A heavyweight FRC appointed Disciplinary Tribunal, led by Sir Stanley Burnton, has handed down a significant decision regarding conduct during the Audit Quality Reviews (“AQRs”) of KPMG’s audits of Carillion plc and Regenersis plc.[1] This detailed decision, running to some 141 pages, is likely to be scrutinised by practitioners and the FRC alike as the leading authority on various aspects of FRC regulation. We focus on the exposure of junior accountants to sanction and comment on what action should be taken by firms in light of this decision and our experience of FRC regulatory investigations.
The Tribunal concluded that members of the audit teams deliberately misled the FRC’s AQR teams by altering existing documents and by creating entirely new documents during the course of the inspection. These documents were subsequently, wrongly, presented as evidence which had been created during the course of the relevant audits, but had through oversight not been included on the audit file. This showed, the Tribunal found, a clear intention to mislead the regulator.
The decision has underlined the regulator’s expectation that integrity should flow throughout an audit team at all levels of seniority. The Tribunal’s decision to order significant sanctions against non-partners is a sobering warning to junior members of an audit team that lack of seniority will not be considered an excuse where they have been involved in matters that have led to the regulator being misled.
Although the Tribunal did not agree to impose the more severe sanctions sought by Executive Counsel, the sanctions are still at a level where they may have life-altering consequences for respondents.
The FRC had sought to impose fines for the senior managers and the partner ranging from £100,000 to £400,000 with exclusion sought for each of between 12-15 years. The Disciplinary Tribunal ultimately imposed fines ranging from £30,000 to £250,000, and the partner and more senior managers were all excluded from the profession for significant periods of time (ranging from 7 – 10 years). The most junior respondent, who had been an assistant manager at the time, received a severe reprimand although was ultimately not fined. Executive Counsel had sought his exclusion for 4 years along with a substantial fine.
Although KPMG also received a severe reprimand and a fine of £14.4 million, this was reduced from £20 million to reflect the fact that KPMG had from the outset admitted its responsibility for any proved misconduct against any of its employees and, significantly, that KMPG’s self-reporting to the FRC was the reason that the misconduct came to light at all. In any audit firm of the size of KPMG, issues will arise from time to time and the goal of the audit firm should be to minimise that risk, to be open with its regulator, and to seek to remediate the issue. The Tribunal took a very positive view of KPMG’s conduct. In a truly awful situation, KPMG took hard decisions and salvaged its relationship with its regulator. Per the Tribunal:
“The Tribunal has been favourably impressed by the action taken by KPMG once it became aware of an issue in relation to the Carillion AQR. We have also borne in mind that … it is only because KPMG self-reported the underlying facts that the Misconduct came to light. KPMG’s comprehensive provision of contemporaneous emails and other documents was fundamental to the fair conduct of the proceedings and the decisions of the Tribunal.
KPMG has also taken steps to seek to ensure that there is no recurrence of Misconduct such as that we have found. …”
The severity of the sanctions sought and imposed highlights the seriousness with which the FRC treats behaviour which is misleading and/or dishonest. Whilst the FRC’s sanctions policy acknowledges that “the primary purposes of imposing sanctions…. is not to punish, but to protect the public and the wider public interest”, the Tribunal explained that, whilst sanctions are intended to act as a deterrent rather than a punishment “it has to be recognised that it is difficult to impose a sanction that is a deterrent without a degree of punishment… It is difficult to see that a fine which is an effective deterrent will not be punitive and that the fine will be regarded as such by the person on whom it is imposed”[2].
The hearing itself, at five weeks long and involving no fewer than fifteen counsel instructed by seven different firms of solicitors, shows the level of resource which the FRC now can – and will – apply to proceedings where the FRC considers that key issues are engaged (PI insurers take note). Carillion is a name in the public mind, but we view the FRC’s attitude to these proceedings as evidence of the FRC’s commitment to safeguarding the sanctity of the AQR process, and of the audit file more generally. The AQR process is the FRC’s principal method of monitoring audit quality across the profession, and it is the audit file that the AQR team (and FRC Enforcement teams) begin their work. If the FRC cannot rely on the AQR, the FRC cannot do its job.
The Tribunal agreed: “Effective audits are essential to the financial system. Management and investors should be able to rely on the audited financial reports of the company in question. The purpose of the AQR’s is to assess… the effectiveness of audits. We are reminded of the old question: Quis custodiet ipsos custodes? Who is the custodian of the custodians? In the case of the auditors of public companies, it is the FRC…. Misleading the AQR undermines the effectiveness of its work”.
As noted above the Executive Counsel had sought the exclusion and a fine for the most junior respondent and whilst the Tribunal ultimately determined that a severe reprimand was appropriate, the decision is a clear marker that the FRC will not make allowances for those involved in misleading behaviour even if those personnel are relatively junior members of a team. Whilst the Tribunal expressed considerable sympathy for the Assistant Manager (which we share – he was not the originator of the misconduct), the Tribunal concluded that he was aware that the minutes he helped create were produced with the intention of misleading the AQR. The Tribunal’s view was clear: he should have questioned his senior colleagues’ instructions “and if he received no appropriate answer… he should have raised their propriety with his performance manager”[3] or the firm’s ethics partner. Lack of seniority was therefore no excuse.
There can be little doubt that the Tribunal’s decision should be treated as a warning to junior auditors: the FRC expects that they challenge instructions which could be considered unethical. Challenging senior members of a team may not come naturally to a relatively inexperienced junior, but where integrity or honesty are concerned, a junior team member should air their concerns in line with the firm’s ethics procedures.
What can audit firms draw from this?
- There is a strong incentive to self-report serious ethics issues. A firm which does so wins trust with its regulator. A firm that fails to do so is damaging its relationship of trust and confidence with the FRC. There is a longer game here.
- Tribunals and (in our experience) the FRC look kindly on prompt remediation. It is in the firm’s interests as well to minimise the risk of a repeat.
- Audit partners should be aware that their compliance with ethical standards protects not just themselves and the firm, but the juniors in their charge.
- Junior team members should be encouraged to exercise ‘inner leadership’ on matters of ethics. That will help protect them, and their firms. Cutting corners to save time and difficulty in the short-run is the audit equivalent of collecting pennies in front of a steamroller.
- We suggest this as a rough rule of thumb – if this conduct were carried out by an audited entity, would it raise an eyebrow from the audit team? If so, the FRC can hardly be expected to feel differently.
[1] https://www.frc.org.uk/getattachment/e3fa9c9f-ea20-4474-81b0-ce6228ea0146/KPMG-Regenersis-and-Carillion-AQR-Tribunal-Report-27-09-22.pdf
[2] Paragraph 353 of the decision
[3] Paragraph 314 of the decision
