Reflections on the continuing absence of audit reform

Earlier this year, Audit reform appeared to fall from the immediate agenda, having been dropped from this year’s Queen’s Speech.

Encouraging news came, however, with the government’s announcement at the end of May of its continuing intention to revamp the corporate reporting and audit regime through a new regulator, greater accountability for big business, and addressing the dominance of the Big Four audit firms.

This recent announcement by business secretary Kwasi Kwarteng coincided with the news that KPMG once again faces a multi-million pound fine. There is melancholia about the need for the government to intervene in the first place and about the fact that the promise of targeted reform measures has been made before, with little sign of fruition.

Turning to the status quo, the first reflection is that despite the absence of regulatory reform, no firm offering audit services of this kind and on this scale has been ‘too big to nail’. There are gargantuan problems across the sector, and any of the big auditors claiming to be ‘better’ than others are simply claiming to be the tallest of the seven dwarves.

In the past, we’ve seen the collapse of Patisserie Valerie and the auditors were heavily implicated in the collapse. The auditors, Grant Thornton, were fined £2.3m for failures in their audits spanning three audit years, and one individual auditor was even fined £150,000 for his role in signing off the accounts and admitting failure to follow audit rules. It is now a requirement for firms to submit an annual report demonstrating details of improvement in its auditing practices.

Rolls-Royce audit failings

KPMG UK is facing the latest in a string of multimillion-pound fines for failings in its supervision of the accounts of Rolls-Royce Holdings, having been fined a total of £3.4m. This was not, however, the first time that the firm had been implicated in auditing failures with the company.

Back in 2017, Rolls-Royce agreed to pay hundreds of millions of pounds in penalties after a protracted examination of allegations of bribery in the UK, US and South America to procure supply contracts. Charges of corruption were on the putative indictment and there was a deferred prosecution agreement so that the matter did not come to trial.

However, there were admitted serious audit failures by KPMG, with the audit partner in the case fined £112,500 and the firm required to pay for an external review of its policies in investigating compliance at client companies.

It’s understood that KPMG has been fined a total of £48m by regulators over the past few years and it seems astounding that a business of this size and repute can find itself on this sort of streak.

What leads some huge outfits to place themselves in the sort of position that Rolls-Royce found itself in 2017, settling bribery and corruption claims that spanned five continents and three decades and incurring fines to the tune of £670m? This is a flagship British enterprise with a sovereign pedigree which makes you wonder what on earth is going on. Where are the internal controls? What can be said of the top-down culture? There is a genuine need to understand why it takes outside agencies of the state to unearth horrifyingly bad practice and punish it. Maybe it is naïve to be puzzled by this, but quite apart from anything else conduct of this sort goes to the bottom line and ultimately makes no commercial sense.

Culture reset

There must be a responsibility reset in the top-down culture of leading audit firms together with a disciplined practice of supporting auditors seized with hugely demanding decisions.

The Financial Reporting Council (FRC) is diligent, tenacious, and resolute. It is just this sort of approach which is in danger of giving regulators a good name. The FRC does the best it can in an area that would make a risk assessment specialist turn pale. The outcome it produced in the KPMG/Rolls-Royce matter, for instance, despite its limited bandwidth is deserving of very high commendation.

When culprits have elected to engage with the regulator, the latter has shown sensible pragmatism in offering worthwhile reductions in sanctions, proving yet again that engagement with the regulator in any sector is almost always the right thing to do.

As waves of scandals continue to hit the Big Four firms, as well as a variety of other auditors, we may see financial regulators put to task in the coming years.

It is rare that one says this, but godspeed to the regulators. It is devoutly to be wished that the promised audit reform legislation will become reality within the shortest possible order and that it will do something to level the terrain for the regulator – so far, its work has been uphill.