RSS feedsWorried about the dominance of the Big Four audit firms and the impact on choice, quality and cost, the Financial Reporting Council established the Market Participants Group last October to suggest possible actions that are largely orientated towards increasing the likelihood of major ‘public interest entities’ selecting non-Big Four auditors.
In an interim report published in April 2007, the working group made 15 recommendations on which it is now consulting:
The recommendations
1. The FRC should promote wider understanding of the
possible effects on audit choice of changes to audit firm ownership rules
subject to there being sufficient safeguards to protect auditor independence and
audit quality.
The report says that non-Big Four auditors have not complained publicly that the current ownership laws restrict their ability to raise the external capital that might be necessary to make a step change in their capabilities. But it is possible that the rules could in future prove restrictive to existing or new audit firms. Moreover, the European Commission is investigating the audit firm ownership rules and is expected to report later this year.
2. Audit firms should disclose the financial results of their work on statutory audits and directly related services on a comparable basis.
Clearer, more consistent information may be necessary so that other firms can decide whether it is economical to make the necessary investment to go after the Big Four market.
3. In developing and implementing policy on auditor liability arrangements, regulators and legislators should promote audit choice, subject to the overriding need to protect audit quality.
The Companies Act 2006 allows a contractual cap on auditor liability (subject to shareholder approval), but whether this will be enough to encourage new entrants to the audit market may depend on whether the professional liability insurance market opens up to major audit firms again.
4. Regulatory organisations should encourage appropriate participation on standard setting bodies and committees by individuals from different sizes of audit firms.
Non-Big Four firms say there are misconceptions about their capabilities, in part because audit members of regulatory standard setters come predominantly from the larger auditors.
5. The FRC should continue its efforts to promote understanding of audit quality and should promote greater transparency of the capabilities of individual audit firms.
While the onus is on audit firms to make the market aware of their capabilities, the report says there is a need to ensure that such information is as accurate and comparable as possible.
6. The accounting profession should establish mechanisms to improve access by the incoming auditor to information relevant to the audit held by the outgoing auditor.
The revised EU Statutory Audit Directive requires outgoing auditors to provide incoming auditors with all relevant information, but there is no agreement yet on how to achieve this in practice.
7. The FRC should provide independent guidance for audit committees and other market participants on considerations relevant to the use of firms from more than one audit network.
The Hundred Group of Finance Directors said in the FRC’s 2006 discussion paper that a revision to auditing standards might be desirable to make it easier to appoint joint auditors.
8. The FRC should amend the section of the Smith Guidance dealing with communications with shareholders to include a requirement for the provision of information relevant to the auditor selection decision.
As some companies use the same auditors for decades, there ought to be more openness in the audit committee report about how auditors are selected.
9. When explaining auditor selection decisions, boards should disclose any contractual obligations to appoint certain types of audit firms.
Non-Big Four firms provided evidence that professional advisers and banks have recommended or even required the appointment of a Big Four auditor – advice that they say is poorly informed and inappropriate.
10. Investor groups, corporate representatives and the FRC should develop good practices for shareholder engagement on auditor appointment and reappointments and should consider the option of having a shareholder vote on audit committee reports.
While, nominally, shareholders vote at the AGM on the reappointment of auditors, in practice, there is little discussion before the vote.
11. Authorities with responsibility for ethical standards for auditors should consider whether any rules could have a disproportionately adverse impact on auditor choice when compared with the benefits to auditor objectivity and independence.
There is concern that UK and, especially, US rules to preserve auditor independence act to restrict auditor choice.
12. The FRC should review the Independence section of the Smith Guidance to ensure that it is consistent with the relevant ethical standards for auditors.
Some companies are thought to take an excessively strict interpretation of the Smith Guidance, thereby preventing providers of non-audit services from being considered for the group audit.
13. Regulators should develop protocols for a more consistent response to audit firm issues based on their seriousness.
There is concern that an Andersen-style collapse could be an unnecessary result of a future Enron-style problem.
14. Every firm that audits public interest entities should comply with the provisions of the Combined Code on Corporate Governance with appropriate adaptations given a considered explanation if it departs from the Code provisions.
Audit firms should explain not only how their UK operations are governed, but also their international networks.
15. Major public interest entities should consider the need to include the risk of the withdrawal of their auditor from the market in their risk evaluation and planning.
Major companies, especially those using a Big Four firm, should consider what they would do in the event of the “withdrawal” of that firm from the audit market.
The Market Participants Group Interim report can be found at www.frc.org.uk. Click on 'About the FRC', then click on the 'Audit choice project' tab.
