Who should watch the auditors?

And still the aftermath of the financial crisis continues. In June the Financial Services Authority (FSA) and the Financial Reporting Council (FRC), published a discussion paper looking into the role of financial services auditors in the financial downturn. In their assessment they found inadequecies. The rationale behind the paper “Enhancing the auditor’s contribution to prudential regulation”, is that, in spite of being given a clean audit opinion, the FSA believes that auditors did not show sufficient professional scepticism, particularly regarding management’s judgement over the valuation of investments. The paper places a question mark over the role auditors play in reporting risks and irregularities to regulators and investors.

The paper aims to encourage more dialogue and a stronger relationship between auditors and the FSA, which is no bad thing. However, the nature of the dialogue must be clearly thought through and carried out in order for it to reap the benefits for all involved. There needs to be transparency and clarity, but there is no requirement for the FSA to become experts in audit or, as is put forward in the paper, to become the regulator of auditors – it is simply not a valuable use of their time, particularly as there are already expert regulatory bodies who oversee the industry to a high standard. Mutually enlightening discussions between the FSA, ICAEW, FRC and auditors about each other’s roles and how best they can complement one another is needed, not a complete overhaul of the regulatory system.

The most positive outcome of the paper is the proposed increased use of the Section 166 skilled person reports. These reports are efficient because they are only carried out where the FSA perceives a need, rather than the alternative of the FSA requiring more audited information from all financial services firms. Use of the s166 reports also supports the FSA’s desired risk-based policy.

Having recognised this positive, the paper unfortunately only discusses audit assistance in terms of banking and insurance, and does not attempt to distinguish assistance for other financial services firms. One size does not fit all. The implementation costs of new regulation suitable to a global listed bank represent a massive burden on a small private equity house and, in some instances, could produce irrelevant data which may inturn hide key information. Although it would require considerably more focussed effort, if the FSA really want to better utilise the skills and experience of auditors, they need to create a sliding-scale of reporting depending on the size, work and risk of the financial services firm. The auditor needs to be looking for the right information, not all of it.

This discussion paper is just one point in a long and interesting debate on the interaction between accounting and regulation. However, claims that it heralds a shake-up of the auditing profession greater than the introduction of Sarbanes Oxley are, to say the least, far-fetched.

Michelle Carroll is a member at Kinetic Partners financial services consultancy. She is also a member of the ICAEW working party and of the ICAEW investment management committee.