‘A balanced and robust approach’

Link: DTI special report

It would have been a folly to sit back and say: ‘It couldn’t happen here’. We owed it to pensioners, savers and business to ensure our corporate governance structures remain among the best in the world.

The package of proposals we announced last week I believe does just that. They are measured and proportionate but we have not flinched from being tough where toughness is required.

Of course the approach to audit and accountancy standards in the UK are markedly different to those in the US. There was no need for us to rush into a Hewitt/Brown equivalent of the Sarbanes/Oxley Bill but we needed a considered, all-embracing approach to Enron.

The Coordinating Group on Audit and Accounting Issues was set up precisely to take that approach. Their thoughtful report is the result of very careful study of the issues from a number of perspectives and wide-ranging consultation.

The resulting measures reflect the Higgs and Smith reports into boardroom practices and the role of the company’s audit committee. Taken as a whole they represent a comprehensive and mutually re-inforcing package of reforms to raise standards of corporate governance in listed companies, to strengthen the accountancy and audit professions and to introduce more effective regulation.

In summary, our proposals establish a bigger role for audit committees; introduce tougher requirements for auditors on independence and on transparency; and require more and active enforcement of accounting standards by a beefed-up Financial Reporting Review Panel and the FSA.

We also announced a much stronger regulatory framework under the Financial Reporting Council, with responsibility for auditor independence standards, ethical guidance and monitoring removed from the accountancy profession itself and passed to the Auditing Practices Board. The first issue it will consider is the provision of services such as IT systems and tax advice by the audit firm. And a new audit inspection unit is being created so that the professional bodies are no longer responsible for monitoring the auditors of listed companies.

We decided against two more extreme ways of addressing auditor independence, which some commentators have advocated. Two issues have been raised: should we have imposed compulsory audit firm rotation and introduced a total ban on audit companies carrying out non-audit services?

The group considered both of these but were unanimous in recommending against them. The UK approach has always been to rely on principles supported by safeguards and in that our approach remains the best one. We do not want to go down the discredited US rules-based approach. Objectives of mandatory rotation can be better achieved by an enhanced role for the audit committee in the appointment of the auditor. Tougher standards, greater audit firm transparency and more independent oversight are preferable to a blanket ban on the provision of non-audit services. We looked at compulsory rotation and concluded there were more effective ways of guarding against the development of cosy relationships between auditor and client. A balance must be struck in safeguarding auditor independence that does not destroy the expertise built up by an audit team in a client firm.

The theme of my reform package is the promotion of auditor independence and measures that strengthen the company audit committees and create a new independent unit to monitor audit quality. Independence is further safeguarded by the profession’s rule changes to ensure lead audit partners are rotated within five years and to institute a two-year ‘cooling off’ period for partners and senior employees of audit firms.

This is a balanced but robust approach. Structures, standards and regulations can never be a complete defence against individuals bent on wrongdoing. But we have been determined to reinforce our defences to protect savers and honest businesses and the reputation of the profession.

And we are doing so by strengthening not just professional standards but the toughening up the oversight, monitoring and enforcement of them.

  • Patricia Hewitt is secretary of state for trade and industry. She announced the review of audit and accountancy, which reported last week, in July 2002

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