External Auditing of Companies: Deficiencies

Lord Livingston of Parkhead Excerpts

Monday 14th October 2024 Lords Chamber

[Lord Livingston of Parkhead (Non-Afl)]

My Lords, I join others in thanking the noble Lord, Lord Sikka, for tabling this important debate.

I am not a renowned academic in this area. My contribution is as somebody who has been a practitioner: I have been the CFO of two FTSE 100 companies and on the audit committee—or chair of an audit committee —in five different companies, in both the UK and the US. The four corporate failures are very important, but there is a danger with all of this that we are looking in the rearview mirror, because they are quite old and a lot of things have changed since then. I will talk later in this debate about that.

I have to say that a number of the contributions describe an audit process I do not recognise. The role of independent directors and audit committees is now very important and strong. On the issue of auditors doing consultancy work for businesses, I am sorry but it does not happen now. In fact, if you wish to do consultancy work for a major corporation, do not be its auditor. Yes, auditors do consultancy work, but they do it for other people. There are some ancillary services, such as valuations, that have to be done—working capital reports, for example, are a non-audit service, but have to be done by the auditors. We are describing, perhaps, a situation that was definitely true 10 or 20 years ago.

This is a debate about auditors, but it should be remembered that the primary responsibility for a company’s accounts and its reporting is with management. It is the executives and non-executive directors who are responsible for the first, second and third lines of events, as it is termed. But there have been failures in the fourth line, among auditors.

The firms and partners involved in these failures have received significant sanctions, and rightly so. There has rightly been a response by the Government, regulators and the profession. We have waited too long for statutory changes, but there have been many other things. So despite the delay in legislation, we have seen many improvements. For example, there is now a much better viability report, which usually stretches to five years and which the auditors report on, that every company has to prepare. That viability report tests various downside scenarios that might happen.

Audit reports themselves, when I first started as an accountant, were two paragraphs and talked about a true and fair view. Today, they run to 10 or 11 pages and cover issues such as the approach to the audit, the going-concern review, key audit matters and how they are dealt with, exceptions, et cetera. The FRC’s role regarding audit quality has been strengthened considerably. This is taken extremely seriously, by not just audit firms but audit committees. I know that committees challenge when their particular firm has had a poor result. Although even among the big four the results are not perfect, a lot of the exceptions have been based on documentation rather than the accounts being wrong.

These changes will be taken forward, we assume, by ARGA, and I welcome that. We expect to see, more explicitly, that all directors should be held to account—and they should be; it should not be about whether you are a member of the accountancy profession. There will be a requirement to report on the adequacy of internal controls. That will cover a wider range of controls than is even covered by the famous Sarbanes-Oxley legislation in the US. For many companies, particularly those that are not US quoted, it will represent a great challenge regarding documentation and testing.

However, more regulation is not necessarily better regulation. The UK governance process has gone from being admired as a good balance of regulation and pragmatism, as encompassed by the “comply or explain” doctrine, to “comply, explain and document at length”. Annual reports can now run up to 300 pages in length, and they are not read by even the most diligent investors. I wonder how many noble Lords have read, cover to cover, an annual report at any time in the last year or two. I obviously defer to academic experts on that, but I suspect not many other people.

We have heard some other suggested proposals, including the mandatory use of second-tier firms, either for whole audits or shared audits. It is worth noting that the FRC’s reviews have seen the big four’s results improve regarding the quality of audit. Regretfully, a number of firms outside the big four not only have lower results but are going backwards. There is a real concern among many companies that shared audits will lead to higher costs and lower quality.

On the mandatory allocation of audits, I will give a practical example. I was involved in a company that wanted to bring in one of the non-big-four on the audit tender. Every single one that was approached said, “We are not able to do this. We do not have capabilities, we do not want the exposure, we do not have the insurance and we do not have international coverage”. The practicalities are more difficult. I agree that there is a problem with there being only four major audit firms, but that cannot be solved by this proposal.

You can never guarantee that a business will not fail, nor in a market economy should we seek that, but we have seen good improvements in reporting, and boards and shareholders do not want another massive rewrite. We understand what is on the table. Today, there is a major investment conference at which the Prime Minister has warned against the negative impact of overregulation. If the Minister and his party are truly committed to growth, my message is that we should continue on a path of evolution and continued improvement, rather than revolution and yet more legislation.