Audit quality: Why do FRC fines keep increasing?

The Financial Reporting Council (FRC) has shown an increasing determination in fining audit firms accused of providing poor audit quality – as revealed in its Annual Enforcement Review published last year.

In 2018/19, the total amount of fines on audit firms reached a staggering £40.6m (end of March 2019), in comparison to £14.8m in 2017/18. The London law firm RPC has also recently estimated the fines issued amount to  £24.9m in 2019 alone.

More fines, but why?

When the annual review led by the FRC was initially published, the regulator listed a series of causes that triggered the increase in the value of its fines on audit firms:

• A growing number of cases being finalised.
• The estimation of the serious nature of misconduct and the size of the audit firms, such as the number of individuals affected by the misconduct for example.
• The size and financial resources of the firm – the bigger the audit firm, the bigger the sanction.

RPC added that the big jump in fines was a reflection on the FRC’s stricter approach, as it recently faced criticism for having a lenient watchdog role.

Another factor the firm believes could have contributed to the rise in fines is the EU Audit Regulation, which came into effect in 2016. The new rule enabled the FRC to cover a broader range of audits, increasing the possibility of issuing more fines.

RPC claimed that the FRC’s publication of its updated Audit Enforcement procedure also led to a reduction of the threshold launching an investigation, widening the potential for further sanctions. Likewise, its revised sanctions guidance in June 2018 could have encouraged tougher sanctions.

Towards a different regulator

The FRC has also increased its enforcement team – marking its move to become a stricter regulator.

Last year, a former head of dispute resolution at a City law firm joined the FRC to lead its enforcement team. The regulator will also be adding a former FCA director of investigation to its team in February this year.

Robert Morris, partner at RPC, said: “Whilst the FRC has been accused of lacking teeth, fines are of the scale where they are now causing real financial pain. We are getting to the point where the FRC and its successor may want to be cautious about increasing the level of fines even further.

“We are now seeing the impact of the regulatory changes that have been introduced over the last few years, which have given the FRC far more power to fine firms. There could be heavier sanctions on the horizon following the recent Queen’s Speech, which said it would develop a ‘stronger regulator with all the powers necessary to reform the sector’.

“The new regulator, ARGA, must ensure that its sanctions are fair and do not discourage firms from taking on work.”

This comes amidst Sir Donald Brydon’s review on the audit profession that also called out for the replacement of the FRC with ARGA, with an audit reform expected very soon.

Brian Palmer, Tax Advisor at AAT, commented on the changing role of the FRC, claiming that the recent detection of audit errors amongst big companies has greatly contributed to the reinforcement of the regulator’s authority.

“While AAT Licenced Accountants are not responsible for Audits per se it comes as no surprise that the FRC has been increasing both the level and number of fines. After all, with heightened level of interest in the audit profession in the wake of the collapse of high-profile PLC’s such as BHS, Carillion and the £40m balance sheet black hole found in Patisserie Valerie’s audited account. Rightly or wrongly, a hike in the level of FRC enforcement activity is the very least that general public would expect.

“Indeed, back in July 2019 the FT reported Elizabeth Barrett, the FRC’s director of enforcement, as saying it had increased the size of its fines to “improve behaviour” at the UK’s largest accounting firms. However, what is of greater interest is to see what difference the former HMRC’s Chief Executive Sir Jonathon Thompson will make now that he has taken over at the top the FRC as it morphs into the Audit, Reporting and Governance Authority.”

Whilst audit firms continuously invest in technology such as AI and big data to avoid sanctions from the FRC, the year 2020 could encounter a changing number of fines issued to audit firms as a new regulator comes into effect.