HOW can we restore confidence in the auditors who check the health of Britain’s largest companies ?
It’s a question that demands an immediate answer. Faith in auditing has hit an all time low after a parliamentary report called on the Competition and Markets Authority to examine a break-up of the Big Four following failings exposed by the collapse of Carillion.
The construction and outsourcing giant left behind a £900 million debt pile, a £590 million pension deficit and hundreds of millions of pounds in unfinished public contracts.
The Big Four - KPMG, PwC, Deloitte and EY - were accused by MPs of “prioritising their own profits ahead of good governance at the companies they are supposed to be putting under the microscope”.
The Financial Reporting Council (FRC) has now told the Big Four audit practices they must act swiftly to reverse the decline in this year’s audit inspection.
Stephen Haddrill, the CEO of FRC, a body which has previously been accused of timidity, didn’t pull his punches.
He said: “At a time when public trust in business and in audit is in the spotlight, the ‘Big four’ must improve the quality of their audits and do so quickly.
“They must address urgently several factors that are vital to audit, including the level of challenge and scepticism by auditors, in particular in their bank audits.
“We also expect improvements in group audits and in the audit of pension balances. Firms must strenuously renew their efforts to improve audit quality to meet the legitimate expectation of investors and other stakeholders.”
According to the FRC, the fall in the quality of performance cross the Big Four is due to a number of factors, including a failure to challenge management and “show appropriate scepticism across their audits” and poorer results for the audits of banks.
Does all this sound horribly familiar? In the aftermath of the banking crisis there were the usual cries of “never again” as commentators wondered how auditors failed to spot Titanic-like flaws in the corporate governance of the big banks.
We might have believed - incredibly naively - that lessons had been learned after the crash of 2008 and, in future, auditors would fearlessly challenge management whose sums didn’t seem to add up. And then along came Carillion, which steamed at full speed into the iceberg.
So what’s the solution? The situation is complicated by the fact that the FRC’s own future is under review. The review, led by Sir John Kingman, is calling for feedback to assess whether the FRC is tough enough to prevent corporate failure. If there was ever a time for the FRC to bang its fist on the table, that time is now. So be prepared for the FRC to match its words with actions.
Regulators must place the blame squarely where it belongs; at the very top of the organisation. The culture of any company is created by its senior management. They have to take personal responsibility for audit failings that destroy jobs and cause havoc in the supply chain.
The Big Four are handsomely remunerated. It doesn’t seem unreasonable to expect them to spot and prevent corporate disasters.
Glaring errors of judgement must result in hefty fines and, in the worst cases, lifetime bans. The law must be changed to make auditors answerable to investors and staff.
To quote Rachel Reeves, the chair of the Business, Energy and Industrial Strategy Committee: “It’s a crazy situation that auditors are answerable to the chief finance officer of a company, whose accounts they should be scrutinising and challenging, not the shareholders and employees who rely on auditors to warn them of any problems.”
Anyone who loses money through reliance on negligent or dishonest auditing should be able to sue the auditors. Regulators should also force a significant proportion of FTSE 250 companies to be audited by firms outside the Big Four. This would, over time, create a healthy check of competition in the sector.
These steps might just protect us from another terrible corporate implosion.