Watch the recording: Director/Audit Committee accountability

Transcript

Andy Kemp: Today I am joined by Hemione Hudson, UK Head of Audit at PwC in our series looking at potential corporate governance and audit reforms.

As you know, there have been a number of recent reviews of the audit sector - the CMA review of the audit market, the Kingman review of the FRC and the Brydon review of the quality and effectiveness of the audit itself. Recommendations from these reviews are now with the government to consider to think about how they are going to be taking those recommendations forward. Hemione, there are certainly some big recommendations aimed at the audit and the regulatory environment in these reviews, but there are also some significant suggestions around increased responsibilities for directors and audit committee members. Perhaps you could elaborate on these.

Hemione Hudson: Yes, although the initial focus was on audit reform, it has become clear that there are many recommendations that will impact a much broader spectrum of participants in the whole corporate governance environment, reporting, and the audit system. This includes directors, audit committees members, as well as the regulator and other stakeholders.

Andy: Can you talk us through some of the potential impacts from these recommendations on directors and audit committees and how it might increase their responsibilities and accountabilities?

Hemione:: Firstly, it’s important to mention the overarching recommendation of Sir John Kingman. He recommended that the existing regulator of the profession - the FRC - be replaced by a new Audit Reporting and Governance Authority (or ‘ARGA’ as it’s become commonly known). Any subsequent recommendations impacting the accountability of directors and audit committees are contingent on ARGA first being established and given the necessary implementation and enforcement powers.

There are two specific recommendations relating to accountability of directors and audit committees coming out of Sir John Kingman’s review. At the moment, the FRC can only take enforcement action against a director if they are a member of an accountancy (or actuarial) body and have no recourse against other directors. There is even a bit of an urban myth that some member-directors have resigned from the ICAEW as a result of that risk! The Kingman review has recommended that this inconsistency be removed and that ARGA should have enforcement powers over all directors, not just those who are members of a professional body. It's suggested that these powers follow the principles of the Audit Enforcement Procedure, with the same threshold for action to be taken, and a graduated range of sanctions.

The Kingman review also recommended an enforcement regime for specific directors. This regime would encompass CEOs, CFOs, chairs and audit committee chairs. He recommends that they are held accountable for their duties to prepare and approve true and fair accounts and compliant corporate reports. As well as their duty to deal openly and honestly with auditors.

Sir John Kingman also recommended that the UK examine the case for a strengthened framework around internal controls by learning from the operation of the Sarbanes-Oxley regime in the US. Sir Donald Brydon also recommended that the CEO and CFO attest to the board over the effectiveness of a company’s internal controls. We don’t yet know what internal control reporting regime will be established, and how directors will be held accountable for it. We do know that in the US, this can result in potential criminal charges and/or hefty fines.

Similarly, we don’t know yet which, if any, of these recommendations will be taken forward, but the overall direction of travel towards greater accountability for company directors seems clear.

Andy: We already have best practice guidance for audit committees over the audit tender process and the need for audit committees to assess the effectiveness of the external audit on an ongoing basis. Do you foresee any changes in these areas being proposed by the government?

Hemione:: The CMA recommended that audit committees should come under greater scrutiny by the regulator. They recommended that the regulator have the power to: (a) mandate minimum standards for both the appointment and oversight of auditors; (b) monitor compliance with the minimum standards; and (c) take remedial action where necessary.

I think the government will choose to implement the CMA’s recommendations, at least to some extent. This means I do think there will be a more structured, scrutinised process and a tightening of the responsibilities of audit committees around the tender process and ongoing monitoring of audit quality. I also know that Sir Jon Thompson, CEO of the FRC, has noted in a number of public speeches, his support for a regime of “minimum standards'' for audit committees.

Andy: We’ve covered quite a lot already! Are there any other areas where directors and audit committees could face increased responsibilities?

Hemione:: There is quite a lot already! Sir Donald Brydon has recommended that audit committees create an audit and assurance policy that provides details of the audit and assurance process. He said this should include how auditors are appointed, how audit fees are set and how materiality is determined. This policy would be shared with shareholders for comment. In doing this, Sir Donald is effectively recommending that the audit committee takes ownership of the plans for assurance as a company and for actively engaging with shareholders. We know that some audit committees are already moving in this direction and certainly embrace this “wider” ownership of assurance, but this may help to formalise that process and make it more broadly practiced.

For directors as a whole, Sir Donald had a number of recommendations for more shareholder engagement and transparency. This includes directors sharing a “risk report” with shareholders. The risk report would outline the principal risks and uncertainties of the organisation, and allow shareholders to input at the start of each audit cycle. The Brydon report also recommended the directors provide more transparency over the resilience of a company, as well as the actions they have taken to fulfil their obligations to prevent and detect material fraud.

Andy: All of what we’ve talked about so far sounds like quite an onerous change for directors and audit committees. Do you think there is anything they should be doing now in advance of the detailed proposals coming out (which we think will be in early 2021)?

Hemione:: I think we do expect to see something in early 2021. We don’t yet know for certain where the government will land with the various recommendations or to which entities they will apply. As we have talked about, I suspect that will be coming as part of the upcoming BEIS consultation process, which we expect to be in early 2021. When that is released, it’s a great opportunity for companies and other stakeholders to feed in their views and I would encourage them to do so. Many companies do already have robust practices in a number of these areas. But, I think directors and audit committees should be thinking about what these changes would mean for them and what work would need to be done if those recommendations come into force. I recognise that we, as auditors, have an important role to play in the reform agenda, and we’re focused on that. But, improving the quality of corporate reporting will only be achieved if directors, audit committees, the regulator and the audit profession work together.

Andy: Thanks Hemione. Lots of food for thought and lots of potential changes coming up. As always, we are here to help you navigate change, so if you would like to discuss this further with us, please contact me, Hemione or your usual PwC contact.