External Auditing of Companies: Deficiencies

Baroness Ford Excerpts

Monday 14th October 2024 Lords Chamber

[Baroness Ford (CB)]

My Lords, I too thank the noble Lord, Lord Sikka, for securing this important and timely debate—important because trust in public information is essential to the proper functioning of our capital and equity markets, and timely because we all expect the long-awaited audit reform and corporate governance Bill later in this Session. I draw noble Lords’ attention to my current and previous interests in the register, particularly to my position as chair of the Centre for Public Interest Audit, a recently created research body focused solely on improving quality in UK audits and supported by the entire range of firms involved in this activity in the UK.

I have worked in the equity and capital markets for almost 40 years and have chaired a number of public companies and large privately owned enterprises, so I absolutely understand the requirement for accurate, truthful and timely public information that has been fully audited and assured. More pertinently to this short debate, I have also worked in a number of corporate restructuring and refinancing situations, so I can genuinely say that I have seen some of the best of corporate behaviour but also examples of some of the very worst.

It would be fair to say that, in those situations, the reason for failure or near failure lay squarely with the directors of the company and the decisions that they took. Companies do not generally fail because of audit failings; they tend to fail because of poor decisions taken by directors. Although the sanctions regime is clear and appropriately punitive as it relates to failings by auditors, there is no equivalent regime for holding directors to account. This asymmetry simply cannot be right, and we should look to the forthcoming legislation to see how we might deal with that.

However, it would be naive to imagine that the auditors do not have a role to play. The public and all those invested in companies, not just financial investors—we think of employees and suppliers—are entitled to be completely baffled when a disorderly period occurs a short period of time after a clean audit opinion is signed. When that failure is as high profile as some of those signalled in this debate today, questioning the role of the auditor has even more resonance.

That question has been the subject of serious and intelligent analysis over the last six years. Things have certainly changed. Specifically, as set out in the CMA report, Sir John Kingman’s review of the FRC and Sir Donald Brydon’s comprehensive analysis, virtually no stone has been left unturned in analysing the environment in which auditing takes place in the UK. We are not short of recommendations on how to improve matters, but we have had no opportunity until now to enshrine some of those important recommendations in legislation. That is why I imagine we all welcome the forthcoming Bill and the Government’s decision to prioritise this important issue.

Because of the time it has taken to get to this point, we have taken some important steps in the right direction without legislation. The CMA’s recommendation on operational separation has been given effect by the four largest audit firms, which have done so entirely voluntarily under the FRC’s close supervision. I hope I can reassure the noble Lord, Lord Shipley, that it is no longer permitted to sell audit services to the same client for which you are the statutory auditor. That has been the case since the standard was changed and it just does not happen anymore. We should all welcome that.

The four largest firms now have to formally demonstrate, to the FRC’s satisfaction, that they are formally separated from the advisory practices and that no persistent subsidy exists between the advisory business and the audit practice. More pertinently, they need to be able to show that their primary focus is on delivering high-quality audit in the public interest. The separated businesses also have to show that partner promotion and renumeration is related above all to audit quality indicators, not to income that is brought into the businesses. All those processes are now overseen by an independent board comprised of non-executives who have a direct line back to the FRC. That is not a trivial development, and it goes quite a long way to satisfying the CMA’s objectives. All the accompanying revisions to the Audit Firm Governance Code in the last few years are also welcome and pretty clear.

On Kingman, the FRC has already taken steps to change the way it works. The focus on audit quality inspection has toughened up considerably, and the very public nature of the AQR framework and scores delivers an unprecedented level of transparency to users and the public. Maybe this is an area on which the noble Lord, Lord Sikka, and I would take issue: the enforcement function has shown serious teeth in the light of the failures that we have been discussing today—although of course it would be better if it did not have to enforce at all.

Just as importantly, the FRC’s revisions to the 2024 Corporate Governance Code, relating particularly to director responsibilities on reporting material controls, are a welcome development. They tread a very fine line between a full-blown SOX regime and ensuring essential accountability for directors, and they are massively overdue.

However, there are numerous other areas in the Kingman and Brydon reviews that absolutely require legislation. I look forward to working closely with noble Lords to make sure we get this right. Time is short today, so I will finish with the hope that, when we receive the Bill in your Lordships’ House later this Session, we do not lose sight of the wider reforms to corporate governance that were outlined in both those reviews.

We have waited a long time for this opportunity. The 1992 McFarlane report contained many of the questions and recommendations rehearsed again by Donald Brydon, and the irony was not lost on him. We have a generational opportunity to get this right, and this time we need to seize it.