Audit Firm Governance Code and its impact on business

Two, three or a handful? Those are the numbers being bandied about by audit firms which say they welcome the Financial Reporting Council’s requirement on them to recruit a number of independent non-executives, which comes as part of a drive to increase transparency and gain greater stakeholder trust.

Applying to the eight largest UK audit firms, the Audit Firm Governance Code is one of the results of the Financial Reporting Council’s review of choice and competition in the larger company audit market, which recommended that audit firms should comply with the provisions of a Combined Code-style best practice governance code, or provide a considered opinion why they would not.

Added transparency
John Griffith-Jones, co-chairman of KPMG Europe, said that he saw the code “preserving trust in the value of external audit” ­ and added that “anything that gives the market and clients increased assurance about the role of auditors is fine with us.”

He does, though, believe the non-executive role among auditors will bed-in well and will provide a strong challenge as to how the firm operates, treats its customers and reacts to regulatory oversight and changes. “We are all grappling with how non-executives should be used to provide the best possible challenge and how they can help give markets and clients the best degree of assurance. This is a role that will evolve over time,” he says.

The big four firms all admit to considering the appointment of three of four non-executives. According to Accountancy Age, the mid-tier firms, Baker Tilly, PKF and Grant Thornton are looking to appoint two apiece. BDO was the only audit firm with two non-executives in post before the code hit.

There is speculation the individuals will be drawn from the finance director world, given their working experience in challenging their own board members and in many cases performing a non-executive role among other businesses, too.

“We are looking for people with different skills and large company experience. Those with previous experience of being a non-executive would be a bonus and someone with a regulatory background would be useful,” says Griffith-Jones.

Deloitte chairman David Cruickshank says his firm already has a shortlist of candidates with the same kind of background that KPMG specified, while PricewaterhouseCoopers says it wants to line up a good spread of candidates from across academia, the public sector, large corporates and from non-finance roles, too.

Richard Sexton, head of UK assurance and an executive board member at PwC, says the firm is looking for people “with a wealth of experience and, in particular, those who can get to grips with the complexities and breadth of the work we do.” Given their close work with auditors and their knowledge of regulation, FDs are going to be joining audit non-executive rosters in their droves.

What’s the point?
However, the code also has its critics. David Tilston, a non-executive director at digital radio manufacturer Sepura, says “I am uncertain what the benefits would be to stakeholders if the audit firms appoint non-executives. Audit firms are already very sensitive about the quality of their audits and regulators such as the audit inspection unit of the FRC are there to chastise them on how they are carrying out their work if it falls below standard.”

Roger Barker, head of corporate governance at the Institute of Directors, says its position on this issue has not changed since the consultation response. In its response to the second consultation paper, dated 17 September 2009, the IoD complained that the Working Group had defined a “very specific” role for non-executives, which includes being a “witness” to how a firm is run, a “safeguard” of a firm’s reputation, and a “channel” for dialogue with stakeholders.

“Our perception is that this proposed role lacks substance,” says Barker. “Non-executives at audit firms will have significantly less power than non-executive directors at limited companies. The envisaged role is that of privileged observer and potential whistleblower with respect to audit firms’ public interest role”. He adds that it appeared “dangerously like window dressing”.

However, City lawyers believe that auditors are likely to follow best practice in the public and private sectors and put non-executives on an equal footing with executives in a bid to promote better corporate governance.

Jacqui Hatfield, partner in financial services regulation at law firm Reed Smith, says, “The code may change in time as audit firms could come under pressure to adopt the same principles as those used by listed companies and FSA-registered firms to ensure that non-executives are suitable, competent and capable of delivering a proper challenge to the board.”