Tag: ARGA

Truss Victory – But Do We Trust Her to Deliver?

Liz Truss has won the election for Conservative Party Leader and therefore will be our next Prime Minister. She won by the expected large majority although she would not have been my personal choice. Lacks charisma. Her acceptance speech was a lacklustre bunch of pedantic soundbites.

She has promised to cut taxes and tackle the energy crisis. But how is she going to control energy prices? It’s easy to impose price controls or subsidise consumption but who is going to pay for it and where is the money coming from are the key questions. She has promised quick answers to those questions but do we trust her to deliver?

Having a surname that is a homophone of trust should have helped her political career but now she faces real problems in the UK economy and social unrest over the cost of living. This will not be helped by the latest news that Russia has turned off the Nord Stream gas pipeline and has no intention of reopening it while sanctions persist. This will drive gas prices even higher.

It was a good morning to release negative news. Abrdn UK Smaller Companies Growth Trust (AUSC) which I hold announced that long-serving manager Harry Nimmo is to retire at the end of the year. This has long been expected and after 19 years of service is probably overdue. There comes a time when even the most respected managers need to be refreshed.

It’s bad news for staff of the FRC after the FT reported that a decision has been made to locate the new ARGA body which will take over their role in Birmingham. Well at least they might find cheaper housing and shorter commutes so they might view it as a positive move.

The new ARGA body is sorely required as the FT reports yet another “brazen $400mn accounting fraud” in a Chinese biotech company (China Medical Technologies). KPMG is being sued in a Hong Kong court for $830 million. The report says that four audit firm failed to ask “obvious” questions that would have “easily” exposed the fraud. These included not questioning a large related-party transaction by the group in 2006, when it acquired a Chinese diagnostics business worth $155,000 for $176mn, according to the liquidator.

These kinds of events are way too common all over the world including the UK. Implementing ARGA is taking way too long but I suspect that it will not be one of Truss’s priorities.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Restoring Trust in Audit – A Long Way to Go Yet

The Financial Reporting Council (FRC) have recently published a “Position Paper” entitled Restoring Trust in Audit and Corporate Governance. It sets out how the FRC will be supporting the Government’s reforms under the new ARGA regime.

This is not a very exciting document as it’s very short on specifics. For example under Corporate Governance and Stewardship is says “including a provision for boards to consider how audit tendering undertaken by the company takes account of the need to expand market diversity…”. What exactly does that mean?

However it does say that the Government intends to put Actuarial Regulation on a statutory footing which is long overdue and the intention is to put ARGA on a new funding basis with market participants paying a levy to meet its regulatory function costs. So perhaps auditors should read this Position Paper carefully.

The Position Paper can be obtained from here: https://www.frc.org.uk/news/july-2022/frc-sets-out-next-steps-in-transition-to-new-regul

There might have been more information provided in a webinar on the 14th August but I missed it for two reasons: 1) they sent the login information but it ended up in a spam folder on my BT server; and 2) They sent it as a Teams invite but even though I chose the web browser option it blocked me with an incomprehensible error message. Is it just me that has endless problems with Teams? I wish people would use other products such as Zoom for webinars which I never have problems with.

Incidentally the latest example of the failures of the audit profession was an announcement by the FRC of sanctions against UHY Hacker Young LLP and their audit partner in relation to Laura Ashley Holdings.

To quote: “LAH’s shares were listed on the main market of the London Stock Exchange. As at 30 June 2019, the Group had 155 UK stores, employing over 2,700 people. The Group’s revenue, operating profit, profit before tax and profit after tax consistently declined between FY2016 and FY2019, and the Group’s loss after tax increased ten-fold from £1.4m in FY2018 to £14m in FY2019. Against this backdrop, the audit reports for FY2018 and FY2019 were unmodified and noted no material uncertainty related to the use of the going concern assumption”. Laura Ashley went into administration in April 2020.

The fine imposed by the FRC was only £217,500, a trivial amount!

See https://www.frc.org.uk/news/july-2022/sanctions-against-uhy-hacker-young-llp-and-martin for details.

There is certainly a long way to go to restore trust in the audit profession after a whole series of failures in the last few years.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Restoring Trust in Audit and Corporate Governance

As it’s Friday afternoon with not much happening, and I have completed my latest complaint about the time it’s taking to complete a SIPP platform transfer, I decided to have a look at the public consultation on “Restoring Trust in Audit and Corporate Governance” from the BEIS Department.

This is a quite horrendous consultation on the Government’s proposals to improve audit standards and director behaviour as foretold in the Kingman and Brydon reviews, with proposals for a new regulatory body (ARGA). That’s after a growing lack of confidence in the accounts of companies by investors after numerous failures of companies, and not just smaller ones. I call the consultation horrendous because it consists of over 100 questions, many of them technical in nature, which is why BEIS have given us until the 8th of July to respond presumably.

