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A merry dance

Mario Christodoulou reflects on what regulators are asking auditors to do for business and how they are responding - or sidestepping

The ongoing government inquiry into audit might be headed by Lord MacGregor, but there is no doubt it has been Lord Lawson’s show thus far. Time has done little to temper the rage of Margaret Thatcher’s former chancellor.

Whether he is taking aim at auditors, who he has described as “one of the dogs that didn’t bark”, or regulators who “were asleep on the job”, his comments have come to sum up the bewilderment and frustration felt by the Lords investigating why auditors did not sound the alarm about what they knew that is now viewed as a contributing factor in the lead-up to the crisis.

The House of Lords’ inquiry may, at first glance, be about market concentration, but its lines of questioning have taken it down a number of side alleys, including accounting standards, banking law and the breakup of the Audit Commission, now the subject of its own investigation.

It is a scattergun approach that has seen the Lords dust off old debates surrounding conflicts of interest and fair value accounting, while also asking penetrating questions about auditor scepticism and regulator engagement.

The Lords have already made clear that it won’t accept “tactical risk spreading” or attempts to dilute the blame.

“I still don’t understand why auditors looking at banks’ balance sheets, seeing huge levels of gearing, seeing all kinds of complex instruments, did not feel it necessary to at least ring a little bell. I find it difficult to understand, given what auditors are meant to do, that looking at these expanding balance sheets and the makings of a crisis did not sound the alarm,” said Lord Forsyth.

The audit industry’s long-standing defence, translated broadly as “it was not our fault, that was never our job” has weakened since 2007. In the intervening years the Big Four, sensing the winds of change, have sought to embrace reform.

In October, Ian Powell, senior partner at PricewaterhouseCoopers (PwC), said: “The audit profession should examine its role and responsibilities, and how they should be changed.” PwC is the first firm to have taken action, embarking on the seemingly noble but risky route of asking its major clients to publish more internal information on risk management. But it is unlikely this initiative will win over the Lords, intent on forcing the accountants to accept some share of the responsibility for the past few years’ troubles.

Some of the more extreme measures, however, may come with their own set of economic consequences. The idea of mandatory auditor rotation has been raised, but in practice it may only increase the overall cost of audit, forcing companies to continually tender and then re-educate new auditors on their business practices. And whether this will solve the competition issue is also far from uncertain.

Simon Michaels, senior partner at the BDO, viewed as a mid-tier but nevertheless the UK’s sixth-largest accounting firm, says it may “compound the concentration issue”.

Another emerging theme has been auditors’ relationships with regulators, specifically the Financial Services Authority (FSA). The past 12 months have seen the FSA steadily applying pressure on the Big Four to speak to regulators about worrisome issues discovered in the course of their audits, to raise the alarm before they can affect the market.

But auditors, keen to maintain strong ties with their paymasters, have resisted attempts to rat out clients to regulators. Instead, they have removed themselves from that conversation by saying that their client companies should go directly to regulators when urged.

Perhaps unsurprisingly, that tactic has so far failed to satisfy the FSA, which says it wants a wider range of powers over auditors including public censure, financial penalties, or the power to disqualify individual partners. Senior auditors are already feeling the heat and are concerned the FSA may eventually damage their hard-fought relationships with audit clients.

Mario Christodoulou is chief reporter for Accountancy Age and a regular commentator on the audit industry

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