Examination of Witnesses (Questions 1-66)|
9 FEBRUARY 2010
Q1 Chairman: Good morning. Welcome
to Audit and Accountancy. We are very sorry that it ran on but,
if you were listening to it, it was an interesting session. Can
I start quickly: I have in front of me a selection of the consultation
papers, the revised guidance, the working groups and statements
that you and other relevant bodies have published following the
credit crunchthey number 18 here. What have they achieved?
Is this just to obfuscate and to keep the debate going and to
make it so technical that we are going to forget about the issue?
Mr Haddrill: Firstly,
it is clearly not to obfuscate. I think the starting point was
that the audit process had not failed in the crisis but there
was room for some improvement, so we needed to be very careful
on what we consulted on and in drawing conclusions. A similar
conclusion was reached in relation to governance that there was
a lot that was right about governance in the UK but in some respects
it had not served us well, so again we needed to be careful there.
What we have done is, as you see, consulted, at the moment, on
the corporate governance code and on the stewardship code, which
I think is a very important counterpoise to the governance code
because there is no point in having a comply and explain system
on governance if there is nobody taking notice of what the explanations
are from companies.
Q2 Chairman: My point, Mr Haddrill,
is if you have 18 papers is this process robust enough because
there are going to be lots of gaps?
Mr Haddrill: I think it is robust
and it is not just the consultation papers that are going on;
you are also seeing the work of the Audit Inspection Unit, which
has been going on for several years now, and has been intensified
over this period in looking at the audits of banks and the work
of the audit firms. So it is underpinned by that whole regulatory
Q3 Chairman: I have in front of me
"Helen Brand, CEO of ACA", and now Dr Steve Priddy turns
up. Why has she been transformed to you? You are the technical
man. Are you here to obfuscate?
Dr Priddy: I am the Technical
Q4 Chairman: Why is she not here?
Dr Priddy: I do not know. It is
Chairman: It is not a good way to treat
the Select Committee, okay, so take it back to her, and I will
look for a nice letter from her. Thank you.
Q5 Jim Cousins: Bank auditing both
in this country and across the world is dominated by a tiny number
of global firms and in this country they have the protection of
limited liability. Is that right? Do we not have too few players
in the market and are not the players we have too well protected?
Mr Haddrill: I do not think it
is right in the sense that the law introduced the opportunity
to negotiate proportionate liability with companies. That is not
something that has actually been pursued so far, so they remain
quite exposed in terms of liabilities. In terms of the number
of firms, we believe strongly in competition and we would like
to see more firms there, but in practice that is unlikely to happen.
Therefore, the key challenge for us now is to make sure that those
big four firms do not become a smaller number of firms, and that
is why we pay so much attention to both audit inspection in the
UK, to encouraging the improvement of governance of those firms,
which we have just done through working with the Institute on
a new audit governance code, and through encouraging genuine international
regulation of audit because, as you say, they are big global entities.
Q6 Jim Cousins: How can regulation
possibly be effective if regulation is, in a sense, protecting
the existence of the big four accountancy firms?
Mr Haddrill: I would not say regulation
is protecting their existence.
Q7 Jim Cousins: You have just said
it is, that you cannot risk a situation where you go down from
a big four to a big three.
Mr Haddrill: I said we wanted
to take action in relation to the activities of the big four so
that they do not go down to the big three. We are robust in our
inspection regime and we would be robust if we found misconduct
in pursuing that.
Q8 Jim Cousins: Is it not the practical
reality that there are a number of legal actions now that are
underway, most of them in the United States, a lot of them now
directed at KPMG because of its activities, in fact some relatively
small and non-headline here, American institutions that they audited?
Are not those legal actions going to be a far more effective way
of regulating, disciplining and improving the quality of auditing
than anything you are likely to do?
Mr Haddrill: I think the liability
that the firms hold is actually part of the system, and I would
agree with you that if they get things wrong they are maybe taken
to court so they will manage themselves in such a way as to try
and make sure that they do not get exposed to that. So I do not
think that, somehow, as a regulator we are in competition with
the courts and the legal system. We are complementary.
Q9 Jim Cousins: Is it not the situation
that the fees the big four accountancy firms are getting from
banks are absolutely enormous and that you are limited in what
you can do as regulators because you have to protect them? We
have a classic cartel.
Mr Haddrill: I do not think that
is right. Certainly the fees that they get are large, and our
expectation is that those large fees get invested into the business,
and it is one of the things we look at in terms of the training
of the audit teams and their investment in improving audit quality.
