5 Statutory audit of annual accounts
| (25479)
7677/04
COM(04) 177
| Draft Directive of the European Parliament and of the Council on statutory audit of annual accounts and consolidated accounts and amending Council Directives 78/660/EEC and 83/349/EC
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| Legal base | Article 44(2)(g) EC; co-decision; QMV
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| Document originated | 16 March 2004
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| Deposited in Parliament | 25 March 2004
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| Department | Trade and Industry
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| Basis of consideration | EM of 22 April 2004
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| Previous Committee Report | None; but see (24659) 10739/03: HC 63-xxxi (2002-03), para 13 (10 September 2003)
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| To be discussed in Council | No date set
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| Committee's assessment | Legally and politically important
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| Committee's decision | Not cleared; further information requested
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Background
5.1 Conditions for the approval of statutory auditors were the
subject of a Directive adopted by the Council in 1984 (the '8th
Company law Directive').[15]
This was followed by a Commission Green Paper in 1996 on 'The
Role, Position and Liability of the Statutory Auditor in the EU'
and a further Communication from the Commission in 1998. The Commission
issued recommendations in 2000 and 2002 on quality assurance for
statutory auditors and on their independence.
5.2 On 10 September 2003 we considered a further
Communication from the Commission on statutory audit requirements.
The Communication was prompted by the collapse of the Enron Corporation,
and the reaction to that event, including the enactment of the
Sarbanes-Oxley Act in the United States as a measure to restore
the confidence of investors. (This requires non-US auditors and
audit firms to be registered.) The Commission considered that
further initiatives were required to reinforce the confidence
of investors in capital markets and to enhance public trust in
the audit function in the EU.
5.3 We noted the Government's support for the Commission's
objectives, but that it was also concerned that the harmonisation
of statutory audit requirements should be at the level of principles
rather than detailed rules, and that such principles should be
flexible in their operation, respecting the Treaty principles
of subsidiarity and proportionality, and respecting the diversity
of approaches within the Member States. We also noted the Government's
concern at the suggestion by the Commission that the Audit Regulatory
Committee should adopt implementing measures under the comitology[16]
procedure and its concern that this should not be used as a means
of imposing detailed and inflexible rules.
The draft Directive
5.4 The proposed draft Directive replaces the 8th
Company Law Directive, and makes a number of changes of substance
to the present rules on statutory audits. The proposal clarifies
the duties of statutory auditors, provides for their independence
and ethical standards, introduces a requirement for external quality
assurance and provides for public oversight of the audit profession
and for improved co-operation between oversight bodies in the
EU.
5.5 Articles 1 and 2 of the proposals are concerned
with definitions. Article 1 refers to the concept of "public
interest entities", which would be subject to the additional
requirements set out in Articles 38 to 43 of the proposal. Such
entities are defined as having "significant public relevance"
because of the nature of their business, their size or the number
of employees and include companies whose securities are admitted
to trading on the regulated market, within the meaning of Article
1(13) of Council Directive 93/22/EEC, of any other Member State,
as well as "banks and other financial institutions and insurance
undertakings".
5.6 Articles 3 to 14 are concerned with the approval,
continuing education and recognition of auditors and audit firms.
Article 3 provides that one of the conditions to be satisfied
before a competent authority of a Member State approves a person
as a statutory auditor is that the majority of voting rights be
held by statutory auditors or audit firms which are approved in
a Member State. The Commission explains that the intention of
the provision is to prevent any requirement that the ownership
be vested in persons in the Member State giving the approval.
Articles 4 to 13 deal with the requirements which Member States
may impose with respect to good reputation, competence, training
and experience. In the case of statutory auditors approved in
a Member State, the procedure for approval by another Member State
may not go beyond the fixing of an aptitude test as to the laws
and regulations of that Member State.
5.7 Articles 15 to 20 require the establishment and
maintenance of a public register of auditors. Articles 21 and
22 require Member States to ensure that statutory auditors and
auditors are subject to rules on professional ethics and that
information is protected by adequate rules on confidentiality.
