Speech by Stephen Haddrill, CEO, FRC, Grant Thornton Conference
News types: Speeches
Published: 12 May 2016
The plain text version of Stephen Haddrill's speech can be found below.
Stephen Haddrill
CEO
Financial Reporting Council
Grant Thornton Conference
The Law Society, London
11 May 2016
Session: Whose Negligence Is It Anyway?
Ladies and Gentlemen,
The themes of this conference – negligence and accountability – could not be more timely as we near the due date for the implementation of the new EU legislation on audit. Just this week the Department for Business is tabling its implementing regulations in Parliament. Only last week the FRC closed its consultation on its new audit enforcement regime, part of our implementation of the new legislation.
The new legislation brings about some significant change and provides an opportunity to address some but not all past problems.
The FRC’s disciplinary arrangements are determined by a scheme agreed with the professional bodies. The FRC may seek a sanction against members of the profession, whether they are an auditor, an in practice in other ways, or in business provided that there is a public interest in the case and we have a reasonable suspicion of misconduct. Misconduct means behaviour falling short of the standards reasonably expected at the time.
A clear strength of these arrangements is that we may take action against the directors of a company if they are members of the profession as well as against the auditor. The disadvantage is that we cannot take action against directors who are not members of the profession. That does not mean they will escape sanction as other regulators may act under company law or financial services legislation. But the cases will be separate and the relative responsibilities of the different parties will not be fully tested in the same courtroom.
Under new legislation the Government is not intending to change this. Breaches of the audit legislation by directors who are not members of the profession will be dealt with by the Department of Business not the FRC. The disciplinary scheme agreed with the profession will however remain in place for the time being and so the FRC will continue to act against directors who are members.
That said there is a debate in the profession about whether the FRC should continue to be able sanction directors even if they are members of the profession unless they are directors of a public interest entity, i.e. principally a listed or financial services company and their perceived misconduct relates to the preparation of the financial statements. Other matters, even when the public interest is significant, would be dealt with, it is suggested by the profession, although it might chose to refer some members to the FRC. This would restrict the scope of the independent regulation and we believe will need careful consideration, not just within the profession, but through public consultation.
The new legislation is not therefore leading to a level playing field between professionals and directors and, indeed, it is hard to see how any legislation that relates to the roles of different individuals rather than to their actions could do so.
Whilst not solving that problem the new arrangements have some important advantages.
First, the legislation requires all persons to provide evidence in relation to an enforcement matter concerning a PIE audit not just members of the profession. A company cannot keep its own records closed in future. That means the regulator and a tribunal should have a fuller picture of the issues and be better able to assess better where any fault lies.
Second, the FRC is proposing an administrative procedure to enable cases to be handled in a faster way with earlier resolution than at present. In many cases, we will propose a sanction if appropriate at an early stage after the evidence has been received and assessed but before the preparation of a case for tribunal is embarked on. Firms and individuals may still elect for a tribunal hearing but we hope many will the advantages of a more efficient closure of the matter.
Third, the legislation sets the test for enforcement action being that there has been a breach of the requirements for audit. This is easier to assess than misconduct and the public interest which are both more subjective concepts. That said, we recognise that we must have a good reason to investigate. We must be proportionate and not pursue minor breaches in a heavy handed way when we have alternative routes, such as reaching agreement on changed practice through the dialogue held between firms and our audit inspectors.
Our consultation has bought forward 13 responses. There is general support for the proposals but some good points have been made which we are considering carefully with the aim of putting final recommendations to our Board next month. We recognise this is a short timescale necessitated by the fact that the regulations have only just been finalised. We will monitor the arrangements carefully from the outset to see if any modifications are required.
Now let me turn to some general considerations.
We seek to put in place standards whether for audit and indeed for accounting that are principles-based. This enables and encourages professionals to exercise their judgement. Most professionals in the UK welcome this. However, principles-based standards do lead to more uncertainty when it comes to their enforcement, particularly as there is very little case law to aid interpretation. Despite these issues of legal uncertainty we remain committed to principles. Our primary goal is, after all, good quality reporting and audit undertaken in the interests of investors. Principles-based standards stand a better chance of delivering that in a complex economic environment than detailed rules that become outdated quickly and stifle good judgement.
Second, the financial crisis had led to a re-evaluation in the public mind about what is meant by a reasonable standard of behaviour. For example, any suggestion that work which failed to provide adequate public protection should escape sanction because it was typically to be found “not as bad” as other work is no longer acceptable to the public. The public expect the profession to protect them by “ being professional” by having an independent mind set and by exercising a high degree of skepticism of those they audit, not just adhering to a narrow definition of standards and regulations. In consequence a victory in court may well not be a victory in the court of public opinion. And that matters at a time when the profession is seeking to restore public confidence and its leaders are working to raise its game. ICAS, the Scottish Institute has spoken about the need for accountants to show moral courage. Audit firms are innovating and setting themselves higher performance standards. Nothing will undermine these efforts by the profession itself more effectively than a points scoring battle in tribunal that is at odds with public expectations.
With that in mind, I would suggest that the question you are debating – in essence who is to blame – is not the right question. The right question is not can the profession insulate itself from the faults of preparers, but how can it take and be seen to provide leadership in challenging and improving the preparation of accounts and in driving excellent preparation not seeking excuses in the faults of others.
