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On 29 July 2021 the FRC released its 2021 Annual Enforcement Review (the “Review”) summarising the FRC's enforcement work over the past year. In this bulletin we summarise and provide our comments on the Review.
As with last year, the failure of auditors to exercise professional scepticism (ISA 200) remains one of the key "live issues" in the regulation of the profession. But the Review also focuses on issues in connection with auditors’ preparation of audit documentation (ISA 230). The FRC underscores the importance of this standard and emphasises that breaches of ISA 230 may result in "significant sanctions".
Other key themes in the Review shine a spotlight on those who prepare and approve the companies’ financial reporting which is the subject of the auditor’s work. The issues highlighted are:
However, the stand out theme in the Review is not enforcement but the successful championing of the Constructive Engagement process as an alternative to full enforcement action. 48 cases have been resolved through Constructive Engagement over the past year. That is an increase of 45% on the previous year. The typical timeframe to resolve cases using the Constructive Engagement mechanism has also reduced from just under seven months to just under five months. As one would expect, the biggest users of the process are the biggest firms: 34 of the 48 cases involved the "Big Four", and 43 included the seven largest firms. Bespoke remedial actions were agreed with firms in 81% of cases that went through Constructive Engagement. Those remedial actions are often similar in effect to types of non-financial sanctions often agreed at the end of enforcement action.
In time-honoured fashion the Review contains a considerable number of statistics about the cases which the Enforcement Division has seen over the past year:
This year finally saw the conclusion of some major cases on which the Enforcement Division has been working for the past few years. Those included Autonomy, which saw the highest financial sanction to date in any FRC matter. The financial sanctions in that case – £15 million for the audit firm, £500,000 for one audit partner and £250,000 to another – made up the lion’s share of the total financial sanctions imposed.
Although the number of concluded cases decreased by four versus 2020, the number of non-financial sanctions imposed increased, which may demonstrate the increased use of non-financial sanctions to attack the root causes of breaches and/or misconduct.
It should also be noted that fewer investigations were resolved this year, which the FRC say partly reflects "slower progress" than they should have liked where cases were concluded by settlement.
In addition to the normal retrospective of the FRC’s annual enforcement reviews, this year’s Review looks ahead to the risks and uncertainties of Covid-19, Brexit and climate change that are yet to be felt in full. Some of the key areas that the FRC has flagged for audit firms and auditors are:
The increased focus on Constructive Engagement should be seen as positive, and firms no doubt welcome a swifter and more contained process in return for making sensible concessions and improvements to their processes. At the moment there appears to be some consensus regarding the "benefit of regulatory cooperation, including where those subject to investigation proactively identify and remediate issues, and self-report or make full and frank early admissions". It will be interesting to see how far firms will be willing to take this in the coming year(s).
Other aspects of the Review seem quite transparently to mesh with the wider reform agenda ushered in by the publication of the BEIS white paper: Restoring Trust in Audit and Corporate Governance (the “White Paper”) in March 20211. One obvious example is the emphasis on issues around preparing and approving companies’ financial reporting, which clearly has one eye on the FRC’s Future of Corporate Reporting Project, and the sustained political and parliamentary focus on the role of audit and the need for audit reform more generally.
Likewise, the growth in the FRC’s headcount is part of its preparations to morph into ARGA (at some point). We expect to continue seeing the upward trend in more investigations being opened as the Enforcement Division expands. Then one has in addition the challenges and risks presented by Covid-19, Brexit and climate change, and the issues for accountants and auditors which are likely to result. There can be little doubt that the FRC/ARGA will be busy in the coming years – particularly if, as proposed, it obtains powers to investigate and sanction directors of Public Interest Entities in relation to corporate reporting / audit related responsibilities.
All in all, we expect all the same key metrics to have increased again by this time next year.
1You can access more detail on what the White Paper means for accountancy firms and auditors via our White Paper series.