That is one thing that we do expect to see. The other thing we
expect is that they pursue their work with a high level of ethical
Q10 Jim Cousins: Excuse me. KPMG
got £9 million from auditing HBOS. How much of that went
back into improving audit quality?
Mr Haddrill: I cannot tell you
Q11 Jim Cousins: Perhaps you could
let us know, because that would be really helpful. Ernst &
Young got $27.8 million for auditing Lehman Brothers. Could you
find out for us how much of that fee went back into improving
Mr Haddrill: It is not my job
to defend the fees of the audit firms.
Q12 Jim Cousins: You have advanced
a justification for the size of the fee in terms of reinvestment
in audit quality. I have asked you one or two direct questions
that follow from that and it is reasonable to expect an answer.
Mr Haddrill: No, I am not justifying
the size of the fee; I am saying that we, as a regulator, expect
audit firms to invest in quality, to invest in the training of
their staff and to invest in their ethical systems as well. I
am not saying that any particular size of fee is the right size
Q13 Jim Cousins: If a regulator says
that one of the justifications for the fees is reinvestment in
audit quality, it is perfectly legitimate for this Committee to
say to you: "Okay, how much of those fees went back into
Mr Haddrill: No, sorry, I think
you are misinterpreting what I said. I am not justifying the level
of their fees at all; I am saying that we expect them to invest
in those activities.
Q14 Jim Cousins: How do you carry
out that expectation?
Mr Haddrill: We audit what they
do, we inspect what they do, we look at the extent to which they
are managing their risks, and we look at the extent to which they
are investing in those activities.
Q15 Jim Cousins: So why can you not
tell me how much of the £17 million that Deloitte got for
auditing Royal Bank of Scotland went back into improving audit
Mr Haddrill: Because what we do
is look at the firm as a whole and we also look at particular
audits, but in terms of the level of investment by the firm as
a whole in those activities that would make sense, not the level
of investment in relation to a particular audit.
Q16 Sir Peter Viggers: Following
the Enron scandal accountants moved out of consultancies. In the
year 2000 something like 300% of audit fees by comparison were
consultancy work, in 2009 they were 70%, and now all the accountants
are moving back into consultancy. Are you confident that this
is a sensible step?
Mr Haddrill: This is something
that we are taking a very close look at. The committee made a
recommendation on non-audit service fees and non-audit service
work, and the consultation on that has just closed and the FRC
will be reaching a conclusion on that over the next two to three
months. I must make that clear. As you say, the level of non-audit
service fees in relation to audit fees has fallen quite significantly,
and we were certainly very pleased to see that. The question is
to what extent is it ticking up now, and I do not think we yet
know the answer to that, and whether it is going to be a sustained
change. If it is going to be sustained, we would be concerned
about that because we want to seeand I think investors
want to seethat the balance is very much in favour of the
fees they earn from audit rather than the fees they earn from
Q17 Sir Peter Viggers: You do not
know whether they are expanding or not? KPMG have said they plan
to treble their consulting revenues to £600 million.
PricewaterhouseCoopers are planning to take on a further 300 consultants
in the next 12 months. This is a matter of public record.
Did you not know that?
Mr Paterson Brown: I think there
is an important issue here with regard to the fragile state of
the economy at the present moment. There are a lot of companies
turning to, if you like, advisers. Therefore, in a lot of companies
the auditors are one source of advice that is close to the company
and able to provide support, and I think in the current situation,
if you like, where we do not want global economies to go back
into recession (or indeed, worse than that) it is important advisory
services are there, and I think they will tick up in the short
term. I think the issue is that the controls and balances are
there to make sure that the balance of these is correct going
Q18 Sir Peter Viggers: Your organisation,
Mr Paterson Brown, had a working group studying this general issue
of audit and non-audit. Who sat on that working group?
Mr Paterson Brown: There were
14 of us. We had a balance of academics, institutional investors
and corporates, and the big four were represented as well, but
there were 14 of us and they were in the minority.
Q19 Sir Peter Viggers: Your recommendations
were to audit committees. Would it not have been more effective
to make recommendations to the auditing firms themselves?
Mr Paterson Brown: To the extent
that we went through the process I think that, if you like, the
issue for us, having done a robust debate which included, I may
say, all of the members of the group, was that we had an issue
with regard to the difference between perception and reality.
The perception out there with regard to certain factions is that,
if you like, there is a problem with regard to non-audit services.
