Should companies’ auditors be independently appointed?

Not qualified to do the job

By Neil Lerner, UK head of risk management at KPMG and also the chairman of the ICAEW Ethics Group

There has been recent suggestions that the principle long established in company law of audit appointments being recommended by management and approved by shareholders should be swept aside and replaced by a quango established to make such appointments.

Let me start by saying that I acknowledge this model works well in parts of the public sector. However, this reflects the ownership structure. It is also important to recognise that public sector companies have relatively straightforward structures and usually operate in homogeneous businesses.

Contrast this to the private sector where many listed companies are complicated multinationals operating in diverse businesses. Each with its own unique risks. Some have suggested that allowing management to be involved in the selection process enables them to exert too much influence on the process.

However, this is to ignore the real safeguards provided by the involvement of the audit committee and ultimate approval by the shareholders. The directors have in-depth knowledge of their businesses, risks and the deliverables they need from their auditors. Audit committees with independent directors are specifically charged with ensuring that the selection process is unbiased and the subsequent performance is what was promised.

I question how a public sector body could understand the business of these complicated companies sufficiently well to ensure the best audit firm is appointed?

How could they have the time, resource or business insight to do this as well as the directors? Allowing a public sector body to make these decisions could lead to a reduction in audit quality.

I have other concerns about this model. These include how it would work for UK subsidiaries of overseas multinationals, the effect of the public sector intruding into private sector business, what such a model would mean for competition and whether this would effectively mean rotation of audit firms.

Finally I question in whose interests a public sector appointments board would be serving? Not the shareholders of the business. They would lose their rights to be involved in the audit appointment and ironically may well end up paying more for a poorer quality audit.

Learn from our experienceBy Steve Freer is the chief executive of CIPFA.

A great deal has been written over recent years about how public sector organisations can learn from the private sector.

From time to time, however, it is important to remind ourselves the membrane that divides the two sectors is permeable in both directions. Just occasionally the experiences of public bodies can shed helpful light on problems which their private counterparts are struggling to resolve.

Tackling the raft of audit questions thrown up by Enron and the demise of Andersen may be a case in point. Should large companies’ auditors be appointed by an independent agency? Should they be rotated? Should they be limited in the amount of non-audit work they undertake for an audit client? In order to answer these questions it is imperative that we tap into relevant experience including the very distinctive audit arrangements which operate in the public sector.

In local authorities in England and Wales, for example, the external auditor is appointed not by the particular council but by the independent Audit Commission. Having been appointed the auditor seeks to build a rapport and a strong working relationship with the client authority.

But the auditor also remains accountable to the commission for the maintenance of high professional standards. The commission lays down requirements for the periodic rotation of audit partners and senior managers, and also manages the rotation of audit suppliers from time to time. The use of audit suppliers to carry out non-audit assignments is also regulated by the commission.

Slightly different arrangements apply in other parts of the public sector which fall within the jurisdictions of the NAO, Audit Scotland and the Northern Ireland Audit Office, but many of the principles outlined are common throughout the sector.

This is not to suggest that the public audit model can simply be transplanted into the private sector at a single convenient stroke. The two sectors are different in many important respects. The lessons of Enron need to be very carefully analysed and worked through. Quick fix solutions are very rarely the right answer.

But there is a body of different experience in the UK public sector which just might be an important part of the solution.

  • Steve Freer is the chief executive of CIPFA.

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