The UK government has unveiled a roadmap to revamp the country’s audit market and make businesses more accountable to stakeholders.
The proposals, however, fall short of plans first aired in 2019 to make directors responsible for the effectiveness of their company’s internal controls with a UK version of the Sarbanes-Oxley Act.
Lord Callanan, the minister for corporate responsibility said: “Collapses like Carillion have made it clear that audit needs to improve, and these reforms will ensure the UK sets a global standard.
“By restoring confidence in audit and corporate reporting we will strengthen the foundations of UK plc, so it can drive growth and job creation across the country.”
Services firm and government contractor Carillion collapsed in 2018 under the weight of a £1.5bn (€1.8bn) debt mountain.
Tim Bush, head of governance and financial analysis at Pensions and Investment Research Consultants, told IPE: “The key message is that reform needs to be tasking auditors with the product they are supposed to be delivering already, not lobbying for watered-down products that are useless.”
“The courts are clear that auditors are responsible for seeking out material fraud, but particular firms have pushed policy in the wrong direction by trying to deny that.”
However, UK lawmaker Sharon Bowles warned against rushing to copy and paste Sarbanes-Oxley as a quick fix for the UK’s corporate-governance woes.
“I think this is quite tricky, SOX-type of responsibility would have meant directors seeking more external assurance and taking out a lot more directors insurance like they do in the US. It strikes me that we have more pressing issues to tackle.”
Ultimately, she explained, the problem goes back to the complexity of the accounting model.
“We can do without SOX if we get simplicity. If we can’t have simplicity – needed among other things because of figures not meaning anything to the ordinary, intelligent person – then we need other assurances.
“Of course, that puts money in the pockets of those who create the complex accounting standards.”
The government has also rowed back on its ambitions to bring private, non-listed companies within its definition of a public interest entity (PIE).
Instead, the new accountability will apply only to those firms with:
- 750 or more employees, and
- an annual turnover of £750 million or more.
The government argues that a threshold based on employee headcount and turnover “strikes the best balance for the widening of the PIE definition, being proportionate whilst ensuring those companies which are economically important and systemically important are within scope”.
In its March 2021 consultation paper, the government floated a much tougher requirement that would have brought more companies within the scope of its PIE definition.
Meanwhile, the government has confirmed it is working to replace the Financial Reporting Council (FRC) with a new regulator – the Audit, Reporting and Governance Authority (ARGA).
‘More incremental approach appropriate’
Today’s proposals mark the culmination of three separate external reviews into the FRC and the UK audit profession: Sir John Kingman’s review of the FRC; the Competition and Markets Authority’s study into audit; and Sir Donald Brydon’s review of UK audit standards.
The Kingman review examined regulation, including the role and structure of the FRC, while the CMA inquiry focused on audit resilience, and the later Brydon review, led by former London Stock Exchange Group chair Donald Brydon, focused on the nature and scope of audit.
One of the core planks of the Brydon review was to impose new duties on directors modeled on the US Sarbanes-Oxley Act to force them to take responsibility for the effectiveness of their company’s internal controls.
Specifically, Brydon recommended that company directors report on what they had done to prevent and detect material fraud.
The government subsequently echoed this proposal in its 2021 White Paper. Such a move, it said then, formed part of “a package of recommendations aimed at raising the prominence and transparency of fraud prevention and detection by both directors and auditors”.
In respect of auditors, the government had proposed a new reporting duty “to state in their report how they have assured the directors’ statement on material fraud, and what additional steps they have taken to assess the effectiveness of the relevant controls and to detect any such fraud”.
“The government’s decision not to pursue the introduction of a version of the Sarbanes-Oxley reporting regime is, the FRC believes a missed opportunity, to improve internal controls in a proportionate, UK-specific manner.”
Jon Thompson, CEO of the FRC
However, in today’s policy statement, the government noted that “[i]n light of consultation responses,” it now believes “a more incremental approach to strengthening the UK’s internal control framework would be appropriate”.
As part of this approach, the FRC will instead be tasked with strengthening the UK Corporate Governance Code “to provide for an explicit directors’ statement about the effectiveness of the company’s internal controls and the basis for that assessment”.
The Code, as it currently stands, only applies to listed companies.
Jon Thompson, the chief executive officer of the FRC, said the government’s decision not to pursue the introduction of a version of the Sarbanes-Oxley reporting regime was “a missed opportunity, to improve internal controls in a proportionate, UK-specific manner”.
“While we await the final piece of the legislative jigsaw, the FRC will continue to do all in our power to ensure that audit and corporate reporting standards remain high to ensure better outcomes for stakeholders,” he added.
Ahead of government legislation, the FRC will shortly be outlining an extensive work plan to advance reforms which can be developed through existing powers or on a voluntary basis.
Other proposals in today’s reform package include reviewing the EU definition of micro-entities in a bid to lighten the post-Brexit regulatory burden on small firms; giving the FRC the power to ban struggling auditors; and measures to break the dominance of the big four audit firms of KPMG, EY, PwC and Deloitte on FTSE 350 audits.