The saga of the FRC's investigations into the audits of Carillion will be familiar to all in this space, with sizeable fines being handed down in respect of the approach taken by a small number of individuals to the FRC's Audit Quality Review ("AQR") process in respect of Carillion following a lengthy Tribunal hearing. Practitioners will be mining the Tribunal Report in that case for years to come, as one of the rare public decisions following submissions made by both Executive Counsel and Respondents in open hearings.
Amidst the attention focused on that decision, it may have been easy to lose sight of the fact that the principal investigation – into the actual audits themselves – was still underway. These investigations have now concluded, resulting in the highest headline fine we have seen against any firm, of £26.5 million, reduced by 30% to reflect co-operation and admissions by the firm.
The FRC has not (yet) published its detailed Decision Notices. Meanwhile, there are some key points of wider application which merit comment.
- High-water mark or a taste of things to come?
These fines are eye-watering. In recent years, such fines have only been going in one direction – up. However, there is a changing of the guard at the FRC. Incoming Executive Counsel, Richard Moriarty, who has identified the need to continue to attract the best talent into the profession, has professed not to get good 'energy' from further blockbuster fines. We welcome a change in emphasis away from ever harsher sanctions, and towards alternative routes on driving up audit quality.
Will this change the emphasis of enforcement investigations and arrest the ever-increasing level of fines? We may have to be realistic about that prospect. To those with a background in the world of FCA investigations and banking regulation, fines which seem eye-wateringly high to the audit profession may not seem so high – especially to those with experience of post-2008 banking investigations. The FRC's Enforcement team is increasingly staffed by individuals with that background.
We nevertheless hope that the FRC will be welcoming of firms making submissions on remediation and in mitigation of sanctions. Mistakes can be made, but firms which 'get it' and apply themselves towards driving up quality should face encouragement rather than punitive measures. This is all the more so now that breach of relevant requirements is the trigger for enforcement action.
- The Audit Enforcement Procedure ('AEP')
Without having seen the published Decision Notices, it is difficult to comment on the number and degree of audit failings identified. However, we find that criticism in a published Decision Notice will inevitably, in our experience, make the issues look stark compared to when balanced against the better audit work on file.
Meanwhile, it remains difficult to understand the reasoning behind the high level of fines. The FRC's published statements hint the high level is because: "Many of the breaches involve failing to adhere to the most basic and fundamental audit concepts such as to act with professional scepticism and to obtain sufficient appropriate audit evidence." In our experience, almost every audit failing could be described as falling into one of those two buckets – 'audit evidence' and 'professional scepticism'.
The FRC's summary of findings, available on the FRC website, is helpful in identifying the issues – but the missing link is how these findings connect to the record-breaking fine.
Guidance for the Case Examiner under the AEP states that the Case Examiner should have regard to whether "the case relates to an event which is high profile or has attracted or is likely to attract significant media or political attention". We have registered our reservations about this provision when responding to the FRC's recent consultation on the AEP. Regulators should be led by the quality of the audit work, and not by the attention of politicians and commentators. It would be a great shame – indeed it would be shameful – if heavy sanctions on the auditor were to follow every high-profile corporate insolvency as night follows day, regardless of the audit work done and without regard to whether that insolvency resulted from an intervening event that could not – at the date of the audit – be anticipated.
We also think it worth reflecting on the fact that high-profile corporate insolvencies are a fact of life. A world in which the same large companies continued to dominate markets for decades after decades is we would suggest, not one in which any of us would like to live. Schumpeter's scythe - https://www.cmu.edu/epp/irle/irle-blog-pages/schumpeters-theory-of-creative-destruction.html - swinging over capital markets is arguably what leads to the creative destruction that is a necessary precondition for a dynamic economy.
We may be at a crossroads in audit enforcement – the next few years will determine which fork the regulator has taken.