Examination of Witnesses (Questions 80-93)
MR MICHAEL GROOM, MR PETER WYMAN, MR DAVID BISHOP, MR ROGER ADAMS, MR BRUCE EPSLEY AND MR RICHARD MALLETT
WEDNESDAY 10 APRIL 2002
80. But you could hardly prevent such a situation emerging, could you, if it was the Financial Services Authority that had prepared the code? That is your recommendation to the Committee?
(Mr Mallett) It probably comes back to the point that was raised earlier, that if it is deemed to be by negligence that a non-executive fails their responsibilities, that is potential already; but the code of best practice is to raise the performance, it is not necessarily to monitor and benchmark every single non-executive director performance against that.
81. But do you not recognise that the consistent theme this afternoon is more mandatory requirements, with the possibility of either civil or other kinds of challenge against directors; but when it comes to auditors, oh, my dear me, it is a different story then, is it not, a very different story?
(Mr Wyman) Can I just say to you what I said earlier, that that is not what I have said. I have said, I think, for the OFR, the auditors should have a responsibility, but that responsibility must be that an OFR has been prepared properly; but it cannot be that the judgements that are made by the directors are the right judgements. And that is the problem that you have. We keep coming back to judgements, and the judgements can be made by directors, auditors can form a view as to whether those judgements are reasonable, but they cannot guarantee, with hindsight, that they were the right judgements.
Chairman: On to audits. Michael.
82. I want to begin on audit with the issue of auditors providing non-audit services, and I would like to address these questions to the Institute of Chartered Accountants, because your submission distinguished, very helpfully, between different types of non-audit services, but seemed to me, of all the submissions we have got, easily the most complacent about some of the risks involved, and did not address the situation where the non-audit work itself could be way out of proportion, in terms of the fees earned, to the actual audit fee. Now you put up four safeguards, I think, in your submission, Mr Groom. Firstly, you said that, under your Institute's code, the firm could either resign, if they felt there was a conflict of interest, or refuse to supply the non-audit service. How many examples of that have there been?
(Mr Groom) I cannot answer that, I do not know. We have a very strong framework, which is backed up also with parts of the auditing standard, that requires that test every year; the firms go through that, we monitor it through an independent joint monitoring unit. But I cannot answer that specific question.
83. But if we have got roughly over 2,000 listed companies, how many examples do we have each year of resignation or refusal, under the code?
(Mr Groom) I do not know.
(Mr Wyman) Can I answer that, Mr Fallon. From the perspective of my own firm, a very large amount of non-audit work is not undertaken, because of an unmanageable conflict; and that is what has led us and other of the large audit firms to have concluded that we should sell off our consulting practices. Because, whilst there are many conflicts that you can manage properly, there are so many that you cannot that the competitive benefit of being together has been replaced by a competitive disadvantage.
84. Your second safeguard was that the audit committee must be written to and told that there may be a conflict; but is that very practical where you may have a medium-size or very small listed company, where the bulk of the audit committee, in my own experience, were actually the bulk of the main board anyway, and may be the people commissioning the non-audit work?
(Mr Groom) If the audit committee is properly constituted, it should not comprise the bulk of the main board, it should have non-executive directors, some of them independent. So I think it is a practical approach.
(Mr Wyman) Certainly, my experience of listed companies is, and answering the question, are audit committees working, this is a very thorough process, the good audit committees that I attend have processes in place to satisfy themselves of the independence of the auditor, the appropriateness of asking an auditor to take on any non-audit work, and it is a challenging and effective process.
85. Your third safeguard was that the audit appointment should not be accepted if the client provides an unduly large proportion (10 per cent) of a firm's gross practice income; but how practical is that when the issue really is the proportion of non-audit work against audit work? And, indeed, the issue raised by the Certified Accountants, which is that the audit partner, or the engagement partner, may have a lot of credibility riding himself on the fee income, in his regional office, or his local office, or whatever?
(Mr Wyman) I think you are absolutely right to say the much bigger threat to the independence of the audit is if the audit partner has an undue proportion of his, or her, fees from one client, and credibility and security in the firm, and so on; which is why there is a completely different set of safeguards against that. The safeguard, first of all, and I think the most effective of all the safeguards, is the requirement for there to be an independent audit review partner, who must not meet the client; by definition, it is more like a non-executive, by definition, however large the client, it will be only a small proportion of that particular partner's time, that partner is responsible for overseeing the planning of the audit and all the audit judgements. I think it is a very effective safeguard. There are also safeguards, if an office has too great a proportion of its fees from one client; that independent partner has to come from another part of the firm. So I think there is a good system of checks and balances in place, but
86. I am sorry to interrupt you; these checks and balances are, in fact, in the ethical code you are referring to, are they?
(Mr Wyman) They are either in our ethical code or in the Auditing Practices Board guidelines, and auditing standards; they are very
87. Because they are not referred to in your submission. The fourth safeguard you refer to, which seems to me the one on which more work needs to be done, is simply to disclose properly, income in the accounts, the type of non-audit services involved. Why do you not make more companies do that?
(Mr Wyman) I think you are absolutely right. I have said, to anybody who will listen, "Don't wait for anybody to require that to happen, do it; it's in both the company's and the auditors' interests." And it is quite interesting, in one or two companies that I am involved with, when you give a greater analysis and you see the non-audit work, I think most people would say, "Well, maybe it's strictly non-audit, but it is exactly the sorts of things we'd expect the auditors to be doing." And the proportion of the truly non-audit, the things that anybody could do, very often, and certainly in companies I have looked at, is a very small proportion of the total fees, but the disclosure that is required under Company Law, just statutory audit and other, gives a very different opinion.
