The Financial Reporting Council has had a busy week. It has published its plans for changes at the Big 4 accountancy firms, and further evidence of its enforcement success on failed audits in Conviviality and Autonomy has emerged. In particular, the finding against Deloitte and two audit partners in the Autonomy case will confirm the need for reform as the Tribunal, chaired by Lord Dyson, has found that they “signally failed” in their public interest duty to uphold reliability of the reporting of Autonomy, which was an FTSE 100 company. On any view, this is a very serious finding and is only one of a number of other serious findings.

The changes to the way the Big 4 firms are structured came as no surprise. A number of independent reports have called for fundamental change, to remove the appearance that independent auditors are in conflict with other lucrative opportunities for the same client such as consulting. Too often, the evidence shows that auditors are not prepared to challenge management on its accounting policies and financial statements as much as they should. In the jargon of audit, the ‘professional scepticism’ of what they see in the company’s books is not what it should be.

The FRC has stated one of its main objectives of the reforms will be to “improve audit quality by ensuring that people in the audit practice are focused above all on delivery of high-quality audits in the public interest”. Good timing perhaps in view of the findings by the tribunal in the Autonomy case, but it also follows much criticism of audit firms in the independent reports, Parliament, and the media with the same complaint. The FRC is asking the Big 4 firms to agree to “operational separation” of their audit practices and to provide a transition plan by October, with implementation by 30 June 2024 at the latest.

The FRC reforms have the following overarching themes:

• Audit practice governance prioritises audit quality and protects auditors from influences from the rest of the firm that could divert their focus away from audit quality;
• The total amount of profits distributed to the partners in the audit practice does not persistently exceed the contribution to profits of the audit practice;
• The culture of the audit practice prioritises high-quality audit by encouraging ethical behaviour, openness, teamwork, challenge, and professional scepticism/judgement; and
• Auditors act in the public interest and work for the benefit of shareholders of audited entities and wider society.

The Autonomy case resulted from claims by HP in 2012 that, following its acquisition of Autonomy, it had discovered that the valuation of the company was substantially overstated by billions of US dollars. There have been settlements, civil claims, and criminal trials in the UK and the United States, and now the FRC has successfully proved its case against Deloitte and two senior audit partners. The details of the findings are not yet published, as the tribunal must first decide on the appropriate sanctions, including a financial sanction for Deloitte, which is almost certain to be the highest yet as the FRC has suggested £15m and Deloitte has acknowledged that it will be over £7m There will be no discount, as Deloitte challenged the allegations before the tribunal.

The audit by Grant Thornton (GT) of alcohol supplier Conviviality Retail is the other enforcement case that was published this week. This case involved a settlement with GT, which reduced the fine from £3 million to £1.95 million. The allegations involved a failure to follow the strict ethical rules that prevent members of the audit team at GT from joining the audit client without a period of ‘cooling off’.

As Director of Enforcement at the FRC between 2012 – 2017, these developments are not a surprise to me and are a consequence of far greater attention being placed upon the quality of audits and the need for the large accountancy firms to exhibit robust independence in the audit of listed entities where shareholders are entitled to expect that financials statements, reports to regulators, and public announcements are challenged by auditors when appropriate.

The government also has a role in this to ensure further reform. This will include the introduction of rules for boards, directors, and those preparing financial statements to ensure breaches can be dealt with by the FRC successor body – the Audit Reporting and Governance Authority. If the auditor is at fault, it usually also involves those at the corporate client, so the powers to investigate all concerned must be equally robust. Perhaps the most important reform that will make a difference alongside the reforms discussed here will be the requirement for auditors to look more carefully at the financial statements to see if there has been fraud or other serious breaches of laws and regulations. That reform does not need an auditor to become a detective, but a far greater degree of curiosity about the accounting for significant sums of money would be a good start.

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