5.8 Article 23 requires Member States to ensure that
a statutory auditor is independent from the entity which is being
audited and is not "in any way involved" in its management
decisions. In addition, a statutory auditor or audit firm may
not carry out a statutory audit if there is any financial, business,
employment or other relationship, including the provision of additional
services, with the audited entity which might compromise the auditor's
independence.
5.9 Articles 26 to 28 are concerned with auditing
standards and audit reporting. Article 26 obliges Member States
to ensure that statutory auditors and audit firms carry out statutory
audits in accordance with those international auditing standards
which have been adopted by the Commission under Article 49 (which
provides for an audit regulatory committee to assist the Commission).
Article 26 further provides that the Commission may adopt international
auditing standards only if they are "generally accepted internationally"
and are "developed with proper due process, public oversight
and transparency", provide a "high level of credibility"
to annual or consolidated accounts and if they are "conducive
to the European public good".
5.10 Article 29 requires Member States to make provision
for quality assurance by means of independent review and monitoring.
Article 30 requires Member States to ensure effective systems
of investigation and sanctions to detect, correct and prevent
inadequate statutory audits. Article 30(2) provides that, without
prejudice to Member States' civil liability regimes, Member States
are to provide "effective, proportionate and dissuasive
civil, administrative or criminal penalties" where statutory
audits are not carried out in accordance with the Directive.
5.11 Articles 31 to 34 are concerned with public
oversight and regulatory arrangements between Member States. Article
31, which sets out "principles of public oversight"
requires systems of public oversight to be governed by non-practitioners,
with only a minority of practitioners to be involved in the governance
of such systems. Article 32 provides for cooperation between such
oversight systems in the Member States. Article 33 provides for
the regulation of auditors to be conducted on the basis of "home
country regulation and oversight" by the Member State in
which the auditor is approved and the audited entity has its registered
office. Article 34 provides for cooperation between competent
authorities when carrying out their duties of oversight and investigation.
5.12 Articles 35 to 37 provide for the appointment
and dismissal of auditors and for communications between the audited
company and its auditors.
5.13 Articles 38 to 43 set out a series of particular
rules for 'public interest entities'. They are required to appoint
an audit committee with at least one member being independent
and having competence in accounting or auditing. The audit committee
is to select the auditor for appointment. The statutory auditor
or audit firm is required to disclose to and discuss with the
audit committee any "threats to their independence and the
safeguards applied to mitigate those threats". The statutory
auditor or audit partner responsible for the statutory audit is
required to "rotate from the statutory audit engagement"
every five years. With regard to the rules on public oversight,
public interest entities may not take advantage of the option
of having a minority of practitioners involved in the governance
of the public oversight system.
5.14 Articles 44 to 47 are concerned with "international
aspects". Article 44 permits competent authorities of a Member
State to approve, on the basis of reciprocity, auditors from third
countries on proof of being approved in the third state and of
possessing knowledge, skills and integrity "equivalent to
the provisions of this Directive" as well as relevant legal
knowledge. Article 45 requires Member States to ensure that auditors
and audit firms from third countries are registered in the public
register of that Member State whenever they provide an audit report
on a company established outside the Community whose securities
are admitted to trading in a regulated market of the Member State
within the meaning of Article 1(13) of Directive 93/22/EEC. The
same applies when a third country auditor provides an audit report
on the consolidated accounts of a third state parent undertaking
to which the subsidiary in the Member State belongs. Member States
may register third country auditors and audit firms only if they
meet requirements equivalent to those of the proposal, and must
apply their systems of oversight, quality assurance and investigation
and sanction to such persons.
5.15 By virtue of Article 46, these latter requirements
may be disapplied or modified, on the basis of reciprocity, if
the audit firms are subject to systems of public oversight, quality
assurance and investigation and sanction in the third country
that meet requirements that are "equivalent" to those
of Articles 29 to 31 of the proposal. Such equivalence is to be
decided by the Commission, assisted by an audit regulatory committee
established under Article 49 and composed of representatives of
the Member States and chaired by the Commission.
