Risk & Economy » Audit » Insight interview – Smith’s not so scary

Insight interview - Smith's not so scary

While the Higgs report has provoked howls of outrage from the chairmen and chief executives of Britain's leading companies, the Smith report on audit committees looks a good bet to make its way into the Combined Code virtually unscathed.

The country’s leading finance directors seem largely in favour, or unmoved, by the guidance penned by a working party chaired by Sir Robert Smith. In an interview with Financial Director magazine, Smith says that, to date, the biggest concern seems to be the need for a financial expert on the audit committee. “We never mention the word ‘expert’, but we do ask for ‘recent and relevant experience’, which is not too revolutionary to ask for,” he says.

Rather than always looking for an experienced and qualified accountant to join the audit committee, Smith has in mind characters who are independent and tough-minded, and won’t be pushed over. “You need people who can say, ‘This major improvement in profit has come about as a result of an accounting policy that seems kind of racy.’ They don’t necessarily need to be qualified accountants,” he says.

As for the power to seek their own accountancy advice and the right to pen separate sections in the annual report, Smith sees those as, in essence, reserved powers that will only be used in extremis when there has been an irretrievable breakdown of the board. But he does not shy away from the fact that guidance will make a difference to the work of the FD.

From Smith’s perspective, the key element that is changing for the FD is the relationship with the external auditor. If you are an FD who has been accustomed to running the external auditor, then life is going to change. From now on, that’s one of the roles of the Audit Committee. And for Smith there is no doubt over the efficacy of the change. He says: “The external auditor is checking up on the work of the FD. So how can you have the person who you are checking deciding whether you are hired or fired, or how much you are going to get paid?”

For anyone who remains unconvinced that non-execs should have such a role, Smith draws a parallel with Cadbury Schweppes that enshrines the notions of non-executives. Critics of Cadbury Schweppes suggest that non-execs could not be so closely involved in running a company, a view seldom heard these days.

The direct responsibility for the auditor relationship may have gone, but Smith is clear about the importance of the FD. “The non-executive directors need to hold the executive directors to account,” he says. “The FD is the executive in charge of the finances. If his role in the preparation of the accounts is weakened, then we have weakened the whole system and introduced a risk (to the company) that wasn’t there previously. That’s not the case; the FD still has a strong voice.”

It is clear that the Smith working party did discuss in some detail the idea of mandatory rotation of auditors. While worried about the possibility of falling audit quality in the years when one lot of auditors were winding down and the new lot were winding up, it seems the group finally rejected the idea because they wanted the audit committee to discuss the effectiveness of the audit on an annual basis, not just every five years when it was time to change.

Rather than the FD being undermined or threatened by the audit committee, Smith reckons there will be times when he or she could be “very grateful” it exists.

“It will be quite nice to have three people who aren’t beholden to the chief executive,” he explains.

Smith emphasises his belief in the unitary board and says that all directors are jointly responsible.

The audit committee is a sub-committee of that main body. But that sub-committee is expected to work and to think. As Smith puts it, “with clout comes responsibility”. And part of that responsibility is thinking out a company’s attitude to using its auditor for non-audit services.

The US Sarbanes-Oxley Act may outlaw the auditor providing nine particular non-audit services, but Smith wants UK companies to build their own model.

So, while it may not be right for the auditor of a FTSE-100 company to provide internal audit services, a smaller quoted company may be sensible to take a locum from the external auditor if a sudden staffing issue should arise.

While not commenting on the particular criticisms of Higgs, Smith dismisses the charges that this layer of corporate governance is at best a distraction, at worst a burden, at a time when many businesses are struggling. “You’re not telling me that this is going to stop you winning an export order,” he says. “This is not about box-ticking; it’s about the fact that companies should not tell lies to deliver profit.” That’s what happened with Enron as the financial markets stopped believing in the accounts. And when that happens, capital stops flowing.

The Smith report is part of a package of measures to rebuild capital markets’ confidence. And, so far, the predictions made by this magazine (and this writer) (February 2002, Insight, page 12) that FDs may rue Smith seem so far unfounded. At the moment, its biggest problem appears to be that implementation may be delayed, while everyone scratches their heads over Higgs.

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