Select Committee on Treasury Minutes of Evidence

Further Memorandum submitted by Mrs Feamley, Mr Brandt and Professor Beattie

  Following our attendance at the hearing there are some key points which my colleagues and I feel need further clarification. These relate first to our own evidence and the questions raised by Mr Plaskitt towards the end of the hearing, and second to the evidence given by Professor Sikka.

  1.  Mr Plaskitt said that he did not know whether we had come hoping to re-assure the committee and raised three questions, which, when presented together, implied that the UK regulatory framework was very weak.

    —  Could there be market failure in the UK?

    —  Does the success of an audit really come down to the individuals assigned to the client?

    —  Can there really be no guarantees of auditor independence?


  Our objective in submitting evidence and attending the hearing was to present evidence based on our independent and objective research. We had no prior intention either to offer assurance or criticism.


  As we pointed out in our written evidence, our research, which has been published in peer reviewed journals of international standing, provides strong evidence that the major reforms of 1991 have improved the quality of financial reporting and auditing. No framework, however rigorous, can provide guarantees that nothing will go wrong in the future. Regulators must be both reactive to events and be pro-active in identifying emerging areas of risk. A complete loss of confidence leading to a failure in the UK market is unlikely but not impossible. Corporate collapses can never be eliminated because risk is inherent in capital markets. Unless there is clear evidence of failure in the UK framework we can see little justification for major legislative change at this stage. However, constant review is needed. Clearly the position is different in the US as the Enron case has exposed major deficiencies in their framework for financial reporting, corporate governance and audit, which will have to be addressed, but despite these major problems the US markets are still functioning.


  The quality and integrity of individuals assigned to an audit client are key factors in the success of an audit but by no means the only factors. Audits succeed or fail through a combination of circumstances, one of which may be the robustness of the individual audit partner and the quality of the relationship between the audit partner and the client. We emphasised this issue because it emerged as a strong influence on good financial reporting outcomes from our research and has received little attention in the independence frameworks of any country. It is not a subject where legislation is appropriate but we believe it should be addressed in the UK independence framework.


  We do not believe any human behaviour can be guaranteed. What is needed is a framework which is kept constantly under review so that dysfunctional behaviour is discouraged and the penalties of compromising independence outweigh the benefits for those who may be tempted. We are in no doubt that the impact of the Andersen collapse will be a most powerful reminder for many years about the dangers of getting it wrong.

  We also re-iterate our concern about knee-jerk reactions post Enron. Regulation is not a confrontational activity. To be effective regulators need both the respect and the co-operation of their constituency. Respect and co-operation can be undermined if regulatory requirements are imposed which the constituency finds unacceptable or burdensome either for cost or other reasons. This can lead to unintended consequences and dysfunctional outcomes as the constituency may seek its own ways to mitigate the impact. For example the imposition of auditor rotation could lead to anti-competitive behaviour on the part of audit firms as has been the case in Italy.

  2.  Professor Sikka referred on numerous occasions to audit failures in DTI Inspectors' reports. Many of these reports date back to events which took place in the 1970s and 1980s, a time when the framework for financial reporting and auditing was recognised as being much weaker than it is now and, of course, attitudes and behaviour have moved on since. For example, money laundering is regarded as a much more serious issue now than it was 20 years ago. The profession has responded to issues raised in DTI reports. For example, following the Roadships reports, auditors of PLCs were disbarred from preparing their clients' accounting records because of the recognised problems of auditing their own work. The Inspectors in the Rotaprint case criticised the firm because the partner had been involved with the client for many years. Provisions for rotation of audit partners were subsequently introduced.

  We are also concerned that Professor Sikka cited evidence from DTI Inspectors' Reports as if it were representative of auditors' behaviour more generally. This is inappropriate as the findings in DTI Inspectors' reports represent the very worst of behaviour from all parties involved, otherwise there would have been no cause for an investigation. Reference was also made to evidence of low-balling and opinion shopping. This evidence was not based on systematic empirical research but on the casual empiricism of one or two examples. Whilst casual empiricism indicates that these activities exist, it is not valid for such evidence to be used to make general assertions about the whole of the audit services market without further evidence from systematic research.

  On a point of information, Professor Sikka states in his written evidence that there is auditor rotation in France. This is incorrect. There is no mandatory rotation for statutory auditors in France. The auditor is appointed by the shareholders for a period of six years. At the end of this period the incumbent auditor may be re-appointed for further periods. As rotation is a sensitive issue, we wish to ensure that the Select Committee is not misled into confusing fixed terms of appointment with mandatory rotation.

  I hope you find these comments helpful. We will be pleased to discuss them further if you wish.

23 April 2002

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