The Financial Reporting Council Attempts to Fight Back

As usual here in Financial Regulation Matters, today’s post looks at something we have assessed on a number of occasions (which likely hints at the systemic and continued nature of these issues that are identified on a regular basis here). Today’s post focuses on the Financial Reporting Council (FRC) as pressure upon continues to increase. Its position, and future as a regulator, is being called into question more and more recently on the back accounting scandals (like that seen with Carillion), but recently the FRC has announced measures which it hopes will be seen as being representative of a proactive regulatory culture within the organisation.

The news came yesterday that the FRC is endeavouring to incorporate new procedures into its regulation of the audit industry, with the regulator taking specific aim at the so-called ‘Big Six’ (in reality it is probably a ‘Big Four’). The new approach dictates that when one of the six firms cited – KPMG, Deloitte, PwC, EY, Grant Thornton and BDO – want to make a senior appointment, the regulator will have to vet them first to examine the candidate’s “appreciation of a high quality audit’ and their ‘experience and knowledge of driving accountability structures through organisations’; this process will include those applying to be appointed for non-executive positions, heads of audit committees, and heads of ethics committees. The regulator has stated that its aim is to limit the risk of ‘systematic deficiencies’ within the sector, which some industry onlookers have described as ‘long overdue’. However, despite the regulator insisting that the proposed structure should be seen as a response to the recent criticism (which intensified when the performance and actions of the auditors in the Carillion collapse were brought to light), the criticism of the regulator and its attempts to establish its authority have continued unabated.

The Executive Director of Audit at the FRC – Melanie McLaren – stated that this approach is not a ‘direct response’ to the recent criticism, but a number of scholars have been clear in their scathing assessment of the regulator, with one describing the approach as a ‘defensive response’ which does not address the issues of accountability at all. Whilst that sentiment may be debated, the fact that the FRC has now power over the process, but can only ‘advise’ the companies on their recruitment, will not help the FRC’s cause as it strives for legitimacy in the face of private and public pressure. In a recent ‘sanctions review’, the FRC announced that the level of fine available to the regulator would rise to £10 million for ‘seriously poor audit work’, although it should perhaps come as no surprise that the instant response from onlookers was that the new tariff ‘may not have enough of a deterrent effect’; KPMG’s revenue last year stood at $26.4 billion.

With the news coming that two leading board members of the FRC have been ‘stood down’, with both having close ties with the regulated auditors, it is apparent that change is in the air at the FRC. However, whether it can survive this current storm is questionable. The criticism from academia is persistently ‘ramping up’, and now the political machine is seeking to ask serious questions of the role of the FRC after the auditors were identified as ‘feasting on the carcass’ of Carillion; a collapse which has brought the issue of public monies and private business sharply into the limelight. Perhaps there are only two ways the regulator can survive, with the first being the hope for them that something else dominates the political agenda so that their deficiencies are relegated against something much more pressing, or alternatively they change their strategy. There are many arguments for the approach of the FRC, but they are starting to be dominated by the criticism. For a regulator to be so heavily tied to their regulated entities, to be so reliant upon self-regulation, and to have their regulatory weaponry be so obviously blunted (£10 million is no deterrent whatsoever for the Big Four), the only thing that can save that regulator is a good track-record; the FRC, regrettably, does not have that. What it does have is a track record of facilitating the growth of the audit industry as it sought to incorporate the sentiment of prioritising high fees rather than accuracy, and for that the regulator will likely pay a heavy price.

Keywords – Financial Reporting Council, Audit, Accounting, Business, regulation, U.K., @finregmatters