How many audit failures will it take for the FRC to admit that the failures are systemic?

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Accountancy Age has reported:

The Financial Reporting Council (FRC) has fined EY £1.8m over misconduct in relation to the audit of the financial statements of Tech Data Limited for financial year ending 31 January 2012.

Julian Gray, senior statutory auditor and audit engagement partner has also been fined £59,000 after he and the firm admitted that their conduct “fell significantly short” of the expected standards.

EY and Gray also admitted that they “failed to act in accordance with the ICAEW’s Fundamental Principle of Professional Competence and Due Care”, according to a statement from the FRC.

The audit misconduct related to a failure to obtain reasonable assurance that the financial statements were free from material misstatement, failure to obtain sufficient appropriate audit evidence and failure to exercise sufficient professional scepticism.

EY was originally fined £2.75m, and Gray £90,000 before having the fines reduced for mitigating factors.

I make no apology for quoting at length, largely because this feels like a reproduced press release in any event, and because to do so is in the public interest.

The reason for doing so is that this is yet another case where it is obvious that a Big Four audit firm has failed. And these failures are persistent: so persistent, in fact, that the utterly incompetent FRC should no longer ignore them, despite the fact that it is, itself, hopelessly captured by the Big Four firms.

As The Times noted behind its paywall this week:

It’s the watchdog at the heart of capitalism. It has the power to investigate, rebuke, fine and ban accountants for life.

It ought to have the audit profession in its thrall. It ought to be playing a potent deterrent effect in keeping auditors straight and prudent and so preventing future financial scandals and frauds.

Yet, according to its critics, the Financial Reporting Council, far from baring its teeth, is much more likely to shut its eyes to questionable practices and roll over to have its tummy tickled.

In June it cleared PWC over the Tesco accounting scandal. The supermarket group lost £326 million over the affair, but its auditor was found to have done nothing wrong.

In August it cleared KPMG over its audit of HBOS during the financial crisis. KPMG had given the bank a clean bill of health in February 2008, only eight months before it collapsed and had to be rescued with £20 billion of taxpayers’ cash.

And last month it cleared PWC over its checks on Barclays. The lender had already been fined £38 million for improperly mixing up client assets with its own money, yet PWC, which repeatedly had signed off on official reports saying that Barclays was complying with client asset rules, was declared innocent.

Some investors say that the exonerations are part of a pattern that goes back years. The Financial Reporting Council, they argue, has been “captured” by the profession it is supposed to regulate. Its people, its governance, its funding arrangements, its legal status and its processes and culture are all said to conspire to prevent it properly policing the nation’s accountants.

 

And as they added:

The FRC is particularly well-stocked with former bank auditors in powerful positions. Brendan Nelson is a former head of banking audit for KPMG, ultimately responsible for the audits of not only HBOS but also Bradford & Bingley, which similarly failed, and the Co-operative Bank, which came very close. He now sits on the FRC’s financial reporting review panel, the powerful committee to which investors are directed to make complaints about company reporting.

His verdict on bank auditors? They “discharged their responsibilities diligently in the context of what the statutory audit responsibility represents”, he has said.

Another former bank auditor now advising the FRC is John Hitchens, former head of audit at PWC. As such, he was responsible for the audit of Northern Rock, as well as of Lloyds TSB and Barclays. PWC was criticised by the House of Lords economic affairs committee, which said that it was “astonished that PWC appeared not to recognise an amber light that flashed so brightly”. He is now deputy chairman of the financial reporting review panel. He is also chairman of the banking committee at the Institute of Chartered Accountants of England and Wales.

It isn’t only banking where the arrangements can look too cosy, critics argue. Jimmy Daboo sat on the financial reporting review panel for ten years until 2015. A partner at KPMG, Mr Daboo was responsible for auditing Rolls-Royce. Those audits are now being investigated by the FRC’s conduct committee.

The FRC is no longer fit for purpose. I am at present joining with colleagues in academia and elsewhere to say so.