FRC’s sanctions under review

Published 15 marzo 2018

The Independent Committee appointed to review FRC sanctions policies has produced its report (published in November 2017) (“the Report”). It is 60 pages long and makes a number of recommendations and provides guidance to the FRC and to an appointed Tribunal on how they should approach imposing sanctions in disciplinary proceedings. Below we comment on the main themes arising from the review and the implications for accountants and their PI insurers.

Main themes

Higher fines: We live in a very different regulatory landscape to that of 20, or even 10 years ago. Whereas regulation used to be seen as “a good thing to have”, it is now seen as essential and any regulated entity, or person, can expect politicians, the courts, tribunals and indeed independent reviews to support increasingly active and interventionist regulation going forward. This is the context to the Report and it is unsurprising that one of the two reasons given for the setting up of the review was concern expressed by “stakeholders” that sanctions imposed by the FRC had been “too low”. This is despite the fact that fines have been noticeably higher in recent years [1]. Inevitably, the focus of media interest in the Report has been on whether we are likely to see higher fines, and there have been several articles which quote the reference in the Report to £10m or more being an appropriate fine in an audit misconduct case involving seriously bad incompetence against one of the Big Four.

The Report itself sought to stay balanced on this subject; it was at pains to stress that any fine must be proportionate to the wrongdoing and it was inappropriate simply to have regard to the size of a firm’s revenue when setting the level of a fine for misconduct.
As a minor but important postscript on the subject, we note that there was no objection in the Report to a firm insuring itself against fines.

Comment

Unfortunately for accountancy firms and individual accountants under investigation, we expect the direction of travel to be one way; fines and regulatory intervention will increase and accountants and PI insurers need to plan and approach their businesses accordingly.

Larger firms are the firms most likely to face FRC scrutiny, and professional standards are already high in those firms; it is a desire to meet those standards, rather than the fear of fines, which drives audit quality. In our view, there is an increasing, and present, risk that in striving to improve standards through higher fines, the regulator will change the focus of auditing from exercising professional judgement to avoiding criticism and sanction.

There is also a real risk of injustice for those under investigation. The Report emphasises the need for fines to be proportionate to the wrongdoing and we hope the FRC changes its guidance to reflect this. However, if the reality is that agreeing to higher fines is the price of settlement for many defendants, this will lead to injustice, particularly if there are no costs consequences for the FRC in pursuing matters to a Tribunal – see below.

Non-financial sanctions: The argument that higher fines necessarily lead to a more professional level of service is debatable, and the cost of regulation ultimately gets passed on to the consumer. The Report expressly recognises this concern and recommends that the guidance on sanctions include a requirement that non-financial penalties be considered instead of financial penalties, or in conjunction with lower penalties. However, although the Report recommends changing the order of objectives set out in the Sanctions Guidance so that “deterrence” does not appear first in the list, we are not optimistic that the FRC or a Tribunal in disciplinary proceedings will choose non-financial penalties as an alternative to high fines when “deterrence” of future breaches of standards is seen, and will continue in our view to be seen as a central objective. Nevertheless, we await with interest to see how this recommendation is taken forward by the FRC and whether it plays an important role in future regulatory proceedings.

The importance of precedent to the level of sanction: A number of stakeholders (including this firm) participated in a consultation which preceded the report. Several advocated the use of tariffs which would lend consistency and fairness to the process. The Report rejects the use of tariffs and does its best to ensure future Tribunals have room to be flexible with almost complete discretion in their approach towards determining sanctions on a case by case basis. From the future defendant’s perspective, what this may mean in reality is that the FRC, unbound by the constraints of having to have strict regard to prior Tribunal decisions, will feel free to suggest higher fines when negotiating settlements, which will make early settlement less straightforward. Whilst we would agree that for more serious and complex cases, case precedents may be of limited value, less serious cases would suit the use of tariffs, or precedent, which would quicken and ease the passage towards early settlement of a complaint. We think this is a missed opportunity.

Costs: The Report supports the current approach under the Audit Enforcement Procedure (which replaced its predecessor, the Accountancy Scheme) which only allows a Tribunal to award costs against the FRC if it concludes it was unreasonable for the FRC to have pursued all, or a substantial part of the case. However, it recommends removing any requirement which only allows an award of costs against the FRC if the Formal Complaint is effectively dismissed in its entirety. If the recommendation is implemented, this may prove significant as it potentially paves the way to an “issues based” costs award against the FRC.

Comment

In today’s regulatory climate, sympathy for the regulated is in short supply and this of course affects the approach of a Tribunal when exercising its discretion in relation to costs awards. In this context, restricting costs awards against the FRC to those cases where a Tribunal concludes the FRC was acting unreasonably in bringing the disciplinary proceedings creates a heavy bias against defendants. There is no real recognition in the Report of the burden defendants face in terms of costs, and no proper consideration of the injustice this can lead to. Allowing “Issues based” costs awards effectively increases the discretion of a Tribunal to recognise injustice and in particular, this may allow defendants to recover their costs in cases where it was reasonable to defend allegations which should not have been made. We hope the FRC does not dismiss this recommendation.

Conclusion

Overall, the Committee’s report comes across as attempting to achieve balance from an independent perspective. Some of the recommendations it makes which we comment on above are significant and worthy of consideration. We hope that the FRC will adopt these recommendations.

Of the significant number of recommendations contained in the Report, none has attracted more attention in the media than the suggestion that the Big Four firms should face fines of up to £10m in the most serious audit misconduct cases. A fine at this level would be significantly higher than anything imposed by the FRC to date. Medium sized and smaller sized firms are also likely to feel the brunt of fines at significantly higher levels than previously; fines of £5m may be on the horizon for mid-sized firms in the most serious cases. We fear the impact of the law of unintended consequences: higher fines, and indeed higher irrecoverable defence costs, is bound to change behaviours, but not necessarily in ways which will in the long term lead to higher audit standards. On behalf of prospective defendants, we are also concerned the current trend towards higher fines will lead to disproportionate fines and injustice.

[1] In the period 2013-2016, the mean “firm” fine increased from £750,000 to £2,146,667 and the highest fine imposed is currently £5. 1 million