The saga that has been the disciplinary procedure brought against Ernst & Young for its audit of collapsed insurance business Equitable has finally come to a close. (Read our story here).
We have learned the cost to the firm is almost £3m – a half million pound fine and the rest in costs. This is down, on appeal, from a total of nearly £10m.
We now know that E&Y should have sought the disclosure of contingent liabilities connected to a court case that Equitable was fighting, and that the auditors should have sought independent legal advice rather than accepting the advice provided its client.
But there is a victory here for the firm too.
The appeal overturned an earlier ruling that E&Y and auditor Kevin McNamara acted without objectivity and independence. The discussion of this issue in the appeal report is fascinating and should have lessons for other audit firms, especially those dealing with complex clients in financial services.
In the end the appeal decided that of failing to act objectively and independently, the finding could not be sustained. And it could not be sustained because there was no evidence to suggest that the auditors had deliberately chosen to avoid all the necessary audit work in an effort to help its client out of its financial predicament.
This was a very serious charge. Independence and objectivity goes to the very heart of an auditor’s work. If they cannot maintain those two vital characteristics, they are no good to anyone, certainly not the investors whose interests they serve. It is no wonder that the firm and McNamara chose to contest this particular finding.
The appeal found that there was no evidence of a lack of objectivity and independence”, nor of an “improper” relationship between the auditors and the client. More importantly in this case the appeal found that you cannot “infer” the absence of objectivity and independence simply because someone was not competent in their work.
And it is probably the victory on this arcane point that will save the firm from any serious fall-out as a result of this disciplinary. It cocked up – but everyone does that from time to time (though usually not on such a grand scale).
The firm did not cosy up to the client, there was no evidence that the auditors decided to help the firm. However, it did not undertake the critical audits properly that would have alerted policyholders to the dangers of the court case in which Equitable was involved.
The lesson is this. Incompetence does not mean your objectivity is lost, but the appeal tribunal points out that objectivity could still be lost “unconsciously” if you are not completely on top of your role.
It also concluded that a close relationship with a client doesn’t mean independence is sacrificed either. In fact members of the appeal tribunal conclude that a positive ongoing relationship between auditor and client is desirable.
But remember that it is the appeal that dismissed the independence and objectivity complaint. Well respected and learned men had, in the first tribunal, concluded that these principles were compromised. This means auditors must take care to ensure that their independence and objectivity is always safeguarded and what’s more, demonstrable. This will have to be achieved through systems, structures, documentation and personal conduct. Unless auditors can do that they will always be at risk of being viewed as having compromised the key principles that makes them so valuable.
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