The FRC on Auditor Independence: It takes... four?

The use of auditors to carry out non-audit work for clients has long been contentious because the independence of the audit could be compromised by these additional ties. But exactly who is in charge of safeguarding auditor independence?

The Financial Reporting Council (FRC) has recently criticised the four biggest auditors, Deloitte, Ernst & Young, KPMG and PwC for doing too little to avoid conflicts of interest in providing clients with auditing services. The annual evaluations of the Big Four auditors, conducted by the FRC’s Audit Inspection Unit (AIU), have come amid increased regulatory scrutiny of the profession and its role in the financial crisis.

The AIU said Deloitte had committed an ethical breach in this area when it assigned two staff to an audit client to advise management for six months. PwC was also deemed to be guilty of an ethical slip when it acted as an actuary to an audit client’s pension scheme.

Paul George, director of the Professional Oversight Board which carried out the inspections, said the auditors “need to think more carefully about whether they can accept [certain types] of non-audit services.” (http://www.ft.com/cms/s/0/c09a15ea-bf6d-11df-965a-00144feab49a.html)

However, the auditors are not the only party responsible for avoiding conflict of interests in this area. Provision C.3.2 of the 2010 UK Corporate Governance Code states that a Board’s audit committee should

develop and implement policy on the engagement of the external auditor to supply non-audit services, taking into account relevant ethical guidance regarding the provision of non audit services by the external audit firm.

In the same provision, the role is further extended to the Board as a whole to whom the audit committee should report, “identifying any matters in respect of which it considers that action or improvement is needed and making recommendations as to the steps to be taken.”

And if the auditing companies, their clients, and the Boards of audited companies all flout their duties, there is provision for shareholders to step in. According to Code section C.3.7,

the annual report should explain to shareholders how, if the auditor provides non-audit services, auditor objectivity and independence is safeguarded

If shareholders are on the ball, they should challenge the Boards of investee companies over questionable external auditor engagement, especially given Principle 3 of the Stewardship Code detailing the ways in which “institutional investors should monitor their investee companies”.

The question arises whether the proportion of blame placed on auditing companies since the global financial downturn should be spread more widely. More importantly, is the FRC’s plethora of guidelines, published by multiple departments and aimed at numerous parties, blurring the lines of responsibility for some of the most crucial corporate governance issues?