Risk & Economy » Audit » Whose turn next?

Parmalat is likely to go down in history as Italy’s – and probably Europe’s – Enron. Its impact will reverberate through political and financial circles for years to come, and not least among audit firms.

Italy is one of the few jurisdictions in the world to have adopted a policy of audit rotation. The principle is that auditors should be replaced periodically by another firm, or at least rotate audit partners, in order to ensure probity and so that any wrongdoing can be brought to light.

Some would argue that such a policy didn’t work very well in the Parmalat case, where skulduggery is alleged to have gone on for some time. Others, such Lino de Vecchi, a council member of the Consiglio Nazionale dei Dottori Commercialisti (CNDC), the Italian chartered accountants body, argues to the contrary.

“From the Parmalat case, we can see that some kind of audit rotation is a good thing. Deloitte was the newly appointed firm that took over from Grant Thornton in June 2003. Once it had time to understand the situation, it raised doubts and that helped start the process of discovery,” he says.

He believes rotation is common sense. “If you know someone is coming along after you to check up on you, and you know you are going to have to respond to them, the chances are that you will pay more attention. At the same time, if you know you are going to move on at the end of your period as auditor, you will be less inclined to close one eye on anything not totally above board. After all, if you work with the same people at the firm you are auditing year in year out, there is a risk that you become overfamiliar.”

Meanwhile, a battle is brewing in Brussels. Among proposals being considered by the European Commission is a suggestion that might require member states to adopt compulsory rotation, either of lead audit partners on a particular account every five years or of the audit firm every seven years. Perhaps unsurprisingly the Big Four firms are resisting such a move.

“To maintain the same firm in the job is completely useless,” says de Vecchi. “And, at the same time, top audit partners don’t review the accounts anyway.” He explains that auditors argue against rotation because it is expensive for the client of each new audit firm to have to get to know the business it is auditing. But if it helps prevent a scandal of Parmalat proportions it may be a worthwhile expense. However, there is little the auditors can do when faced with wilful wrongdoing, as is alleged in the Parmalat case.

One change which came into effect in Italy in 2003, and which seems to have been effective, is the ‘Principle 600’. This requires that the main audit firm audits not only the largest part, ie 51% of the business by sales, but also by importance to the business. In the Parmalat case, pressure was applied by the Commissione Nazionale per le Societa e la Borsa (Consob), the Italian securities regulatory commission, to observe the requirements of Principle 600. As a result, incoming lead auditor Deloitte took over a greater part of the Parmalat audit from Grant Thornton and, in particular, that of offshore funds located in the Cayman Islands about which there was something of a black hole as regards information.

Deloitte is reported to have shed light on these controlled offshore activities, whereas Grant Thornton is alleged to have accepted, without investigation, what little information it received from Parmalat.

The question of what Italy and the European Commission will do next about audit discipline is likely to take some time to answer. As we go to press, submissions and deliberations are continuing in Brussels. In Rome, two parliamentary commissions are currently examining a final text of a legal draft which unifies several pieces of previous legislation and which will incorporate new, more stringent regulations for auditors in the wake of Parmalat.

In its submission before a commission comprising representatives from both houses of the Italian Parliament, Consob made proposals that included greater powers for itself to revoke company appointments of auditors.

There was also a proposal to separate audit and other advisory roles performed by the same firm and increased powers to suspend auditors pending further investigations of malpractice.

The Italian parliament has so far delayed the debate and approval of the new legislation a couple of times, but insiders understand that approval is thought likely before the European Elections on 12-13 June this year.

Audit rotation seems, in the opinion of Italian experts, to have been effective in bringing to light the alleged wrongdoings at Parmalat. Others, however, will still argue that it wasn’t able to do so soon enough.