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June 23, 2009

Auditor independence and FSA co-operation highlighted in report

A UK government committee has questioned how useful audit currently is and said the process results in tunnel vision, where the big picture is lost in a “sea of detail and regulatory disclosures”.

The UK House of Commons Treasury Committee’s new report, Banking Crisis: reforming corporate governance and pay in the City, examined the role that auditors played in the UK banking crisis and how their performance could be strengthened in the future.

The committee concluded auditors fulfilled their duties as currently stipulated, but raised concerns and made suggestions in a number of areas, including auditor independence and co-operation between auditors and the UK banking regulator, the Financial Services Authority (FSA).

Ban non-audit work

The committee suggested audit firms should be banned from conducting non-audit work for audit clients and recommended the UK Financial Reporting Council (FRC) consult on this proposal as soon as possible.

Institute of Chartered Accountants in England and Wales (ICAEW) chief executive Michael Izza told The Accountant he is concerned that the report does not specify whether they thought the independence of auditors should be looked at in the context of banks alone, all financial institutions or the wider audit community.

“I have a bit of an issue if auditors were being told that they had to be more independent for some audit clients than for others,” he said. “Independence is independence. If, for example, a major audit firm was auditing a bank and they had to provide a different standard of independence to that bank than they had to provide to Shell, or GlaxoSmithKline, I think that is a very difficult intellectual road to go down.

“Do you end up with some audits being more independent than others? That just doesn’t give me an easy feeling.”

Izza said it is important there is a factual base for any discussions about auditor independence because a lot of non-audit services benefit shareholders. Examples include reviews of interim reporting and some work on Sarbanes-Oxley requirements.

“Some clarity over what is actually for shareholders and what is for management should be the starting point for this,” he said.

The committee also considered whether the role of the auditor could be extended to provide greater assurance to shareholders.

The report accepted FRC chief executive Paul Boyle’s advice that auditors are not well placed to provide additional assurance on the risk management practices of financial institutions, and also accepted an ICAEW recommendation that there could be better co-operation between auditors and the FSA.

Izza argued that while risk management may not be something auditors have the skills to opine on today, it is an area chartered accountants understand well.

The ICAEW’s financial reporting faculty made a submission to the committee that noted auditors had much more frequent contact with the previous financial services regulator, the Bank of England, than they do with the FSA.

“The FSA, when they came into being, took the view they would do things themselves. There has been a massive regulatory failure here,” Izza said.

“If the FSA, in their deliberations as to how they are going to do things going forward, can see a role for auditors and auditors can adapt their work or do additional things that are helpful to them, I think that is something we should explore.”

The ICAEW’s financial services faculty has been involved in discussions with the FSA now for several weeks.

Izza said that in general the audit profession needs to begin discussing whether there are some ways in which auditors should have a wider brief.

Graduated ladder of concern

The committee also recommended the FRC should consider replacing going concern with a graduated ladder of concern, where auditors could “transparently express an opinion on a bank’s future, without triggering emergency action by the FSA”.

It also suggested financial reports should move to a more narrative model.

“We would like them to read less like dictionaries and more like histories,” the committee said.

“A useful approach would be to insist on all listed firms setting out their business model in a short business review, in clear jargon-free English, to detail how the firm has made [or lost] its money and what the main future risks are judged to be.”

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