DESPITE the profession’s opposition to changes in how sanctions are calculated, the FRC is pushing ahead with guidance that takes into account a firm’s revenue when dishing out fines.
Although the Financial Reporting Council put the guidance up for consultation, almost all the arguments were rebutted by the reporting watchdog.
The guidance asks disciplinary tribunals to take into account factors such as profitability per partner, market share, number of audit and non-audit clients and their size, revenue and profitability when deciding how much a firm should be sanctioned.
There is also no upper limit on financial sanctions, meaning a firm could be charged record-breaking amounts.
To offer a snippet into many firms’ point of view, PwC’s response to the consultation said: “A sanction should be proportionate to the seriousness of the misconduct and the harm caused thereby. It should not be linked to the size of the firm in question.
“In respect of … Indicative Sanctions Guidance, we do not agree that sanctions should have a punitive effect.”
PwC added: “We do not consider that natural justice is served by applying higher monetary sanctions on a firm merely because of its size, rather than by reference to the nature of the offence and the harm caused. Further, we do not agree that the ability to pay should be a proper basis for increasing what would otherwise be the tariff for the relevant conduct.”
In a summary of responses to the consultation on the sanctions guidance, most respondents claimed that hiking the size of fines was not warranted or required. The summary added that the deterrent effect is overstated as most disciplinary cases don’t involve reckless or deliberate behaviour.
However, the FRC argued in its response to the consultation that, following a review of the disciplinary cases undertaken by its disciplinary arm, previously the AADB, many cases did involve reckless or deliberate misconduct and not just a failure to comply with professional standards.
The FRC added that it remains of the view that the financial penalties should reflect the scale of a firm’s wrongdoing and should enhance public confidence in the regulation of the profession.
The watchdog wants to move down the road of the Financial Services Authority’s method of calculating fines, which will lead to costly sanctions. Respondents are unhappy with this plan.
The respondents’ argument was that the FSA’s approach is concerned with disgorgement of profits, punishment as well as deterrence. Many who are handed down fines by the FSA have misled investors and the public and have made losses, such as UBS, handed down a £29.7m fine for failing to prevent large-scale unauthorised trading.
According to the FRC, firms should be governed by the same sentiment for improperly prepared and/or audited accounts that may have misled investors, counterparties and the public.
Most respondents claimed that revenue and profitability should not form part of a tribunal’s approach to deciding fines because it was potentially unfair and could distort the position of the sanction. Largely because the fine would take into account the revenues of the firm as a whole, rather than the revenue of the division at fault.
That claim was rebuffed by the FRC, which argued the tribunal must be able to consider whether the level of fine would send the necessary message to achieve its objective of punishment and deterrence. However, it did agree that a tribunal should take into account the structure of a firm, and the area of business linked to the breach that occurred.
This is in contrast to the actual guidance, which stated that, in the majority of cases where a member firm will be fined, the amount of revenue generated by the firm will be a factor in the calculation of the fine.
Where revenue is not appropriate, the tribunal should seek to measure other indicators such as the profitability per partner, market share, the number of audit and non-audit clients and their respective size.
One of the last points in the consultation summary is where the tribunal should start when deciding how to determine the level of fine.
Some suggested the engagement fee as a starting point, but the FRC did not regard this as an appropriate approach because it was unlikely to enhance public confidence in the profession.
Other respondents supported a firm’s turnover, in the relevant division, as a starting point and advocated taking an average over the last three years to ensure a balanced and representative approach, which the FRC had no arguments against.
According to PwC’s initial response, changes to sanctions should relate to the harm caused and not the size of the firm. There is an argument that a smaller firm which may have caused more damage to the reputation of the profession and harm to investors could face a smaller fine than a larger firm which has affected investors and the public confidence less.
The Guidance will be used by FRC tribunals from 1 February 2013.
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