88. That, it seems to me, is what needs changing; because it is precisely that element of non-audit service, which may be very small, which a shareholder would expect to be put out to best value anyway, and the auditor themselves might not be the best value person to do it?
(Mr Wyman) I entirely agree. I would like not only there to be this disclosure, by category, of work; we were saying earlier, in relation to audit committees, that there should be greater disclosure, greater visibility, of the process the audit committee goes through. The best audit committees have very clear policies for approving non-audit work, and where anybody could do it, it all has to be approved by an audit committee, but where anybody could do it then there has to be a really positive case proven why it should be the auditors. Now, if you have that policy, that is actually in the directors' report, with the breakdown, then at the AGM any shareholder can question the audit committee as to how, in a particular circumstance, it came to approve that piece of non-audit work.
(Mr Groom) Can I just add to that, sorry, Chairman. You said, in your question there, why do we not do something. In 2000, we had a committee looking at various aspects and we recommended greater disclosure; the European Commission independent recommendations, which are very much based on our own ethical code in this area, requires an analysis. It is actually a Company Law issue, it is not something we can do, we can recommend but we cannot actually put it in force.
(Mr Bishop) I think, also, there is the question, what is likely to compromise independence, and doing non-audit work, in certain circumstances, could compromise it. And there are clients who say, "You do the audit, and that's it," and very big companies have taken that attitude. Other firms have said, "We will not do certain sorts of work for audit clients." Ernst & Young have said that they will not do internal audit work for audit clients, and they have withdrawn from that market.
89. Sorry to interrupt you, Mr Bishop, you cannot really have this both ways; you cannot say, you, as the big five, or the Institute, on the one hand, "We've got an ethical code that carefully polices this area," and, on the other hand, say "We're all trying to get rid of our consultancy arms, because it's all getting too complicated to police"?
(Mr Bishop) I am saying what is actually happening; that is what I was explaining to you.
90. But the ethical code is not working?
(Mr Bishop) The ethical code is working, but, in practice, what you have got is, and what I was describing was, a different attitude and a different actual process that are used by clients. Some say, like Unilever, "You do our audit, and nothing else." Others say, "Yes, but we would want you to tender for everything," and we would say, "No, we will not tender for large systems implementation work, because we think that that might compromise our independence." And that is under our ethical rules. All I was doing was giving you examples of what actually happens, in practice, now.
91. But, at the same time, you are telling me that the big audit firms are actually getting rid of their consulting arms?
(Mr Bishop) Yes, that is true; we have done it, at KPMG.
(Mr Wyman) Can I just say, two things. One is that the reason the Institutes here cannot insist on greater disclosure in companies' accounts is because they are the companies' accounts, and we have no ability to say to a company, "You must put things in your accounts." So that is that issue. The second issue is, it is because our ethical code is working that firms like mine and like KPMG have decided that they have to get rid of their consulting practices, it is because those tests have proven, in so many cases, to say, "You cannot do this work," that the commercial advantage of being part of the same firm has gone. So I think it is working very well.
(Mr Adams) Could I just say that I think that we have talked about various mechanisms, and so on; obviously, the accountancy profession at the moment is reflecting on the creation of the Accounting Foundation, the Review Board, the Independence Standards Board, the Ethics Standards Board, and so on, the new structure which is just coming into being. One of the issues that is being pursued there, quite actively, is looking at issues, perhaps about non-audit services, and the disclosure side, because there are plenty of people on the corporate governance lobby front, the PIRCs, organisations like this, who have been monitoring these types of comparative trends in non-audit services for some time. And one of the issues that we have been discussing with the Review Board is a way of exploring actually what the comparative financial aspects of that are.
Chairman: That prompted me to ask something on the Accountancy Foundation; however, I will resist and hand over to Nigel for the last question.
92. The question is, should there be a delay before someone who has acted as auditor to a company takes up employment with the company?
(Mr Wyman) Again in our ethical code, we have, at the moment, a safeguard approach, which is to say, is there a threat to the independence and objectivity of the auditor if somebody has gone across; and in some cases the answer is yes, and in some cases the answer is no. Personally, I believe that this is one thing which we must look at now. I am not satisfied in my own mind that our current approach is sufficient; and, whilst the Institute has not come to a conclusion, I think it is something we should look at urgently, and are looking at urgently, to see if the point you are making is one we would support.
(Mr Bishop) I think there is a difficulty here. And one of the difficulties is the Human Rights Act, particularly with our staff; if they want to go, how can we stop them. With partners, we have some means of perhaps restricting their availability, but that applies to partners but it does not apply to staff. So the Human Rights Act aspect should be looked at.
93. Can I thank you for your evidence. If you were cut off and you felt that there was something more to say, although I have found out today that accountants can talk, and talk, and talk, but if you really want to write to us again, we will be delighted to receive that. Also, as you know, this is first session of what could be quite a lengthy inquiry, we have quite a number of submissions to come in to us yet, and we will analyse them, and, if it is agreeable with you, we would be quite happy to have you back, possibly, near the end of our inquiry. But there is no truth in the rumour that accountants are boring. Thank you very much.
(Mr Groom) Chairman, on behalf of our team, can I thank you for listening to us; and we will be happy to come back, if necessary. Thank you.
Chairman: Thank you very much.