I won’t even attempt to cover all the questions and my views on them in this brief note. But I would encourage all those who invest in the stock market, or have an interest in improving standards in corporate reporting, to wade through the questions and respond to the on-line consultation (see link below). Otherwise I fear that only those with a professional interest as accountants or as directors of public companies will be responding. The result might be a biased view of what is needed to improve the quality of financial information provided to investors.

The general thrust of the proposals do make sense and it would be unfortunate if the proposals were watered down due to opposition from professional accounting bodies and company directors.

But there is one aspect worth commenting upon. Some parts of the proposals appear to believe that standards can be improved by imposing more bureaucracy on auditors and company directors. This might add substantial costs for companies in terms of higher audit fees and more management time consumed, with probably little practical benefit.

We need simple rules, but tougher enforcement.

The audit profession appears to be already seeking to water down some of the proposals according to a recent article in the FT which reported that accountants were seeking leniency on “high risk audits”. That’s where they take on auditing a company for the first time which may prove difficult, particularly where corporate governance is poor. This looks like yet another attempt by auditors to duck liability for not spotting problems which has been one of the key problems for many years.

BEIS Consultation: https://www.gov.uk/government/publications/restoring-trust-in-audit-and-corporate-governance

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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FRC Seminars, Lookers Results, Caparo Judgement and Autonomy Case

I attended two seminars organised by ShareSoc and UKSA with the Financial Reporting Council (FRC) yesterday (24/11/2020) and the day before. The first session was about the “ARGA transformation”, i.e. the steps being taken to improve the audits of companies and the reporting of accounts following the Kingman review two years ago. ARGA stands for Audit, Reporting and Governance Authority which will be the new name for the FRC.

Before reporting on the meeting, it’s worth noting the latest example of how audits have failed to disclose substantial errors in accounts, including fraud, in the case of Lookers (LOOK). In their announcement on Tuesday they made it clear that profits had been wildly overstated for some years and the balance sheet was likewise overstated. To quote from the announcement: “A total of £25.5m of non-cash adjustments are necessary to correct misstatements in PBT over a number of years” and “Adjustments reduce  PBT by £10.9m in 2019 and £7.2m in 2018 with the balance cumulatively decreasing PBT by £7.4m in 2017 and earlier”. Auditors Deloitte have resigned.

It is a regular occurrence that the published accounts of public companies are subsequently shown to be wrong and that fraud goes undetected. The audit process which investors rely on to enable them to have confidence in the accounts on which they are basing investment decisions is clearly regularly failing.

The FRC seminar was presented by Sir Jon Thompson, their new CEO following a wholesale shake-up of management, and Miranda Craig, Director of Strategy and Change. They reported on the progress to implement the required changes, many of which require changes to legislation. They hope to get those implemented in the second half of 2021 with ARGA becoming live in 2022. But none of this is certain as it depends on Government co-operation and priorities. There will also need to be another consultation round on the details of the proposals.

The Kingman review proposed joint audits be introduced but the Government has decided against that but managed shared audits are being considered so as to give smaller audit firms some involvement in bigger audits.

ShareSoc Director Cliff Weight asked a question about the Caparo legal judgement and the problem of people holding shares in nominee accounts not being “members” of a company.  I followed up with some points on Caparo, which Sir John Thompson did not appear to know much about and assigned a response to someone else.

Let me explain why this issue is so important and how the Caparo legal judgement undermined the duties of auditors.

Investors in the stock market purchase shares on the basis of the published accounts of companies being a fair view of their financial position. Before the Caparo legal judgement in 1990 it was widely assumed that auditors had a duty of care to shareholders – after all what was the purpose of the audit other than to provide reassurance to shareholders? Historically that was why audits were introduced. See this ShareSoc blog for more information https://www.sharesoc.org/blog/regulations-and-law/audit-quality-caparo-judgement and there are more details of the legal case on Wikipedia.

This judgement effectively meant that no shareholder in a company could sue the auditors for incompetence or breach of duty, only the company could. But that rarely happens, when it is the shareholders that have typically lost money as a result. In fact some auditors have claimed that even the company does not have a claim if the reported accounts were false because it might not necessarily have affected what actions the company took. Sometimes when a company goes into administration the liquidators might sue, as in the recent example of Patisserie (CAKE) but there is no certainty of success or any pay-out to shareholders.

The failure to make auditors responsible financially to investors relieves them of a big financial incentive to do their work properly and to identify false or fraudulent accounts.