We believe the reality is that the safeguards are in place and
that actually what we need is greater transparency, disclosure
of policies and procedures, improved analysis of audit fees and
non-audit fees and enhanced corporate governance. To that extent,
we think some of this, if you like, comes back to the companies
and the audit committees, and we believe that those findings will
be supported when the work comes out in a couple of weeks' time.
Q20 Sir Peter Viggers: Mr Haddrill,
your organisation put out a press release in November warning
audit firms about providing internal and external audits. Why
do you think that audit firms need to be warned about taking on
internal and external audit when you do not need to warn them
about taking on consultancy work? Is there not a similar risk
Mr Haddrill: The concern is that
the audit firm is not taking on work which could compromise their
ability to do a proper audit. I would say the issue is whether
they are taking on consultancy work which is particularly relevant
to the audit and gets them into the position of auditing their
own work. That is what we are trying to avoid. We have made clear
in our ethical standards that is something that auditors need
to avoid and need to think very carefully about, and in the inspection
work that is something we pay a lot of attention to.
Q21 Sir Peter Viggers: It seems that
the profession is accepting the need for greater transparency,
so can I ask each of you whether you would support greater transparency
of auditor remuneration in the company's annual report, showing
more details of the non-audit services provided to the company,
and more disclosures from auditors themselves giving information
as to their various undertakings. Would you support greater transparency?
Mr Hodgkinson: Yes, and I think,
going back to your figures of 300% to something like 70%, that
applied to individual companies, the ratio between the non-audit
fees and audit fees. What has happened is there has been a real
transformation in practice which has not been communicated appropriately.
We have had a lot of reform and change in substance, but actuallyand
it was evidenced by the reaction of this Committee and othersthe
perception has not changed. It is important that there be transparency.
There are absurdities in the present disclosure, like most people
would regard work on an interim set of accounts by auditors as
audit work but it gets classified as non-audit work. There is
a host of anomalies which mean that, quite rightly, people look
at what has been disclosed and say, "Has a lot changed?"
If I could just make a comment about what you said earlier about
the growth in the firms. There is no plan that I know of for firms
to increase, as a matter of policy or strategy, the ratio of non-audit
fees to audit fees. We are talking about the total business and
we will be talking about business done for non-audit clients.
That is just to clarify the comparison made between the press
announcements and the issue of non-audit fees on audits.
Q22 Sir Peter Viggers: Disclosure,
Dr Priddy: Yes, I totally agree
Mr Haddrill: Yes, I think disclosure
is very important. Just to pick up a point that was made before,
it is both disclosure by the auditor and disclosure by the audit
committee of what its policy is. I think the two have to go together.
Mr Paterson Brown: It goes to
the very core of the working group report.
Q23 John Thurso: Can we go on to
the question of fair value mark-to-market accounting and pro-cyclicality?
Perhaps we will start with you, Mr Hodgkinson. Do you think
that fair value accounting will always result in an element of
pro-cyclicality? Is it inevitable?
Mr Hodgkinson: This question of
pro-cyclicality, as you know, has been subject to a lot of attention,
and it is fair to say that the professional standard-setters before
this crisis probably had not given it enough attention. There
is a very good speech, which I am sure you are aware of, that
Lord Turner gave at the ICAEW a couple of weeks ago setting out
a very clear analysis of how the model that was used for providing
against loans and the model that was used for marking certain
instruments to market could contribute to pro-cyclicality. That
is a good analysis. I think what we need to look at, though, and
be careful about in our research, is whether that actually happened
in practice, because there are within individual entities ways
that some of them do not respond to fair mark-to-market accounting
in ways which lead them to get over-exuberant, but there are controls
that are in place as to how regulatory capital is calculated and
controls in UK company law as to how dividends are based on accounts.
There are safeguards in there. Yes, there is a tendency towards
pro-cyclicality, but I think we should be looking at the safeguards
and the alternatives to mitigate those effects rather than say
that mark-to-market accounting is a bad thing. As Lord Turner
acknowledged in his speech. There are reasons why it is very good.
Q24 John Thurso: It has the opposite
ill-effects of historical cost, basically.
Mr Hodgkinson: Yes.
Q25 John Thurso: In one it lets management
get away with being too optimistic, the other lets the market
get away with being too optimistic.
