ESMA proposes guidance on accounting and auditing enforcement actions

The European Securities and Market Authority (ESMA) has proposed guidance on enforcement actions involving the filing of audited financial statements and information in an effort to achieve consistency throughout the European Union. ESMA is of the view that in order to achieve a proper and rigorous enforcement regime to underpin investors’ confidence in financial markets and to avoid regulatory arbitrage by issuers in the EU Single Market, there is a need for a common European approach to the requirements in the Transparency Directive on the enforcement of audited financial information.

It is axiomatic, and ESMA acknowledges, that the issuance of accounting standards and the interpretation of their application is reserved to standard setters such as the IASB.. Therefore, ESMA and enforcers do not issue any general IFRS application guidance to issuers. Nevertheless, as part of their enforcement activities, enforcement authorities have to apply their judgment in order to determine whether accounting practices are considered as being within the accepted range as permitted by the relevant reporting frameworks.

Reporting by ESMA of any material controversial accounting issues, as well as ambiguities and any lack of specific guidance, discovered during the enforcement process in cases of IFRS application to the bodies responsible for standard setting and interpretation (IASB and IFRS IC), is a necessary step in ensuring consistent application and enforcement. This is also the case for any other issues identified which create enforceability constraints during the enforcement process.

Moreover, Recital 16 of the IFRS Regulation on the application of international accounting standards provides that: a proper and rigorous enforcement regime is key to underpinning investor confidence in financial markets. ESMA reminded that Member States are required to take appropriate measures to ensure compliance with international accounting standards.

ESMA has revised the objective of enforcement in the earlier CESR guidance to reflect the importance of compliance with the relevant financial reporting standards and transparency of financial information. These elements contribute to market confidence and investor protection. The concept of enforcement has been extended in order to include, in addition to the enforcers’ review of the financial information, any other actions which might contribute to enforcement such as for example issuing alerts.

The purpose of enforcement on issues relating to financial information, as defined under the Transparency Directive, is to protect investors and promote market confidence by contributing to the transparency of financial information relevant to the investors’ decision-making process The provision of full and consistent information concerning issuers of securities promotes the protection of investors. Moreover, such information provides an effective mean of increasing confidence in securities and contributes to the proper functioning and development of securities markets. The challenge for a competent authority is to make sure that no prospectuses with obvious inconsistencies is approved and to develop appropriate procedures for taking into account the risk related to an issuer.

An important element in the enforcement process is the level of materiality. Provided that enforcement is aimed at taking actions where departures from the reporting framework are detected, noted ESMA, materiality should necessarily be defined consistently both for reporting purposes and for enforcement purposes. For example, where financial statements are prepared in accordance with IFRS, reference should be made to the definition of materiality provided under IFRS.

As material misstatements could, by definition, have an impact on investor and other users’ decisions, it is important that investors are not only informed that there is a misstatement, but are also provided with the corrected information on a timely basis.