Memorandum submitted by PricewaterhouseCoopers
1. As a member of the world's largest professional
services organisation, with more than 150,000 people in 150 countries.
PricewaterhouseCoopers welcomes the opportunity to respond to
the Treasury Committee's inquiry into the financial regulation
of listed companies. As the largest firm of auditors in the UK,
we have substantial practical experience of the areas into which
the Committee will be inquiring.
2. We support the memorandum that has been
submitted to the Treasury Committee by the Institute of Chartered
Accountants in England and Wales (ICAEW). We therefore do not
attempt to cover all the ground in that submission. Rather we
bring out some key points from our practical experience, particularly
3. While we naturally concentrate on the
UK, the Committee might also find helpful the attached paper "Accounting
for the World"
which we have distributed to our clients and others, which summarises
PricewaterhouseCoopers' position on the issues as we see them
The importance of good corporate governance
4. We begin with the subject of corporate
governance because that must be the starting point for considering
issues of this kind. It is corporate governance that has the crucial
role in driving the creation of the nation's wealth as well as
protecting investors and other stakeholders in companies. Good
corporate governance secures good management and bad corporate
governance tolerates bad management. Good corporate governance
also secures good accountability and transparency in companies'
affairs. Good corporate governance needs to be encouraged by many
parties in our financial system: institutional shareholders, bankers,
professional advisers and, not least, auditors.
5. Good corporate governance in turn is
essential to an effective audit. The audit of a larger public
company requires many judgements. These require a responsible
dialogue with the directors, not least the independent directors;
a great practical value of audit is the cross-examination of the
auditor by the board and its audit committee of independent directors.
There will usually be a substantial number of items on the audit
"scoresheet", that are as much concerned with the quality
of the profit as with its mathematical quantity; these will range
from loss provisions and the value of assets to the effect of
unusual events on the underlying earnings. This dialogue cannot
be replicated with thousands of shareholders of a public company
and therefore depends on strong independent directors.
6. The auditor's statutory duty is to the
shareholders, but there is a practical need for the auditor's
support and advice to be available to the directors, particularly
the independent directors, on the shareholders' behalf. Indeed
in practice the directors will seek the auditor's independent
advice on a range of issues covering the company's, often far
flung, operationsfrom the quality of the internal controls
to the quality of management.
7. It has been suggested that shareholders
might elect their own audit committee, but that is precisely what
they should, in effect, already be doing in electing the independent
Improvements in corporate governance
8. Our experience is of a substantial improvement
in British corporate governance, and business management, over
the last decade. The role and calibre of the independent directors
in the unitary board have been greatly strengthened. Audit committees
are generally taking their responsibilities seriously within the
unitary board. Many of the reforms now being suggested in the
US were implemented in the UK in the 1990s. The UK's governance
code has also been emulated by a great many countries outside
Company Law Review
9. Nonetheless, the improvements have not
been reflected in every company and the need for continuing vigilance
by all concerned is important to the nation's competitiveness.
We therefore welcome the DTI's Company Law Review. This seeks
better to define, to a high standard, the responsibilities of
directors, institutional shareholders and auditors in corporate
governance. Combined with the proposed Company Law and Reporting
Commission to keep a continuing watch on corporate governance,
the proposals should do much to maintain a climate, which is conducive
to good governance. We urge legislation to implement the proposals.
10. Our judgement, which is based on substantial
current experience, is that concern about any general malaise
in the quality of UK financial reporting is misplaced. Great improvements
have been brought about over the last 10 or more years, through
the Accounting Standards Board, the Financial Reporting Panel
and, not least, we believe, the accounting firms.
11. All our experience leads us to support
whose who advocate the continuance in the UK of an accounting
regime which is based on principles rather than legalistic rules.
The presentation of the overall quality of profit and financial
position is as important as its mathematical accuracy determined
by compliance with set piece rules. In addition, the importance
of the UK's "true and fair view override" is fundamental
to the substance over form culture of accounting and auditing
in this country.
12. We also support the move to international
accounting standards (IAS) with the proviso that the global standard
should be a principles-based one. The fact that the world's financial
system has sustained a shock surely adds urgency to the implementation
of IAS. The European Commission is aiming to adopt IAS by 2005;
we are urging the US to do likewise although we do not underestimate
the political and cultural barriers to be surmounted. The PricewaterhouseCoopers'
publication "Accounting for the World", attached,
further explains our position on these and related matters.
13. We also support the Company Law Review's
proposal for a reasonably controlled framework (the Operating
and Financial Review) for a company's narrative reporting on the
drivers of shareholder and stakeholder value, given the limitations
of the present historical accounting modeland for explicit
auditor association with this. Indeed PricewaterhouseCoopers has
been promoting for some time a model ("ValueReporting")
which recognises that the value of a company is increasingly represented
in its less tangible assets, such as market position and investment
laid for the future.
14. We recognise the crucial role that audit
plays in the UK's financial system through the underpinning of
confidence it provides to the capital markets.
Integrity of professionals
15. Overwhelmingly, the quality of auditing
depends on the calibre of audit partners and staff in particular
their integrity, ability, experience and personal courage under
adversity (for example against hostile management).