Mr Hodgkinson: There is also an
issue that if you allow people to hold assets at way below their
market price then you give them discretion to manage their earnings,
because all they need to do is release a flow of under-valued
assets and managed earnings, which isn't what investors would
Q26 John Thurso: So we know the danger
but, on balance, we think it is the least of the two. The FSA
proposed that, basically, we go to two lines for loan loss provision,
so you have the one which is historical, which says that is what
has happened, and the other which is an estimate and basically
tries to aim off on the market's optimism, as it were. Do you
think this will be (a) more informative for investors and (b)
help mitigate the risk?
Mr Hodgkinson: It is a suggestion
which has been around for some time. We are quite sceptical about
it because we think that presenting two numbers risks confusing
people and, heaven knows, we are concerned enough about the complexity
of financial reporting without having the complexity that that
introduces. I think the approach which the IASB has been taking,
which is trying to find a way in the published accounts that are
useful to investors, of introducing an economic approach to provisioning,
rather than the "incurred loss" approach, is trying
to tread a middle path. It is always possible for regulators to
have their own overrides and rules which modify the reported numbers,
so it would be really hard trying to find a single number in the
accounts, otherwise people will just say: "Which one are
we supposed to look at?"
Q27 John Thurso: Anybody else?
Mr Haddrill: We have to watch
within the incurred loss approach that we do not ask it to do
more than it is capable of doing, because the incurred loss can
still only be recognised at a particular time by banks as their
market changes, so we could still have volatility even with an
incurred loss approach. The point Robert makes very well is that
there is only so much accounting can do here, and there is much
that regulators may well have to do on top of the accounting provisions
in terms of asking the banks to reserve against losses that are
arising. We should certainly not devise accounting rules that
apply to the whole of the economy just to sort out the problems
of the banks. If the regulators are asking for more capital to
be put aside because they perceive particular risks applying to
banking or particular banks, the disclosure issue is, how does
that get fed through into the accounts? We need to see disclosure
of the consequences of the regulator's decisions.
Q28 John Thurso: At the heart of
this is the whole thing Warren Buffett always used to come up
with, which is that in the short-term the market is a voting machine
but in the long-term it is a weighing machine. What we are seeing
is that the pure voting has got very little relevance to actual
underlying value; it is whatever people are prepared to pay in
the market, and if it goes across a year and everybody gets a
big bonus they pump that back in, whereas what we need is the
weighing machine approach somehow to be reflected. Can accounts
ever do that or is that always going to be a matter of judgment
Mr Haddrill: I think accounts
are always, to some extent, going to be a record of what happened
the year before, but there is also the report at the front end,
the directors' statements, and what you are getting with more
fair value is that there is more judgment in the accounts and
more reliance upon understanding of the business strategy in order
to interpret the members. There needs to be more understanding
of the business strategy. We therefore feel that the quality of
the front end of the report and accounts is very important and
maybe the auditors should have a bigger role in ensuring what
the management is saying about where it is going than they have
done so far.
Mr Hodgkinson: Could I add another
perspective on this? Stephen is quite right to say that the context
in which you report the accounting numbers is important, but I
think it is also important to recognise that the accounting profession
as a whole has a range of users of information; they need to be
given information which is fit for purpose. We have tended to
have a debate over the past year about there being only one set
of numbers, and there is a fight for who kind of controls the
steering wheel: is it for investors or is it for regulators? I
think it is more constructive to say that you have, as far as
possible, a core set of numbers and then you make it very clear
to those involved in remuneration decisions or distribution decisions
or regulatory decisions the limitations of the information for
their purpose. I think we need to get away from this idea that
if there is more than one number then somehow we have let people
down or it is duplicitousactually, people have different
purposesand I think acknowledging those differences, rather
than just saying: "The numbers are for the investors, everyone
else forget about it", is not helpful.
Q29 John Thurso: We are tight for
time, so can we go on to the next issue? Stephen Haddrill, perhaps
I can ask this of you: have you had any feedback on your revised
guidance on the going concern issue?
Mr Haddrill: The feedback has
been positive and seems to be being adopted effectively, so we
feel that is satisfactory.
