

The report also highlights the significant increase in financial sanctions imposed on firms and individuals by the FRC in 2018–2019, as set out in the table below:1

 

2016–2017

2017–2018

2018–2019

Total financial sanctions imposed pre-discount

£12 million

£15.5 million

£42.9 million

Total financial sanctions imposed post-discount

£9.3 million

£13.1 million

£32 million

Settlement 

The review emphasises that settlement continues to be encouraged, as reflected in the staged discount on the fines imposed. The FRC also recognises exceptional cooperation, such as self-reporting and volunteering information that has not been specifically requested, as an additional mitigating factor.

Key issues resulting in investigations

The key issues resulting in FRC investigations are: integrity; objectivity and independence; and professional competence and due care (including audit evidence and professional scepticism).

Integrity

The review notes that integrity is the “overarching principle of the FRC’s Ethical Standards applicable to audit engagements” and “requires that auditors are trustworthy, straightforward, honest, fair and candid and comply with the spirit as well as the letter of applicable ethical principles, laws and regulations” so as to maintain the public’s trust in the auditing profession.

Objectivity and independence

The review notes that “objectivity is critical given that many of the questions involved in the preparation of financial statements are matters of judgement and involve the application of discretion. If directors make biased or otherwise inappropriate decisions, the financial statements may be misstated or misleading. The auditor therefore needs to be in a position to make impartial judgements in light of all available evidence and adopt a robust approach, challenging management where necessary”.

Professional competence and due care – audit evidence and professional scepticism

Many of the FRC’s findings result from “a failure by auditors to obtain sufficient appropriate evidence to draw reasonable conclusions on which to base the audit opinion. Sufficiency requires an assessment of the risks of material misstatement and the quality of the evidence. Appropriateness relates to the relevance and reliability of the evidence which might include consideration of, for example, whether it is from an independent third party, whether it came directly to the auditor or via the company itself, and the purpose for which it was obtained”. In addition, auditors are required “to plan and perform audits with professional scepticism, recognising circumstances may exist that cause the financial statements to be materially misstated”.

Conclusion and key takeaways

As set out above, there have been significant increases in the number of cases referred to investigation, the number of investigations concluded and the number of financial penalties imposed in the last year. The Audit, Reporting and Governance Agency (ARGA) is intended to strengthen the FRC’s current enforcement regime so it is likely that this trend will continue when the ARGA takes over the FRC’s role.

In light of the current climate, firms may want to bear in mind the following:

  1. Audit firms should have robust conflicts procedures in place and should carefully consider whether they can remain objective and independent if providing non-audit services to audit clients.
  2. The audit team should be wary of delegating responsibility to insufficiently experienced staff, and partners must ensure junior staff have adequate supervision and support.
  3. The audit team should challenge management by testing assumptions and estimates, and obtaining independent or corroborating audit evidence.