UK Profession Scrutinized

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The United Kingdom has named Donald Brydon, retiring chairman of the London Stock Exchange Group, to head a government-commissioned study of the audit market. The new group was announced just after three reports on the topic were released in mid-December: “Reforming the Auditing Industry” commissioned by the Shadow Chancellor of the Exchequer, John McDonnell, MP, and conducted independently by an academic team led by Professor Prem Sikka; “Statutory Audit Services Market Study” developed by the Competition and Markets Authority (CMA); and “Independent Review of the Financial Reporting Council (FRC)” by Sir John Kingman, chairman of UK Research and Innovation. These reports were called for in response to the collapse in early 2018 of Carillion, a British multinational facilities management and construction company that resulted in the loss of approximately 19,500 jobs. Professor Sikka’s paper begins by stating: “Auditors have been unable to deliver independent and robust audits and the auditing industry is in disarray, dysfunctional and stumbles from one crisis to another.” All three of the reports offer many recommendations on how to improve UK auditing, including changes to the Financial Reporting Council’s role, and Mr. Brydon’s group will be examining the future of audit as a practice and the quality of audit work in the UK.

All of the reports focus on the concentration of the audit work for the largest companies in the Big Four firms. “Competition and regulation should work together so that audit firms and individuals all have the strongest possible incentives to deliver quality,” the CMA advises. The Big Four firms now account for over 97 percent of UK audit clients in the FTSE 350 (Financial Times Stock Exchange’s largest companies by capitalization which have their primary listing on the London Stock Exchange) and over 99 percent of the audit fees. However, CMA’s market study found: “Overall, the balance of views from audit committees and investors was that audit in the UK is generally of high quality…This positive overall view of quality is also reflected in the recent FRC survey of audit committee chairs, which suggested that 86 percent of respondents rated their external auditor as either ‘excellent’ or ‘above average.’”

The European Union and the UK Competition Committee have put into place mandatory tendering of auditing firms every ten years, with switching auditors at least every 20 years. The CMA reports: “While the rate of switching has increased significantly since the introduction of the CC and EU remedies, we have found that switching has been almost entirely between the four largest auditors in the FTSE 350.” Only five of the FTSE 350 companies switched: four went to Grant Thornton and one to BDO.

The CMA proposes several “remedies to create incentives for better audit quality, in tandem with improved regulation as recommended in the separate review of the FRC ”:

1. Close scrutiny of audit appointment and management by the regulator, to secure audit committees’ accountability and independence from companies.
2. FTSE 350 audits should be carried out jointly by two firms, at least one of which is outside the Big Four. As an alternative, a market share cap.
3. Firms’ audit and non-audit businesses should be split into clearly defined separate operating entities, with separate management, accounts and remuneration, but with the ability to remain under the same organizational umbrella.
4. Peer review of audits should be commissioned by and reported to the regulator.

The review of the FRC by Sir John Kingman offers 83 recommendations beginning with: “The FRC should be replaced as soon as possible with a new independent regulator with clear statutory powers and objectives. It should be named the Audit, Reporting and Governance Authority.” This new body would be accountable to Parliament and receive a remit letter at least once each Parliament, as the Financial Conduct Authority and the Prudential Regulation Authority do. In commenting on the FRC’s weaknesses, the report states: “The FRC’s work on audit quality does not command the same credibility as that of, for instance, the Public Company Accounting Oversight Board (PCAOB) in the United States.” The US system is also pointed to when the report recommends “…give serious consideration to the case for a strengthened framework around internal controls in the UK, learning any relevant lessons from operation of the Sarbanes-Oxley regime in the US.”

Professor Sikka’s report, commissioned by the Labor Party, provides 49 recommendations that begin with: “Statutory Auditors of large companies and other entities must act exclusively as auditors.” This report also calls for the creation of a new independent regulator and that there be “no statutory regulatory powers for the Financial Reporting Council or any of the accountancy trade associations.”

Some of the uncommon recommendations include: “There must be personal liability for audit failures upon partners responsible for audits, “ and “All accounting standards must be stress tested.”