Stephen Haddrill
CEO
Financial Reporting Council
Grant Thornton Conference
The Law Society, London
11 May 2016
Session: Whose Negligence Is It Anyway?
Ladies and Gentlemen,
The themes of this conference – negligence and accountability – could not be more timely as we near the due date for the implementation of the new EU legislation on audit. Just this week the Department for Business is tabling its implementing regulations in Parliament. Only last week the FRC closed its consultation on its new audit enforcement regime, part of our implementation of the new legislation.
The new legislation brings about some significant change and provides an opportunity to address some but not all past problems.
The FRC’s disciplinary arrangements are determined by a scheme agreed with the professional bodies. The FRC may seek a sanction against members of the profession, whether they are an auditor, an in practice in other ways, or in business provided that there is a public interest in the case and we have a reasonable suspicion of misconduct. Misconduct means behaviour falling short of the standards reasonably expected at the time.
A clear strength of these arrangements is that we may take action against the directors of a company if they are members of the profession as well as against the auditor. The disadvantage is that we cannot take action against directors who are not members of the profession. That does not mean they will escape sanction as other regulators may act under company law or financial services legislation. But the cases will be separate and the relative responsibilities of the different parties will not be fully tested in the same courtroom.
Under new legislation the Government is not intending to change this. Breaches of the audit legislation by directors who are not members of the profession will be dealt with by the Department of Business not the FRC. The disciplinary scheme agreed with the profession will however remain in place for the time being and so the FRC will continue to act against directors who are members.
That said there is a debate in the profession about whether the FRC should continue to be able sanction directors even if they are members of the profession unless they are directors of a public interest entity, i.e. principally a listed or financial services company and their perceived misconduct relates to the preparation of the financial statements. Other matters, even when the public interest is significant, would be dealt with, it is suggested by the profession, although it might chose to refer some members to the FRC. This would restrict the scope of the independent regulation and we believe will need careful consideration, not just within the profession, but through public consultation.
The new legislation is not therefore leading to a level playing field between professionals and directors and, indeed, it is hard to see how any legislation that relates to the roles of different individuals rather than to their actions could do so.
Whilst not solving that problem the new arrangements have some important advantages.
First, the legislation requires all persons to provide evidence in relation to an enforcement matter concerning a PIE audit not just members of the profession. A company cannot keep its own records closed in future. That means the regulator and a tribunal should have a fuller picture of the issues and be better able to assess better where any fault lies.
Second, the FRC is proposing an administrative procedure to enable cases to be handled in a faster way with earlier resolution than at present. In many cases, we will propose a sanction if appropriate at an early stage after the evidence has been received and assessed but before the preparation of a case for tribunal is embarked on. Firms and individuals may still elect for a tribunal hearing but we hope many will the advantages of a more efficient closure of the matter.
Third, the legislation sets the test for enforcement action being that there has been a breach of the requirements for audit. This is easier to assess than misconduct and the public interest which are both more subjective concepts. That said, we recognise that we must have a good reason to investigate. We must be proportionate and not pursue minor breaches in a heavy handed way when we have alternative routes, such as reaching agreement on changed practice through the dialogue held between firms and our audit inspectors.
Our consultation has bought forward 13 responses. There is general support for the proposals but some good points have been made which we are considering carefully with the aim of putting final recommendations to our Board next month. We recognise this is a short timescale necessitated by the fact that the regulations have only just been finalised. We will monitor the arrangements carefully from the outset to see if any modifications are required.
Now let me turn to some general considerations.
We seek to put in place standards whether for audit and indeed for accounting that are principles-based. This enables and encourages professionals to exercise their judgement. Most professionals in the UK welcome this. However, principles-based standards do lead to more uncertainty when it comes to their enforcement, particularly as there is very little case law to aid interpretation. Despite these issues of legal uncertainty we remain committed to principles. Our primary goal is, after all, good quality reporting and audit undertaken in the interests of investors. Principles-based standards stand a better chance of delivering that in a complex economic environment than detailed rules that become outdated quickly and stifle good judgement.
Second, the financial crisis had led to a re-evaluation in the public mind about what is meant by a reasonable standard of behaviour. For example, any suggestion that work which failed to provide adequate public protection should escape sanction because it was typically to be found “not as bad” as other work is no longer acceptable to the public. The public expect the profession to protect them by “ being professional” by having an independent mind set and by exercising a high degree of skepticism of those they audit, not just adhering to a narrow definition of standards and regulations. In consequence a victory in court may well not be a victory in the court of public opinion. And that matters at a time when the profession is seeking to restore public confidence and its leaders are working to raise its game. ICAS, the Scottish Institute has spoken about the need for accountants to show moral courage. Audit firms are innovating and setting themselves higher performance standards. Nothing will undermine these efforts by the profession itself more effectively than a points scoring battle in tribunal that is at odds with public expectations.
With that in mind, I would suggest that the question you are debating – in essence who is to blame – is not the right question. The right question is not can the profession insulate itself from the faults of preparers, but how can it take and be seen to provide leadership in challenging and improving the preparation of accounts and in driving excellent preparation not seeking excuses in the faults of others.