Further Memorandum submitted by Mrs Feamley,
Mr Brandt and Professor Beattie
Following our attendance at the hearing there
are some key points which my colleagues and I feel need further
clarification. These relate first to our own evidence and the
questions raised by Mr Plaskitt towards the end of the hearing,
and second to the evidence given by Professor Sikka.
1. Mr Plaskitt said that he did not know
whether we had come hoping to re-assure the committee and raised
three questions, which, when presented together, implied that
the UK regulatory framework was very weak.
Could there be market failure in
Does the success of an audit really
come down to the individuals assigned to the client?
Can there really be no guarantees
of auditor independence?
Our objective in submitting evidence and attending
the hearing was to present evidence based on our independent and
objective research. We had no prior intention either to offer
assurance or criticism.
As we pointed out in our written evidence, our
research, which has been published in peer reviewed journals of
international standing, provides strong evidence that the major
reforms of 1991 have improved the quality of financial reporting
and auditing. No framework, however rigorous, can provide guarantees
that nothing will go wrong in the future. Regulators must be both
reactive to events and be pro-active in identifying emerging areas
of risk. A complete loss of confidence leading to a failure in
the UK market is unlikely but not impossible. Corporate collapses
can never be eliminated because risk is inherent in capital markets.
Unless there is clear evidence of failure in the UK framework
we can see little justification for major legislative change at
this stage. However, constant review is needed. Clearly the position
is different in the US as the Enron case has exposed major deficiencies
in their framework for financial reporting, corporate governance
and audit, which will have to be addressed, but despite these
major problems the US markets are still functioning.
The quality and integrity of individuals assigned
to an audit client are key factors in the success of an audit
but by no means the only factors. Audits succeed or fail through
a combination of circumstances, one of which may be the robustness
of the individual audit partner and the quality of the relationship
between the audit partner and the client. We emphasised this issue
because it emerged as a strong influence on good financial reporting
outcomes from our research and has received little attention in
the independence frameworks of any country. It is not a subject
where legislation is appropriate but we believe it should be addressed
in the UK independence framework.
We do not believe any human behaviour can be
guaranteed. What is needed is a framework which is kept constantly
under review so that dysfunctional behaviour is discouraged and
the penalties of compromising independence outweigh the benefits
for those who may be tempted. We are in no doubt that the impact
of the Andersen collapse will be a most powerful reminder for
many years about the dangers of getting it wrong.
We also re-iterate our concern about knee-jerk
reactions post Enron. Regulation is not a confrontational activity.
To be effective regulators need both the respect and the co-operation
of their constituency. Respect and co-operation can be undermined
if regulatory requirements are imposed which the constituency
finds unacceptable or burdensome either for cost or other reasons.
This can lead to unintended consequences and dysfunctional outcomes
as the constituency may seek its own ways to mitigate the impact.
For example the imposition of auditor rotation could lead to anti-competitive
behaviour on the part of audit firms as has been the case in Italy.
2. Professor Sikka referred on numerous
occasions to audit failures in DTI Inspectors' reports. Many of
these reports date back to events which took place in the 1970s
and 1980s, a time when the framework for financial reporting and
auditing was recognised as being much weaker than it is now and,
of course, attitudes and behaviour have moved on since. For example,
money laundering is regarded as a much more serious issue now
than it was 20 years ago. The profession has responded to issues
raised in DTI reports. For example, following the Roadships reports,
auditors of PLCs were disbarred from preparing their clients'
accounting records because of the recognised problems of auditing
their own work. The Inspectors in the Rotaprint case criticised
the firm because the partner had been involved with the client
for many years. Provisions for rotation of audit partners were
We are also concerned that Professor Sikka cited
evidence from DTI Inspectors' Reports as if it were representative
of auditors' behaviour more generally. This is inappropriate as
the findings in DTI Inspectors' reports represent the very worst
of behaviour from all parties involved, otherwise there would
have been no cause for an investigation. Reference was also made
to evidence of low-balling and opinion shopping. This evidence
was not based on systematic empirical research but on the casual
empiricism of one or two examples. Whilst casual empiricism indicates
that these activities exist, it is not valid for such evidence
to be used to make general assertions about the whole of the audit
services market without further evidence from systematic research.
On a point of information, Professor Sikka states
in his written evidence that there is auditor rotation in France.
This is incorrect. There is no mandatory rotation for statutory
auditors in France. The auditor is appointed by the shareholders
for a period of six years. At the end of this period the incumbent
auditor may be re-appointed for further periods. As rotation is
a sensitive issue, we wish to ensure that the Select Committee
is not misled into confusing fixed terms of appointment with mandatory
I hope you find these comments helpful. We will
be pleased to discuss them further if you wish.
23 April 2002