Q30 John Thurso: Can I, just for
the form, ask the rest of you if you have any feedback to give
Mr Hodgkinson: I think that everyone
concerned thinks it has been a big success, and I think it is
a big success in an important way because it shows that the accounting
firms, the accounting profession and the regulator all realise
that they were potentially brewing a systemic problem here because
individuals reporting on individual banks and individual entities
could have created a systemic problem because of the going concern
regime. I think identifying that everybody needed to understand
what the reporting meant and also realise the importance of banks
helping businesses clarify their facilities and everyone helping
people to think through their business plans helped to avoid a
systemic problem. It is easy to focus on systemic problems that
have happened, but we have not had a systemic problem of mass
qualification of accounts or modifications leading to a collapse
Q31 John Thurso: The core point,
really, is what we are seeking is to get away from that cosy relationship
where the chairman of the audit committee and the senior partner
of the audit sit down together andif not managemake
sure that everything is all right, to something where the auditor
really feels quite free and has a clear responsibility to say
and enter things in different degrees of tone without it bringing
the whole edifice collapsing down.
Mr Paterson Brown: To the extent
that I am currently a finance director and was previously a finance
director in the City of London, with regard to a listed 250 company,
the cosy relationship between the audit partner and the chairman,
I think, is a perception rather than reality.
Q32 John Thurso: I have sat on a
number of audit committees and watched it happen.
Mr Paterson Brown: It does not
happen in the areas I have been involved in. What I would say
is that by flagging the issue at an early stage and by getting
everyone focused on it, if you like, there were more than actions
taken with regards to discussions; a lot of money was raised by
companies in the marketplace with regards to rights issues, there
was a lot of discussion with regard to banks, with regard to banking,
a lot of action was taken with regard to the going concern, and
I think by getting issues out on the table early and getting people
sensibly discussing them we, if you like, headed off a lot of
problems that may have emerged and, thankfully, did not.
Q33 Chairman: Stephen Haddrill, you
talked about the Audit Inspection Unit as a way of keeping tabs
on the auditor. Is that correct?
Mr Haddrill: That is their role.
Q34 Chairman: In its 2007 report
on PwC the Audit Inspection Unit found that PwC audit staff were
selling non-audit services to audit clients. As you know, that
is not allowed. A year later they were still doing it. So do audit
firms have any regard for the AIU's findings?
Mr Haddrill: We believe that they
do. Being only two months into the job I am a bit reluctant to
comment on two years ago.
Q35 Chairman: But the case I have
put to you
Mr Haddrill: I understand that.
We pursue the questions that are raised in each inspection report
the following year to make sure that there is follow-up and that
we are satisfied with that and that we continue to do that.
Q36 Chairman: It did not happen in
Mr Hodgkinson: It did happen in
the sense that we have continued to pursue it.
Q37 Chairman: They are still doing
it. What is the use of the AIU if they are still doing it?
Mr Haddrill: Because we have highlighted
it; we have raised it.
Q38 Chairman: There is no use highlighting
it if there is no behavioural change.
Mr Haddrill: I think there has
been behavioural change in this case. I will ask the firm to respond
to that, but what we have put in the public domain is an anxiety
and I think that is of considerable interest.
Q39 Chairman: Do you have any sanctions?
Mr Haddrill: We have sanctions
if there is misconduct, and I think one of the things that we
are increasingly concerned about is that we have got a sort of
nuclear sanction in relation to the firm but we do not have an
intermediate set of proportionate sanctions.
Q40 Chairman: You said earlier, and
I just make the point, that there is a difference between perception
and practice. The perception is that this is going on, but in
this case the practice is that it is going on as well. If the
AIU does not have decent sanctions to do anything about it, it
just seems as if things will be business as usual.
Mr Haddrill: I think I am agreeing
with you that there should be a more flexible set of sanctions
rather than removing an auditor's licence to practice.
Q41 Nick Ainger: Mr Hodgkinson, in
our report on the banking crisis and corporate governance, you
came forward with five suggestions about strengthening the links
between auditors and the FSA. We have seen the written response
from the FSA. How is it actually working out in practice?
Mr Hodgkinson: First of all, thank
you for referencing those suggestions. I think that we need to
disaggregate them a little bit because there are different powers
the FSA has unilaterally to change things, because some are in
company law and some are about international agreements. Just
to give some examples of things changing, I think it is worth
saying that the FSA now supports supervisors with an accounting
review team, and that there is an expectation that there are annual
meetings, at least, on institutions, and they have doubled or
tripled the use of section 166 reports, and that is quite a change
in practice. These things take time, but I think they are indicating
a change in the right direction. Also, we established towards
the end of last year an Audit of Banks working party, which we
expect to report in April this year, which will have had the input
we said was necessary when we made our submission to the committee
of a wider group of stakeholders as to whether this potential
expansion of the role was seen as being helpful That is something
which is ongoing.
