The self-regulation conundrum

In June the US Securities & Exchange Commission voted unanimously in favour of improving the accountability of auditors of public companies by setting up a Public Accountability Board. At the time of the announcement Harvey Pitt, SEC chairman, stated ‘this model sends a loud and clear message that the era of self-regulation of the accounting profession is over’.

The Sarbanes-Oxley Act was passed in July and formalised the proposals of the SEC. The Public Company Accounting Oversight Board is to be responsible for the regulation of the audit of US public companies by US and foreign accounting firms involved in the preparation and issue of their audit reports. Similar developments are occurring in Canada.

At about the same time, the interim report of the UK government’s Co-ordinating Group on Audit and Accounting Issues was published, with trade secretary Patricia Hewitt welcoming the Accountancy Foundation Review Board’s study into the registration and monitoring of firms who are undertaking listed company audits.

Any such study needs to take account of the international perspective.

As well as developments in the US, close liaison is needed with IFAC and the Forum of Firms over the form of potential global monitoring arrangements.

Would all accounting firms undertaking transnational audits of public listed companies be covered by such arrangements?

The European perspective is also important bearing in mind the need to ensure compliance with international accounting, and possibly auditing, standards by 2005. Although changes are occurring gradually, one is struck by the multiplicity of different monitoring arrangements across Europe.

A 1998 FEE study suggested: self-assessment by the firms (Austria, Italy); peer review by a panel of auditors (Belgium); peer review on a firm on firm basis (Denmark); monitoring of individual auditors (France, Norway); external regulation (Germany, Czech Republic); and self-regulation by the accountancy bodies (Spain, Finland and the UK).

So which is the preferred model?

It is interesting to note the duties of the PCAOB in the US relate to the registration of accounting firms undertaking public company audits (annual reports of these firms to be made available for public inspection); setting auditing, ethical and quality control standards and rules regarding the preparation of audit reports; and the inspection of auditing firms (with subsequent disciplinary action against transgressing firms and individuals).

Closer examination suggests these functions will mirror existing UK arrangements with regard to auditing, ethical and quality control.

For instance, the Sarbanes-Oxley Act refers to the need for working papers to be retained for seven years (SAS 230 already requires such papers to be retained for at least six years); the need for second partner reviews to be undertaken (SAS 240 already requires such reviews); the need to monitor auditing firms’ professional ethics and independence standards (already required by the CAJEC’s and ACCA’s ethical standards); and the need for internal communication by audit firms on accounting and auditing questions (already required under SAS 240).

The Act also requires auditing firms to be inspected annually if they undertake more than 100 audits of public companies. In the UK this would require the inspection of five auditing firms, yet the Joint Monitoring Unit, under the auspices of ICAEW, ICAS and ICAI, inspects the top 20 auditing firms covering 95% of public listed companies on an annual basis.

Any study of the JMU must focus on its effectiveness (whether current monitoring arrangements are sufficient, whether more inspectors are required) and ownership (is there evidence or public perception that these arrangements are impacting adversely on the independence of the JMU?).

The Review Board recently commissioned an attitudinal survey of auditors, audit clients and institutional shareholders from MORI.

It revealed the majority of auditors (61%) considered the JMU and ACCA monitoring units were able to cope with increasingly complex client and business models and audits. But opinion was divided among auditors as to whether the monitoring units should remain under the accountancy bodies (49%) or be transferred to an independent external regulator (42%).

If ownership of the JMU were transferred to an external regulator, one would have to consider the costs of transfer and the possible disruption – the JMU is closely involved in ICAEW’s practice assurance initiative for 15,000 firms, half of whom have never been regulated before.

Also alternative decision-making arrangements (for the initial and continuing registration of firms) would be required. This is currently undertaken by the accountancy bodies’ Audit Registration Committees and requires sapiential knowledge not acquired by an external regulator’s lay membership.

Another option would be to consider whether a specialist team should be set up, appropriately resourced, and focusing on the monitoring of the largest audit firms (possibly the top four, six or 20). There would almost certainly be diseconomies of scale in having two monitoring bodies, as well as problems of rotation within the specialist team – but it is worthy of consideration. Whether the specialist team would remain under JMU ownership or be transferred to an external regulator would need a decision.

There is no doubt that whatever decisions are made on these issues by the Co-ordinating Group on Audit and Accounting Issues, they will have substantial implications for the future of regulation in the UK. But at this stage it would be premature to suggest Harvey Pitt’s comments regarding the end of self-regulation of the accountancy profession apply to the UK.

• Colin Reeves is director of the Accountancy Foundation Review Board and a member of the Co-ordinating Group on Audit and Accounting Issues.