Size does matter according to incoming AADB sanctions

MEMBER FIRMS should take heed that the accounting watchdog has rolled up its sleeves and is about to crowbar public confidence into financial reporting systems.

It plans to do this by drastically increasing the way in which it dishes out fines to members and member firms found guilty of misconduct, according to a recently launched consultation. The watchdog hopes the change in the way fines are calculated will see more proportionate reprimands dished out, but what is that going to mean for firms?

Recently the Accounting and Actuarial Disciplinary Board (AADB), an operating arm of the Financial Reporting Council, was unhappy at the low level fine it dished out to PwC for its audit of JP Morgan – even though it was the most substantial it had ever handed down. Although the £1.4m fine slapped on PwC in January by the AADB tribunal arm may have been the largest ever given, it was a drop in the ocean to the £2.46bn in fee income the firm posted for the year ending 30 June 2011.

“… we do consider that the increases in recent times of the fees payable by firms such as [JP Morgan] to firms such as [PricewaterhouseCoopers] indicate the need for a substantial increase in the level of penalty payable for misconduct of the kind under consideration in this case,” the document says.

Back in January following the announcement of the record fine AADB’s executive counsel Tom Martin told Accountancy Age: “This many now be a point to have a debate on financial sanctions on accountants to ensure that it is proportional”.

The AADB wants to increase fines on larger member firms because the way they are currently calculated is not adequate to incentivise the right behaviour and is failing to be a “credible” deterrent in the public’s eyes.

It claims accountancy has changed so much and with the Big Four dominating 99% of the audit contracts in the FTSE 100, misconduct by one of them is considered more serious and potentially more damaging in the public interest as a result of their size and scale. Therefore a reprimand must be seen to have actual consequences rather than a paltry sum of £1.4m.

Spoilt for choice

The board is consulting on three structures to calculate fines in the future. Firstly is the minimum starting point, where a member (individual or firm) must pay a yet to be defined percentage of group turnover so the reprimand would be proportionate to the size and scale of the firm. Essentially a firm with a lower turnover will receive a lower fine for the same misconduct than a larger firm, but it should be proportional and have the same effect.

Second is a range calculation. This is where the Tribunal will determine the level of the misconduct (they suggest five levels) and apply a percentage of turnover as the fine depending at what level of misconduct the member is found guilty of. For example, a level one misconduct would be x% but a level five would be significantly higher at y%.

The third structure in discussion is a maximum percentage of turnover. So a Tribunal would agree that it cannot be more than x% of annual turnover.
In the event no annual turnover can be used the Tribunal will look at profits per partner, market share, the number of audit and non-audit clients, partners and employees to determine the size of the firm.

For individuals the Tribunal will take into consideration their salary and all benefits including pension, bonus and share options. However, the AADB has yet to determine whether or not assets will be included in the calculation or not.

Changing the reprimand structure to a percentage-based system is something the AADB hopes will instill public confidence into the system. It also means there is no limit to what the Tribunal can charge, the fine will be purely determined by the members turnover or income.

Don’t throw stones

The sanctions guidance is not just about structures, it delves deeper and outlines some of the behaviours seen in the accountancy profession that it wants to put a stop to or prevent. Most notably it highlights that many firms are pinning the blame of audit failures on partners, when they are not the only ones at fault. The audit partner may have to bear the brunt of the responsibility, but they would not have acted alone and the responsibility of conduct ultimately lies with the accountancy practice.

The Tribunal wants firms to take responsibility in disciplinary proceedings for the conduct of its partners, directors and employees. It hopes the changes to the sanction structure will encourage practices to update training and or change its internal processes.

“It would not be in the public interest if member firms were able to transfer all responsibility, blame and consequence to the individual members involved, thereby neutralising the deterrent to member firms pursuing business practices that could damage public confidence in the accountancy profession and corporate reporting in the UK,” it said.

The AADB also advises firms considering loopholes to keep their fee income down that calculations will be based on group turnover – which is expected to mean for all of the UK – not including Europe or global earnings. Any firm considering separating their audit business or setting up a separate company for each audit should be warned, the AADB will not accept that as a turnover figure.

The Tribunal arm is expecting a surge in appeals thanks to the increase in monetary reprimands, but it claims it’s ready and believes the benefits of the changes will far outweigh any disadvantages and costs. Members have until 11 July to make their voice heard before the consultation closes.

Not out to sink the ship

For large firms, that take on hundreds of audit cases, if they are to face several disciplinary actions it has not yet been defined whether the Tribunal will take into consideration fines already dished out and changes made. For example, if a firm is facing two disciplinary actions for two separate audits by the same partner it is unclear whether those changes will be taken into account in both cases or just the first. We could see a firm having to pay x% of overall fee income for the year ending April 2012, and then see them paying the same again for overall fee income for the year ending April 2012 in a separate case – meaning firms could stand to lose a significant percentage of their overall fee income if they are slapped with several reprimands in a year.

However, it is not the intention of the AADB to bankrupt a member or put a firm out of business. Tribunals will not impose an unreasonable penalty on a scale that will have a devastating effect on the member and it is encouraged to consider the effect of the fine on business continuity. It will also give discounts to firms and individuals that admit their mistakes, work with the investigation team and make changes.

Overall the changes seem harsh but they could mean firms and individuals will change the way they work to ensure everything is by the book. That we are about to see a huge spike in appeals.


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