I put it to Miranda Craig that all that was required to fix this problem was a simple Act of Parliament to overturn the Caparo judgement. She suggested they did not have the powers to implement this but that is a weak excuse.  They could surely suggest to the Government that such an Act be introduced as it’s perfectly practical. It just needs to reinstate the duty of auditors to shareholders and overturn the somewhat perverse decision in the Caparo judgement.

Another attendee at the seminar raised the issue of the auditors being able to limit liability to the company by contractual means which is another issue that needs tackling.

The second seminar was about “Enforcement”, presented by Claudia Mortimore and Jamie Symington. There has been growth in the enforcement team – from 9 staff in 2012 to 54 now. Certainly enforcement has been more active but they are still hampered in some cases by limitations on their powers – for example they only have powers over members of regulatory bodies whereas many company directors are not such members (even finance directors or chairs of audit committees). There are plans to change this.

They have identified two main issues from past audits: 1) A failure to plan and perform audits with professional scepticism; and 2) Failure to obtain sufficient audit evidence.

Enforcement does seem to be improving, but there are still some issues as Robin Goodfellow pointed out (a failure to communicate with complainants over FRC findings or during investigations).

There is also an issue that fines on audit firms or partners are still not enough to discourage poor behaviour or match the losses incurred by shareholders due to incompetence or inadequacy. For example, one of the cases mentioned in the seminar was that of Autonomy. Deloitte was fined £15 million in September over their audit work for the company. But Hewlett-Packard (now HPE) claimed for £3.8 billion over their losses resulting from the acquisition of Autonomy, i.e. 250 times what Deloitte were fined!

Altogether these were somewhat disappointing seminars for those of us looking for vigorous action and speedy revolutions in the FRC. I am not convinced the culture of the FRC has yet changed, with progress being slow and decisive actions to improve audit standards not being implemented, although others do think there is progress being made. Improvements are being implemented but not nearly as quickly as I would like and auditors are still being protected from the worst impacts of incompetent audits. The fines that are issued are still too low – for example Deloitte registered a profit of £518m for the year ended May 2020 so they probably won’t worry too much about a £15 million fine.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Brydon Audit Review and FRC Update

Readers probably don’t need to be reminded of the poor reputation of auditors and accountants. The announcement yesterday from Staffline Group (STAF) reiterates the point. They note the latest analysis indicates that 2018 profits were overstated by about £4 million. The CFO, Mike Watts, has left with immediate effect.

Sir Donald Brydon has published his review of the audit market and makes recommendations for significant changes. This is what he says in a preface:

“The quality and effectiveness of audit has become an increasingly contested issue, with the result that this Review has been commissioned. Some consider that audit is good enough but the starting place of this Report is that it is not.

At a time when information is everywhere and there is no obligation on users of the internet to be truthful, it matters even more that shareholders, and others, can trust what directors are communicating. Auditors have a unique advantage in having the right to see everything that goes on in a company and to assess whether that trust is deserved”.

The recommendations encompass:

  • A redefinition of audit and its purpose;
  • The creation of a corporate auditing profession governed by principles;
  • The introduction of suspicion into the qualities of auditing;
  • The extension of the concept of auditing to areas beyond financial statements;
  • Mechanisms to encourage greater engagement of shareholders with audit and auditors;
  • A change to the language of the opinion given by auditors;
  • The introduction of a corporate Audit and Assurance Policy, a Resilience Statement and a Public Interest Statement;
  • Suggestions to inform the work of BEIS on internal controls and improve clarity on capital maintenance;
  • Greater clarity around the role of the audit committee;
  • A package of measures around fraud detection and prevention;
  • Improved auditor communication and transparency;
  • Obligations to acknowledge external signals of concern;
  • Extension of audit to new areas including Alternative Performance Measures; and
  • The increased use of technology.

Comment:

Many of the proposals may improve the information available to investors and help prevent fraud or false accounts. But they will add a substantial burden on auditors, and hence costs on companies. I can see some opposition from the latter when the details are consulted upon.

Some of the proposals will increase engagement with shareholders and the role of the Annual General Meeting so are to be welcomed.

The proposals are likely to be taken forward by the new ARGA body which will replace the Financial Reporting Council (FRC) and which was included in the Queen’s Speech today.

You can read the Brydon Report here: https://tinyurl.com/t7va5fl – 120 pages of Christmas reading to fill the days when there is no news and little to do.

The FRC have also published a revised version of their “Ethical Standard” so as to strengthen auditor independence and ban conflicts of interest. See  https://tinyurl.com/soc8hq3 – that’s another 102 pages for Christmas reading although this may be more of interest to auditors than investors.

