No contact between watchdogs and auditors in the year before crisis

THERE WAS no contact between regulators and the auditors of Northern Rock in the year before the bank went bust.

A memorandum from the Financial Services Authority (FSA) reveals that 2006 saw no contact between the FSA and Rock’s auditors PwC. Contact resumed in 2007 but Northern Rock received a bail out from the Bank of England in September of that year.

The same year, 2006, saw the FSA have no contact with KPMG, auditors of Bradford and Bingley, and only one telephone conversation with KPMG over audit client HBOS.

The information comes as part of evidence submitted to the Lords economic affairs committee and its inquiry into the audit market and audit during the banking crisis.

The FSA memo also revealed that it has stepped up the use of so-called section 166 orders which allows the regulator to force banks and other institutions to commission extra reports from experts, including auditors, on their systems.

In 2006/07 the FSA commissioned just 18 reports on three institutions. In 2010/11 the FSA has already demanded 90 studies on 16 organisations.

The FSA candidly states in the memorandum that contact between the regulator and auditors fell away when the regulator took over banking supervision and said it admits that was “wrong”.

The FSA adds that “we established supervisory specialists in-house, supported by further in-house specialists in policy, risk and sector-specific areas. This in-house expertise was designed to reduce the need for regular reporting by auditors on supervisory matters relating to individual firms.

“One consequence was that, over time, meetings between supervisors and
auditors also became less frequent. There were still cases where FSA supervisors continued to meet with the auditors at least once a year, but this happened on a less structured basis. In line with our supervisory philosophy of that time, we made less use of third parties (i.e. use of section 166 reports) and placed more reliance on what firms [banks] told us.”

The Lords unquiry will wrap up formal hearings next week when it hears evidence from Treasury secretary Mark Hoban and employment minister Ed Davey.

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