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Audit regulators need regulating too

The House of Lords investigation into audit shows that regulators need as much regulating as auditors

The whole point of corporate governance is that someone does it. It can exist as a system, or in a manual, in your head, or even laid down as law. But for it to have the desired effect and produce useful benefits it has to be pursued and achieved. Even when, as a recent example has shown, a law exists to reinforce behaviour, it can easily fall into disuse almost without anyone noticing.

What is required to keep the whole thing up to scratch is some outside body or investigative tribunal that keeps asking difficult questions. The problem is that in corporate life there is not nearly enough of this going on. Regulators may be set up to ensure that everyone is kept on their toes. But they fall all too easily into a pattern of self-aggrandisement and empire-building, becoming internally focused and taking their eye off the ball as a result.

There was a very fine example of how to wake up regulators recently at one of the hearings into the world of audit being carried out by the House of Lords Economic Affairs Committee. These hearings have been deceptively amiable. Occasionally, they miss the point because they do not have enough of a grasp of the audit world. But often, where things have not been too technical, they have really startled the complacent.

The November afternoon that showed this best was when the regulators were appearing as witnesses, in particular the Financial Reporting Council (FRC) and the Financial Services Authority (FSA). Half an hour into proceedings, it was almost possible to discern the adrenaline running through the body of Lord Lawson, one-time chancellor of the exchequer and the architect of the 1987 Banking Act, which laid down confidential communication systems between banks, bank auditors and regulators.

It was his turn to ask a question. He stared across at those present from the FRC, but particularly at those from the FSA. “To summarise the answers we have heard so far,” he started, “it is that you were asleep on the job, and to the extent that you were half awake, your eye was not on the ball.” The assembled regulators looked startled. They probably had an idea of what was going to come next. Lawson wanted to know why they had ignored the Banking Act that he had introduced.

It was a classic example of a chunk of hugely useful governance that had fallen into disuse because the regulators let it.

Lawson quoted from the statement the FSA made to the Committee at the outset of the hearings about meetings between regulators and bank auditors, making it sound as though, frankly, they were closing the stable door after an entire cavalry regiment of horses had bolted.

“Well,” he said. “That’s pretty weasel words. So I’d like to get to the facts. Can you please tell me, insofar as Northern Rock, Halifax Bank of Scotland, Royal Bank of Scotland and Bradford and Bingley, precisely how many of these meetings took place in 2006, in 2007 and in 2008?” He sat back and waited.

“I can’t give you those statistics now,” said the man from the FSA, “but I would be very happy to put them in writing to you.” At this point one person sitting in the public seats who, as the Financial Times would say, is familiar with the matter said in somewhat less than a sotto voce way: “It’s going to be hard to get it very much above zero.”

It was wonderful to see proper governance being pursued and someone properly put on the spot. And it continued as the afternoon light darkened into dusk. Towards the end of the hearing, amid another discussion about the auditors of Northern Rock, Lord Lawson fired a swift off-the-cuff question.

“Who were the auditors of Northern Rock?” he asked Stephen Hadrill, the chief executive of the FRC. There was a silence. “I can’t recall, I am afraid,” he then replied. Keeping regulators on their toes should be the first law of corporate governance.

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