Saturday, June 18, 2011

UK Government Rejects Mandatory Joint Audits as Way to Expand Public Audit beyond the Big Four, Says No Firm Too Big To Fail

While desirous of a resilient audit market that could withstand the withdrawal of a Big Four audit firm, the UK Government does not believe that mandatory joint audits of company financial statements would enhance competition. Responding to a parliamentary committee report on audit concentration, the Government said that companies have moved away from joint audits because they found the single auditor model more efficient and effective.

In a letter to the Economic Affairs Committee, Secretary of State Vince Cable also said that creating risk committees and prohibiting the company’s auditor from advising the committee would not open up an opportunity for the Following Four to get into large public company audit, since there is no compelling reason to prohibit the company’s auditor from also advising the risk committee. Indeed, said the Minister, in many cases the auditor of the company’s books will be best placed to highlight risks relating to the company’s business which it has considered during the audit. Moreover, while the risk committee might often want to seek additional external advice, it might also wish to ask the auditor to provide assurance work for it outside the statutory audit, especially when this is closely linked to the audit work.

The Minister said that the Government has been working with oversight regulators like the Financial Services Authority on potential responses to one of Big Four exiting the public audit market. While any response would reflect the particular circumstances, the Minister emphasized that no audit firm is too big to fail.

If an audit firm did withdraw from the market, the emphasis would be on mitigation of the wider consequences for the audit clients and their investors. The Government will explore with the audit profession issues around contingency planning, including whether the major firms should have living wills. Contingency plans may need to be coordinated cross-border by regulators and governments and firms in order to minimize market disruption, noted the Minister, and the UK will continue to press for this in the EU.

The Government did agree with the Committee that it would improve the health of the audit market if major company audits were put out to tender more frequently than is typically the case. The frequency with which company audits are put out to tender should take into account the size and complexity of the company; noted the Minister. In addition, the largest companies should explain each year the basis for the audit committee's recommendations to the Board and to shareholders as to who should be appointed auditor, how long the current auditor has been in its post, and when a tender was last conducted. The Government also agrees on the importance of a dialogue between the principal shareholders and the audit committee, but does not believe it would be right to limit this to once every five years.

Since the leading second-tier audit firms told the Committee that their scope for growth is not constrained by access to capital, the Government sees no immediate grounds to change the law to lift limits on shareholdings by non-auditors in audit firms. However, subject to ensuring auditor independence, the Government believes that it is wrong in principle to limit the sources of capital, and has therefore called on the European Commission to propose the necessary changes to European law to enable this to happen.

The Government rejected the idea of imposing a statutory mandate on audit firms to meet regularly with regulators in favor of proposed changes to the Code of Practice indicating a minimum level of such meetings. The FSA has proposed principles to guide interactions between regulators and outside auditors. The FSA recognizes that timely, relevant information sharing is an essential part of an effective working relationship, and it indicates a minimum level of bilateral and trilateral meetings that should take place for high impact firms. The Minister also mentioned that the Bank of England has not indicated that they would wish to see a duty for auditor-regulator meetings placed on a statutory footing. He also noted that the power to request that this type of dialogue take place is already in the Financial Services and Markets Act 2000.

More broadly, the Minister emphasized that shareholders must be equipped with good quality information that allows them to make well-informed decisions. Thus, in the summer of 2011 the Government will propose improvements in company reporting to make it less complex and enable shareholders to access information more easily. These proposals will set out the role of audit and assurance in relation to these issues.

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