Q42 Nick Ainger: The annual meeting
which takes place between the auditors and the FSA, where is that
in relation to the audit itself? How close is it? Is it immediately
before, is it immediately after or is it during? When does it
Mr Hodgkinson: I think it is fair
to say that I am not a bank auditor and privy to those, so it
is difficult for me to comment on that.
Q43 Nick Ainger: Does anybody else
know when these meetings take place? Perhaps you can let us know
on that because, obviously, the concern would be that maybe if
something is shown up and the meeting does not take place for
six months, nine months or whatever, then the FSA is not made
aware of this.
Mr Hodgkinson: I am sorry; I think
there is a well-established regulatory framework so that where
there are things which need to be brought to the attention of
the regulator then there are professional obligations to do that.
It is also important to say that auditing these businesses is
a round-the-year activity, not only in relation to quarterly statements
from the US but half-year announcements, and the fact that you
cannot complete the audit in a few weeks after the year-end. I
think we can give an assurance, even without having detailed knowledge
of the timing, that those sorts of concerns that you raise should
not worry the Committee too much.
Q44 Nick Ainger: Can I ask the rest
of the panel then have you seen a change in the relationship between
auditors and the FSA since our report?
Mr Haddrill: I think what we have
seen is the FSA paying more attention to the auditors' knowledge
of what they are saying and to that information set alongside
the direct supervisory reports that the FSA gets itself.
Q45 Nick Ainger: So there has been
an improvement in those relationships?
Mr Haddrill: I think the FSA is
certainly paying more attention to that.
Q46 Nick Ainger: If another bank
were to fail or get into serious difficulty, would it be absolutely
clear now who was responsible for telling whom about what the
problems were? That was part of the problem with Northern Rock.
Mr Hodgkinson: It is quite a rich
question which makes some assumptions about what happened in Northern
Rock. What is important is to recognise that there is a greater
acknowledgement of how two different functions, one a regulatory
function and one an audit function, which are distinct but are
both based on having an understanding of risk, can benefit from
dialogue. I think if we look at the collapses that we saw, I do
not think it was a conclusion of the committee that they were
caused by the auditors, nor was it a crucial fact in those failures
that there was not communication between auditors and the FSA.
I think what we were trying to do was talk about, in our suggestions,
ways in which there could be extra safeguards and greater confidence
so that when people asked, "What liaison is there between
FSA and auditors and how do they mutually benefit each other?"
there was a better answer. I think there will be a better answer
Mr Paterson Brown: I think it
is not just the FSA and the auditors; it is the FSA, the companies
and everything else. Working currently in a regulated business,
the level of communication is hugely different now with the FSA
from what it was 18 months, two years ago.
Q47 Chairman: We asked a question
about the big four going to the big three, but what steps have
been taken to increase competition?
Mr Haddrill: There was the market
report that was produced between the FRC and the Department some
three years ago. There were 15 recommendations there, they have
been implemented and we will be reporting on their effectiveness
in the coming year.
Q48 Chairman: So four years later
you are reporting on their effectiveness. The APB ethical standard
four prohibits a firm from accepting a client if the fees are
more than 10% of the audit firm total annual fees. Does this unhelpfully
restrict competition in the accounting world?
Mr Haddrill: I do not think it
restricts competition. I think if there is one area where we would
certainly like to see competition grow it is in relation to the
smaller end of the listed market. If you look at the AIM market
you see auditors abounding other than just the big four. If you
look at the 350 around the FTSE you do not see that. Actually,
I think there is not just a challenge to regulators to encourage
companies there to look outside the big four, I also think there
is a challenge to investors to encourage it as well.
Mr Hodgkinson: Could I just make
an observation: the point you make is a good one which shows that
there are conflicting regulatory objectives and public policy
objectives because the reason that 10% rule is there is for independence,
and the appearance of independence. Yes, you are right that if
an audit firm which does not have a very major client is looking
to enter that market you could create problems, so there are conflicting
public policy objectives.
Q49 Chairman: Can we take it that
you disagree with the Governor of the Bank of England then when
he says that to rely on Chinese walls is a triumph of hope over
Mr Haddrill: He said that in this
Q50 Chairman: The institutions. What
about you, Dr Priddy? We have not got you here for nothing!
