Memorandum submitted by Chantrey Vellacott DFK
FINANCIAL REGULATION OF PUBLIC LIMITED COMPANIES
Thank you for your letter of 25 March 2002 to Mr Brian Callaghan, Senior Partner, inviting Chantrey Vellacott DFK to submit written evidence to the Treasury Committee's inquiry into the financial regulation of public limited companies. We are pleased to have the opportunity of making a submission in this letter.
Chantrey Vellacott DFK is a firm of Chartered Accountants with some 50 partners and 400 staff, ranked in the "Top Twenty" firms of Chartered Accountants in the United Kingdom. The firm has been established since 1788 and provides services to a broad client base, including companies listed on public markets in the United Kingdom and abroad. Chantrey Vellacott DFK is a leading member of the DFK international association of accountancy firms, which is represented in more than 70 countries.
We believe that the implications of the Enron affair have damaged confidence in all public markets. We believe that it is important to rebuild confidence in the markets and that the inquiry by the Treasury Committee is an important step in this process. We feel that it is inappropriate to discuss the specific issues arising from the Enron affair, but we believe that we are well qualified to comment on the broader governance issues which arise and their context with regard to the United Kingdom.
In our opinion, a rigorous system of regulation for public companies exists in the United Kingdom, and this system should give confidence to the public markets. Large scale business failures have taken place in the United Kingdom, and, in particular, it is very difficult for any system of audit or monitoring to detect organised fraud involving directors and senior officers of the company. However, our system of regulation has learnt much from the business failures of the late 1980s and early 1990s and the system that has emerged greatly reduces the risk of an Enron type failure taking place in the United Kingdom.
The United Kingdom has a very advanced system of accounting standards for public companies. Our system of Financial Reporting Standards (FRSs) are now proving to be very influential in the development of global International Accounting Standards (IAS). Off balance sheet financing was virtually outlawed in the United Kingdom following the issue of FRS5 Reporting the substance of transactions in 1995. There is no similar standard or set of principles in the United States.
Therefore, as a result of FRS5 a key feature of United Kingdom financial reporting is disclosing the transparency of transactions. This feature is illustrated by the new accounting standard FRS17 Retirement benefits. This standard has created controversy because it has been "blamed" for the demise of a number of defined pension schemes. However, the standard has a transparent objective, as for the first time it will require balance sheets to show the full financial effect of funding defined benefit pension schemes. In the long term, this transparency will be beneficial to all investors, including pension fund members.
The development of corporate governance principles has been lead by the United Kingdom, beginning with the Cadbury Code in the early 1990s, and continuing most recently with the Turnbull Report covering systems of internal control and risk management. Public companies now provide extensive corporate governance disclosures in their annual reports, and standards have been established for the effective working of audit committees, independent non-executive directors and internal audit functions. Similar principles of corporate governance and disclosures do not exist in the United States.
The development of corporate governance principles must continue to be encouraged. In particular, standards covering the role and conduct of non-executive directors need to be expanded. However, care must be taken to ensure that the principles can be practically implemented by all public companies. Small companies can find the full set of principles expensive and impractical to apply, and specialist corporate governance standards for the more than 2000 listed companies outside FTSE350 need to be developed.
There has been much debate recently over the standard of work conducted by the auditors of public companies and about the independence of the audit firms from their clients. The conduct of the audit profession is now subject to independent oversight by the Accountancy Foundation and the United Kingdom has an established set of Statements of Auditing Standards which are based upon the standards set by the International Federation of Accountants. The monitoring of audit firms conducting audits of public companies is rigorous, involving the submission of annual returns to and the receiving of annual monitoring visits from the Joint Monitoring Unit of the Institutes of Chartered Accountants (JMU). Probably no other country has such a well development system of independent monitoring of auditors, and it is likely that this approach will be replicated in the United States.
It is a matter of concern to us that public company audit appointments have become increasingly concentrated on the "Big Five" firms of accountants and the likely emergence of a "Big Four" potentially reduces customer choice and increases the risk of conflict of interest. Other firms have the resources and experience to audit public companies, and steps need to be taken to reduce the concentration of audit appointments among a small number of firms. Causes of concentration of appointments have, in part, arisen from a belief among institutional investors and non-executive directors that "Big Five is best". This attitude needs to be reversed. In addition, some companies have sought to source their audit, taxation and related professional services from one large provider. This increases the risk of conflict of interest, and whilst preventing auditors from providing other services is an extreme solution, professional standards relating to the provision of "other services" by auditors need to be revisited
In conclusion, we are of the opinion that an effective system of regulation of public companies exists in the United Kingdom, and that this system is globally regarded as strong. We appreciate that there must be no grounds for complacency and that the United Kingdom must continue, to set leading standards. In particular, the development of corporate governance must continue, and the process of Company Law Reform must be completed by the presentation of a Companies Bill to Parliament.
This submission has been prepared by our Technical Partner, Mr David Chitty, and all enquiries regarding the submission should be addressed to him. Mr Chitty is a Fellow of the Institute of Chartered Accountants in England & Wales and is a member of the Council of the Institute. Mr Chitty writes and lectures widely on financial reporting and auditing practice.
4 April 2002