Memorandum submitted by Kingston Smith, Chartered Accountants
FINANCIAL REGULATION OF PUBLIC LIMITED COMPANIES
I am writing in reply to your letter of 25 March.
I commend the approach of the Treasury Committee in considering all arrangements for financial regulation of plcs in the UK and not just concentrating on the relationship between the companies and their auditors.
The Institute of Chartered Accountants in England and Wales came to the conclusion, some three years ago, that firms who provide other services to audit clients were not jeopardising their independence as auditors by receiving fees for other services so long as other guidelines for independence and objectivity were met.
That said it is clear that the very large firms of Chartered Accountants do receive substantial income from audit clients for other services and whilst their independence as auditors should not be jeopardised because of this, there may be a public perception that this is the case. It is my view, however, that we do not require, in this country, a total segregation of audit services from other services.
In fact for Small and Medium Enterprises and small public companies the necessary work that has to be carried out in auditing is a valuable base of information and independent view to enable the management to benefit from other services (taxation, systems advice, advice on the application and disclosure of Accounting Standards etc) in a cost effective way.
However, as I mention above, public perception may demand a change but my feeling is that any change should only affect the larger companies, say those within the FTSE 250. There is, for example, some merit in the suggestion that fees for certain specific advising work should be capped at the amount charged by the firm to that same client for audit, taxation and basic accounting services.
In addition to the above I would ask your committee to consider the following:
1. Section 389A Companies Act 1985 which makes it an offence to deliberately mislead an auditor is, so far as I am aware, rarely used. I believe the existence of this Section should be specifically mentioned in the Statement of Director's Responsibilities in Financial Statements. In addition it could also be mentioned in the Form 288A (appointment of a director) so that a director is aware of the section when he signifies his willingness to act as a director.
2. The section should also be expanded to include the withholding of information from auditors.
3. There should be a requirement for a written statement from all the directors of listed companies to the auditors each year stating that in their opinion there is nothing to bring to the auditors' attention which could influence the audit opinion.
4. There should be a strengthening of corporate governance concerning directors in order to control the few chief executive officers/chairmen who hold a very dominant position in the company. For companies within the FTSE 250 list there should be total segregation of the roles of Chairman and Chief Executive Officer. In addition I consider there should be a "cooling off period" of at least six months between the time a former chief executive officer leaves that role and could be appointed chairman of the same company.
5. There should also be a prohibition on an audit manager or audit partner of the auditors leaving to join a listed client company in a senior executive position if he has been materially involved in the audit of the company during, say, the previous three years.
6. My firm understands that there are instances where subsidiary companies of large public companies have virtually no audit tests carried out on them due to the concept of immateriality having applied to the group as a whole, although we have no direct knowledge of any current specific examples. This could encourage management to "bury" certain transactions within subsidiary companies where they perceive the auditors will not conduct tests. I would suggest that for all FTSE 100 companies there is a different auditor appointed to subsidiaries or some strengthening of the necessity to treat each subsidiary as an independent "stand alone" audit ignoring overall group risk criteria.
7. It is my understanding that some of the recently perceived problems have arisen as a result of the audit exemptions enjoyed by overseas entities either because of local statute or the nature of the entity itself, eg a partnership. As a result considerable pressure is placed on UK group auditors not to insist on audits of these entities. I believe that some mechanism has to be put in place to strengthen the hand of the group or primary auditors in insisting on a local audit or enabling them to carry out such an audit themselves.
8. I also feel the concept and make up of the Audit Committees of listed companies should be looked at again. Audit Committees are currently made up of non-executive directors of the company and they have the power to discuss with the auditor the conduct of the audit. Very often the non-executive directors would not be in possession of enough facts concerning the business to bring matters to the attention of the auditors and therefore the Audit Committee becomes sterile with the only input coming from the auditors. The make up of this committee should be changed to ensure that it could contribute properly to the audit function and have a duty to bring matters specifically to the attention of the auditors. Many larger companies have internal audit departments and it is my view that such departments should have a formal role and input into the Audit Committee proceedings as should some main board executive directors whose central role is likely to have provided them with a greater knowledge of the workings and infrastructure of the group.
I appreciate that some of the above suggestions will increase the cost of auditing, but in view of the number of corporate "disasters" that have occurred in recent years it is important, from a public perception, that audit and corporate governance are strengthened so that the worst excesses of management can be brought under control.
5 April 2002