5.16 Article 47 regulates cooperation by the competent
authorities of Member States with third countries. Member States
may allow the transfer of audit working papers or other documents
to third countries provided that these relate to audits of companies
which have issued securities in the third country, and the competent
authorities in the third state meet requirements which the Commission
has declared to be adequate.
5.17 Article 48 empowers the Commission to adopt
implementing measures "in order to take account of developments
in and related to statutory audit and to ensure uniform application
of this Directive". These measures are to be adopted by the
Commission assisted by the audit regulatory committee established
under Article 49, following the regulatory procedure.[17]
The Government's view
5.18 In her Explanatory Memorandum of 22 April 2004
the Minister for Industry and the Regions and the Deputy Minister
for Women and Equality at the Department of Trade and Industry
(Jacqui Smith) explains that the Government supports the majority
of the provisions in the proposal, and welcomes in particular
the adoption of International Standards on Accounting, and the
principles of auditor independence, quality assurance and public
oversight.
5.19 The Minister adds that the Government's main
concern will be to ensure that the requirements imposed by the
proposal do not cut across the reforms being undertaken in the
UK. The Minister states that the UK will wish to make specific
points about most of the draft Articles and draws attention to
the following specific concerns:
"The Process. We need time for consultation
and proper economic assessment to guard against unintended consequences
and unforeseen costs. We propose to consult with stakeholders
and undertake a RIA [Regulatory Impact Assessment]. We will urge
the Commission to do the same, in line with their recent commitment
to do so from the start of 2004.
"Scope. The
Directive raises issues on scope. We are concerned that it may
go wider than audits required by Company Law. For example, does
it enter the realm of financial services through the provisions
on non-EU companies listed in EU? There is also the question of
what is meant by 'public interest entity'.
"Subsidiarity.
Does it leave Member States sufficient
flexibility? There is a risk that under comitology, principles
could be implemented as detailed rules.
"International aspects.
The Directive introduces the registration
of audit firms from third countries, by way of a requirement to
impose the directive requirements on third country auditors of
companies established outside the Community but with a listing
within the Community, with a derogation for equivalence determined
at the European level. We believe this would be bureaucratic and
difficult to operate and will not add to the quality of regulation.
The UK has serious reservations about these provisions —
they are unlikely to achieve our objective regarding mutual recognition
against the US and are not desirable for their own sake. We would
question the cost and benefit implications and would support a
lighter touch with greater discretion for member states to determine
equivalence. It may also not be within scope of this directive".
Conclusion
5.20 We thank the Minister for her detailed and
helpful Explanatory Memorandum and we shall look forward to seeing
a Regulatory Impact Assessment in due course. We believe the Minister
is right to press the Commission to produce its own regulatory
impact assessment, and we note with concern that the Commission
appears not to have complied with its own undertaking to do so.
5.21 We share the concerns expressed by the Minister,
including the open-ended nature of the definition of "public
interest entities". We also note the excessive scope of the
power delegated to the Commission under Article 48. In this connection,
we do not believe it to be either necessary or appropriate to
delegate a power to the Commission to legislate "to take
account of developments in and related to statutory audit"
.
5.22 We note that Article 30 refers to the imposition
of criminal penalties, and we doubt whether such a provision is
legitimate under the EC Treaty. Provided the sanction is proportionate,
effective and dissuasive, it is for Member States to decide which
kind of sanction is to be imposed, and we ask if the Minister
agrees that the reference to criminal sanctions is inappropriate
and should be deleted.
5.23 We shall hold the document under scrutiny
pending the Minister's reply.
15 OJ No. L 126 of 12.5.84, p.20. Back
16
The procedure whereby certain legislative functions may be delegated
to committees formed of the Commission and representatives of
the Member States pursuant to Council Decision 1999/468/EC. Back
17
The procedure under Council Decision 1999/468/EC (the 'Comitology'
decision) which provides for the Council to adopt the measures
proposed by the Commission if the committee disagrees with the
Commission's proposals. Back
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