Auditors: doesn’t add up

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Got a problem? Form a committee. Still not happy? Form a second committee to oversee the first. That sounds like a parody, but as a description of proposed audit reforms in the UK, it comes close to the truth. A group of big institutional investors, including RPMI Railpen and Legal & General, thinks the suggested reforms are inadequate. They are right.

The problem is simple: the “Big Four” accountancy firms dominate large-scale audit work globally. This has various adverse consequences, including the potential for chaos should one of the firms fail. But the situation is made worse because companies themselves shy away from auditor changes for reasons of cost and conservatism. One-third of FTSE 100 groups have had the same auditor for more than 20 years, two-thirds for over a decade.

The UK’s Competition Commission has already concluded that it is investors who suffer. But its follow-up reform proposals are fairly modest. Audit work would have to be re-tendered regularly; a standards regulator (the Financial Reporting Council) would review all FTSE 350 audit engagements; and more onus would be put on groups’ internal audit committees (including the job of passing on FRC findings). What the CC did not back was mandatory rotation of audit work – now being adopted in a few countries such as Holland. That, the institutions said this week, was a big lacuna.

It is hard to dispute their logic. Without a cut-off, audit committees will face the same pressures as management to keep an existing firm. And tenure caps are the sole way of ensuring that audit work is, in due course, really audited. Some, like the FRC, argue that milder “comply or explain” guidelines are bringing changes anyway and that mandatory rotation risks excluding the firm that could do the best job. HSBC has switched auditors: Barclays may do likewise, after an incredible 117 years. But it is the global crisis, and a realisation that no auditor flagged up bank problems pre-2008, that can largely be thanked for this. And if changes are welcome, surely a 15-year audit backstop to ensure they take place is worth having? Zealous auditing is not a cure-all. But it is a core safeguard for investors.

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