Mr Haddrill: I think that one
of the things that we are consulting on in relation to this whole
question of non-audit services, and which we will reach a conclusion
on, is whether there is sufficient clarity in the ethical standards
about what non-audit work can be accepted and whether there are
tight enough lines around the quantum of fees from one set of
activity versus another. To that extent I would agree with the
Governor that there is always a question to be looked at as to
whether you actually need harder black letter rules.
Mr Hodgkinson: I think the experience
of firmsand it is supported by the inspection regimeis
actually the accounting firms do have a good record in relation
to Chinese walls, and the system, again, has other objectives,
because in terms of making available to corporates a variety of
services in a market which is to the proportionate degree regulated
and director choices are limited, if you are going to do that
in as limited a way as possible that supports economic prosperity
then you have got to have some trust in safeguards. It would be
very easy to have no trust in any safeguards but just constrain
economic activity in a way which would not be helpful; it is a
Q51 Chairman: You deal with ethical
issues as well, Dr Priddy, do you not?
Dr Priddy: Yes.
Q52 Chairman: Chinese walls and the
Dr Priddy: I think the point that
I would make is that at the heart of this is a commercial decision
between the audit firm, the board of directors and shareholders,
and all those key players have something to play in that commercial
decision. I think when you look at the way services are procured,
audit committees will look very carefully at the best person to
provide the services, and my experience is that Chinese walls
do work very well.
Q53 Chairman: There have been recent
instances where a firm has been advised to go into administration
and those advisers have overseen the administration and made large
amounts of money. As the Chairman of Woolworths said, is this
not a clear case of a conflict of interest?
Mr Paterson Brown: I think in
business life one comes across conflicts of interest all the time.
One needs to clear them and one needs to make sure the appropriate
safeguards are in place, and one moves on. To think that you can
go through your business life without coming across a conflict
of interest is impossible at a senior level; what you need to
make sure is
Q54 Chairman: Hold on, hold on. If
you are going to advise an entity to go into administration and
then you are going to oversee that administration, maybe your
initial advice could be a little bit wonky. If there is a conflict
of interest there why do you not separate it? Those giving the
advice and those undertaking it at a later date, surely that is
a real clear conflict of interest there. It is not good enough
just to say: "There are conflicts of interest in life every
day; let's forget them; let's get on with business".
Mr Paterson Brown: No, the comment
was that the advice with regard to going into administration can
be given with the safeguards in place. Having gone into administration
that work can be done, if you like, having exercised the safeguards
with regard to the original decision. I do not see that the two
need to be completely linked.
Q55 Jim Cousins: Following the Chairman's
issue there, is this whole area of abusive pre-pack insolvencies
and the relationship with advice from auditors that goes into
this something you are looking at?
Mr Haddrill: It is not something
I have looked at in my current job; I certainly looked at it in
my previous one, at the ABI, where we were concerned about whether
a pre-pack was, effectively, in the interests of the owners of
Q56 Jim Cousins: Pre-packs are an
absolute outrage and they are spreading like wildfire. Clearly,
people are being advised to set them up.
Mr Haddrill: I think pre-packs
are (I do not know whether I would use the word "outrage",
but let's use it) an outrage where they are set up for a purpose
which is not in the interests of the people who have a relationship
with a company as investors and so on. If, however, it can be
set up in a way where there is proper disclosure, the business
remains in being as a result, and people remain in employment,
and everybody understands what is going on, then I think it is
potentially a good thing.
Q57 Mr Love: Insolvency practitioners
have always argued that if you look at the evidence pre-packs
are good for the creditors, especially the smaller creditors.
Is there any validity to that argument?
Mr Haddrill: You are taking me
into territory where I think it is probably best that I do not
answer from an FRC perspective because that is not part of our
responsibility now. I was looking at it in relation to having
experience in the insurance industry before, in a previous job.
Mr Hodgkinson: If it would helpand
it is not something on which I am deeply knowledgeableto
provide the Committee with further information we would be happy
to do that.
Q58 Chairman: There does just seem
to be a little degree of complacency here.
Mr Hodgkinson: It is probably
just a degree of unfamiliarity with the territory.
Q59 Chairman: We have been told that
there has been a real transformation in practice. Can each of
you set out one of the most significant things achieved since
the credit crunch? Why do we not start with Dr Priddy, then he
can get full marks for being here today.
Dr Priddy: Thank you very much.
I think one of the things that has come through for me as being
a really good advance is the role of the audit committee and the
duties of the audit committee within the new corporate governance
codes that have come through. I think this is a really good, positive
step forward, it does highlight much more clearly the role of
the audit committee, and I think that is very good. I think, also,
the guidance that has come through on going concern is very important,
and that has also been a great progress as a result of this crisis.