16. The UK profession has long been fortunate
in attracting those high quality people. We believe that the integrity
and ability of our professionals remains second to none in the
professional and business communities. In the current debate on
the regulation of the profession, nothing should be done which
would reduce its attraction to people of this calibre.
17. We welcome the new independent regulatory
regime for the profession in the UKwhich goes further than
that for other professionsbecause we realise the importance
of public confidence in what we do.
18. However, unlike some other regulated
industries, the interests of our regulatorsand our own
interestsprecisely coincide in a single objective: audit
quality. For our part, it is difficult to over-estimate the consequences
of quality failure to the reputation of the firm, the careers
of individuals and the cost and management time of litigation.
However, ill or well founded an allegation of negligence, a partner
will spend his time substantially dealing with the litigation
rather than developing his or her career.
19. Our own quality procedures include:
Independent review partners, who
have little or no contact with the client, in order to preserve
Special review panels of senior partners
in cases where audit judgement are particularly difficult.
Post-audit quality reviews by independent
Rotation of audit partners every
seven years, in accordance with professional guidance.
Continuous personal appraisal of
partners and staff.
20. The considerable interest in audit independence
is entirely understandable. If we believed there was a systematic
problem, we would in our own interests take management action
to do something about it. But all our experience is that threats
to audit independence are human rather than structural, for example
occasional lack of personal resolve by the partners to stand up
to "bullying" management or insufficient scepticism
of what he or she is being told. We address those threats by the
procedures referred to in paragraph 19 above.
21. We firmly believe that a "principles-based"
approach to independence, such as that already in place in the
UK and now recommended by the European Commission, is to be preferred
to a rule-driven regime. This is because, as with accounting,
principles will result in a more objective approach to the subject.
22. We accept there are some honestly held
views that the provision of other services to audit clients is
such a threat to independence that, in varying degrees, regulations
might prohibit them. We honestly believe otherwise. Others have
explained to the Committee the reasons why further restrictions
would be misplaced, reasons which we support. Suffice it to say
that we believe they would in time reduce rather than enhance
the quality of auditing. This is because of the importance of
variety in the firm to attracting and retaining good people in
a very competitive employment market. Variety is also very important
to the skills and experience they bring to the audit which need
constantly to broaden as business techniques and transactions
become more complex (eg treasury, IT). We believe that an "audit
only" service to audit clients could ultimately lead to an
"audit only" firm because too many choices of which
service to provide would have to be made.
23. The following example illustrates these
points well. PricewaterhouseCoopers is in the process of disposing
of our management consulting practice. This was a management,
not a regulatory, decision driven by the needs of the consultancy
sector increasingly to establish business alliances with other
companies, some of whom would be audit clients, and equity-based
payment from audit clients, based on results. PricewaterhouseCoopers
judged that the potential threat to audit independence was insurmountable.
Too many immediate choices needed to be made, between retaining
the audit or a consultancy joint venture to make the combined
business a continuing viable proposition.
24. Another proposition being put forward
is that audit firms should be "rotated" every few years.
There are many practical arguments against this which have been
made by others, with whom we agree. Our comment focuses on why
we think rotation would reduce audit quality. Our experience is
that it takes time to understand the complexities of a large company
and, put colloquially, to find "buried bodies".
25. Audit committees are excellently placed
to make the judgement on what matters overwhelmingly in practice,
the personal demeanour of the partners and senior staff. It would
be strange, to say the least, not to trust them to make that judgement,
but to require the very same people to conduct "beauty parades"
when, for just those companies minded to pursue "aggressive
accounting", acceptability of accounting policies could become
a competitive factor. Rotation of audit partners, rather than
firms, best addresses the "familiarity" threats in practice.
26. Finally, we refer to auditor liability.
A professional should be responsible and pay for his mistakes.
But the present system of joint and several liability means in
practice that litigants naturally sue the "deepest pocket",
usually the auditor. This distorts the incentives of others for
good corporate governance and such is the potential scale of litigationoften
the amounts claimed are upwards of one hundred times the annual
audit feethat the profession has become increasingly risk
averse in the kind of client it will accept and the scope of the
audit. We do not believe that the public interest is served by
defensive auditing. On the contrary, the Enron experience shows
the need for auditors to be fearless in the discharge of their
27. PricewaterhouseCoopers believes that
a system of liability proportional to blame is the logical solution.
However, we have reluctantly accepted the conclusions of the Company
Law Review that this is not practicable and so therefore support
its recommendation for auditors to be able to contract reasonably
to limit their liability as a proxy for proportionality.
The need for continuing vigilance
28. Increasing pressures of the capital
markets, and of results-based directors' compensation, for "performance"
strain the resolve for objective financial reporting. PricewaterhouseCoopers
takes these threats very seriously, through continual enhancement
of the quality procedures we have described above. The resources
that we devote to risk management are several times greater than
what they were only a few years ago; we accept that as a necessary
price for ensuring the highest standards of professional practice.
29. We believe that the Committee should
focus on the responsibilities of all concerned in our financial
system to encourage and sustain good corporate governance. For
our part, we will continue our increasing vigilance as an essential
part of that system. As we have explained, our own interests and
the public interest are precisely aligned.
30. We are happy to help the Committee in
any other way to help advance those mutual objectives.
18 April 2002
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