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UK audit reform: Balancing rigour with competitiveness

Tom Martin
22/02/2021

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United Kingdom

Proposals for a stricter audit regime, including making company directors personally liable for the accuracy of corporate accounts, will require regulators to make some tricky decisions.

 
The UK government will shortly publish proposals for the reform of UK corporate governance and audit oversight, which may lead to directors becoming personally liable for the accuracy of their company's financial statements.

The long-delayed reform process will start with a 200+ page white paper issued by the Department for Business, Energy and Industrial Strategy (BEIS), containing significant changes to the rules on how audits are conducted.

Reform of audit procedures and accountability was deemed necessary in the wake of high-profile accounting scandals at companies like Patisserie Valerie, BHS and Carillion. However, progress towards implementing change has been slow and the process of legislating for reforms may still be lengthy.

The white paper is expected to have a 16-week consultation period, much longer than normal for a policy document, given the extent of the proposed reforms, which run to more than 100 recommendations.

The impacts of reforms

The pace and detail of the consultation period indicates that the government is still considering whether to introduce 'radical' reforms, such as personal liability for accounting failures.

The model for imposing personal liability on directors is the US Sarbanes-Oxley Act of 2002, which requires management and an external auditor to report on the adequacy of the company's internal controls on financial reporting, and the CFO and CEO to certify financial statements.

Critics in the US have complained about the increased compliance cost of implementing the Sarbanes-Oxley Act, which they claim impacts disproportionately on small companies.

Similar misgivings have been voiced in the UK about stifling recovery in the context of the Covid-19 pandemic and Brexit, by imposing more administrative burdens on businesses at a time when many are struggling to get back on their feet.

As well as increased compliance costs, it is likely that a move to impose personal liability on directors will increase premiums for directors' and officers' insurance policies.

The growth in regulatory actions has seen regulatory investigations and criminal prosecutions become the single biggest driver for D&O claims on a severity basis in many European countries. A tougher audit regime for directors in the UK, with fines and bans for major failures, will further exacerbate that trend domestically.
In addition to a stricter regime for management, reforms are expected in relation to auditors.

The government has backed the operational separation of the audit and advisory work of the Big Four accountancy firms. It is expected that BEIS will push for a "managed shared audit" for all FTSE 350 companies.

This would allow smaller audit firms to audit a "meaningful proportion" of a company's business – such as its subsidiaries.

Some structural reforms are being introduced voluntarily by the Big Four, who are now waiting to see how far the government means to increase competition.

While a stricter auditing regime is a bold statement of regulatory direction, the UK may not want to go out on a limb after Brexit by making changes that might harm the UK's competitiveness.

As of 22 February, it remains to be seen how far-reaching the government's audit reforms turn out to be.

This article was authored by Tom Martin, corporate director at Fieldfisher.
 

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Corporate