Those are two things I would flag.
Mr Haddrill: I would mention two
things. I think within governance the much clearer focus on risk,
the rise of the risk committee within the businesses and the appointment
of people to make sure that boards really understand risk. Also,
I think, from our perspective in relation to audit on an international
level, the growing liaison between auditor regulators on an international
Mr Paterson Brown: Obviously I
came in to chair this working group and, therefore, have not been
involved as far back as other people. I think what I would say
is that, if you like, post-2002 we have seen a change in the world
with regard to governance and with regard to regulation, et cetera,
and I think we need to keep moving down the transparency, disclosure
and governance route. I do not think we have ended the journey.
Mr Hodgkinson: I am a little bit
hampered being the last but, maybe, rather than talking about
specifics, the important thing is that this, as the Committee
summarised, was not primarily an audit crisis, but the challenges,
for example, that you laid down in your nine recommendations have
caused us a lot of reflection: the value of audit; risk management
responsibilities; liaison with regulators and auditors, and going
concern. These are important issues which I think we have been
forced to reflect on; in particular the question that Mr Thurso
raised about thinking about pro-cyclicality and the impact on
the accounting profession not just on a micro level relating to
individual entities but thinking about the consequences. I think
that consciousness is something that will lead us to do a lot
of work over the next few years.
Q60 Mr Love: The word "rotation"
has not come up as yet. I wondered whether you felt (I am asking
you collectively) that rotation has a larger role to play than
it currently has done up to the present time.
Mr Haddrill: Certainly the decision
has been taken not to relax on rotation and there was pressure
Q61 Mr Love: Should we strengthen
Mr Haddrill: I do not think we
need to strengthen it because we looked at both sides of it when
we reviewed it, but I certainly think that one of the things that
has come out of the work over the last couple of years is we should
not be relaxing it.
Q62 Mr Love: Does anybody have a
Mr Hodgkinson: Are we talking
about rotation of auditors?
Q63 Mr Love: Yes, rotation of auditors.
Mr Hodgkinson: I think that as
an issue for regulatory change it is not considered a live one.
What I would emphasise is that rather than looking at these ways
of constraining activity to build confidence we have to have the
audit firms and the profession building their own confidence.
We have not mentioned the publication by FRC and the ICAEW two
weeks ago of an audit firm governance code. It is all about the
profession taking its own responsibility to build confidence rather
than waiting for another regulatory constraint or limitation.
I think it will be seen more actively ...
Q64 Chairman: At the beginning I
said you had 18 working papers. I would like to see some
coherence in that and that it is not just 18 disparate pieces
of work. If I take you back to the genesis of our concerns it
was where we saw that within days of getting a clean bill of health
from the auditors many banks simply collapsed. We said the fact
that the audit process failed to highlight developing problems
in the banking sector did cause us to question exactly how useful
audit currently is, and I think that is still a live question
for us. I think there is a problem in terms of perception and
reality, and you have quite a bit of work to do there. I would
hope that the successor Committee to this in the next Parliament
looks at this and we keep engaging on that so that we do have
more clarity and transparency in the process and have a real understanding
of exactly what an audit is about and how we ensure that we have
real time information that is shared so that if the business models
are skewed or wonky something can be done about it.
Dr Priddy: Can I just say something
from an international perspective, because Stephen did refer to
that? We have been doing some round tables across different territories
and I was in the Ukraine the week before last. Around the table
we had people from the World Bank, people from the audit profession,
people from the regulators and people from business. One of the
points that was made very clearly there is that the way the UK
works in terms of its audit framework, in terms of Companies House
and having transparency of accounts, and so on, is something that
other countries in the world look to with great envy.
Q65 Chairman: Maybe with regard to
the Ukraine the UK does do it betterI do not doubt thatbut
I think we need our own standards and the standards need to be
raised, Dr Priddy. We want, as a Committee, to engage with you
in that exercise.
Mr Hodgkinson: Can I also say
that we did not have time to talk about the activities of the
Audit Quality Forum, which was set up five years ago to raise
these issues amongst all the stakeholders in audit. Although we
have not got time to go through the work that has been done since
last year on this, there are important initiatives which I think
respond to your challenge, and, again, we would be quite happy
to update you.
Q66 Chairman: It is still a work
Mr Hodgkinson: Work in progress.
Chairman: Thank you very much.