To conclude, Donald Brydon included this poem in his report just to amuse you, and to show that the concerns about audits are not new (it dates from the 1930s):

The Accountant’s Report

We have audited the balance sheet and here is our report:

The cash is overstated, the cashier being short;

The customers’ receivables are very much past due,

If there are any good ones there are very, very few;

The inventories are out of date and practically junk,

And the method of their pricing is very largely bunk;

According to our figures the enterprise is wrecked….

But subject to these comments, the balance sheet’s correct.

 

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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FRC Revolution to Fix Audit and Accounting Problems

A major announcement that will impact investors was made yesterday by the Government. You may not have noticed it in the midst of political turmoil, but it’s worth studying.

The Kingman review of the Financial Reporting Council (FRC) was published last December. It was a quite damning criticism of many aspects of the current regulatory regime that had resulted in so many audit failures and poor-quality financial reporting. See my previous blog post on this subject here: https://roliscon.blog/2018/12/18/all-change-in-the-audit-world/

There are few experienced investors who have not suffered from audit failures in the last few years. Accounts need to be accurate, reliable and trustworthy but they have been far from that in the last few years. It is now proposed that the FRC, which regulates the audit world and sets accounting and corporate governance standards, be scrapped and replaced by a new body to be called the Audit, Reporting and Governance Authority – ARGA as it will no doubt be abbreviated to. ARGA will have stronger powers, a new mandate and new leadership.

There is a public consultation on the proposed new body and supporting legislation which can be obtained from here: https://tinyurl.com/y55a376d . Anyone with an interest in improving auditing, and preventing company failures such as those at Patisserie or Carillion and major banks in 2008 should respond. But there are so many changes proposed that the document may take time to digest. I pick out some of the more important ones below:

A new Chairman and Deputy Chairman are being recruited to head ARGA so there will be change at the top. Let us hope they manage to change the culture of the FRC even if many of the FRC’s staff move into the new body. It needs to be more than a change of name.

The ARGA will have clear statutory powers with a clear purpose and objectives, supported by a “remit letter” from the Government. One objective will be “to protect the interests of users of financial information and the wider public interest…” which is a positive statement and replaces the unclear historic accumulation of limited powers by the FRC.

The new board responsible for the ARGA will be smaller, more diverse and less representative of “stakeholder” interests. Let us hope that this means less dominated by major audit firms and the audit profession.

The Audit Firm Monitoring Approach will be put on a statutory basis and with enhanced skills and seniority in the team. There are also proposals to improve the Audit Quality Review system which sound promising although such reviews only affect large companies. There will also be expansion of Corporate Reporting Review activity focused on higher risk companies and the new regulator will have the power to change accounts without going to Court.

The “audit expectation gap” where, for example, investors expect auditors to detect false accounting or even fraud whereas auditors don’t perceive that as part of their job will be reviewed. There is indeed a problem with the failure of auditors to challenge the information they receive from management and the latter’s forecasts and interpretation. Let us hope that is a meaningful independent review that results in some changes.

A new “pre-clearance” system will be introduced to enable companies and their auditors to obtain approval for “novel and contentious matters in accounts in advance of their publication”. This may assist auditors to “pass the buck” to someone else if they have doubts about how to present the financial figures.

More transparency in the new body is encouraged on such matters as disclosure of undertakings from concluded cases and it will become subject to the Freedom of Information Act. There will also be more publication of information on complaints and improved handling of them. Such changes are to be encouraged to stop the current secrecy under which the FRC operates which frustrates investors.

The oversight of the accountancy profession is proposed to be improved although the details are unclear and it may require primary legislation. The wording suggests that audit firms may escape substantial change.

The prevention of corporate failure is to be tackled by developing a market intelligence system to identify emerging risks in companies. This will enable a change from a purely historic analysis of corporate failures which is rather like shutting the stable door after the horse has bolted to a more proactive, future-looking approach. Auditors may also be required to warn of concerns about viability.

The AARG will be able to commission a “skilled person review” where concerns are raised about a company. Details of how this will operate are to be determined, but this appears to be a useful step forward. The cost would be charged to the companies where it is invoked.

The Government accepts that there is merit in improving internal company controls by something along the lines of the US Sarbanes-Oxley regime. They will explore options in this area and do a consultation on it in due course. This is a welcome move and I covered the benefit of such a change in a previous blog post: https://tinyurl.com/yxmx9gzg

It is proposed to improve “viability” (i.e. “going concern”) statements and the FRC has been tasked with taking that on immediately. Such statements are certainly ineffective at present and could be improved in several ways, e.g. to avoid the “all or nothing” approach at present. Such questions are not simple black and white issues in most cases.

It is proposed to replace the existing, and most peculiar, voluntary funding arrangement of the FRC with a new statutory levy for the ARGA. This is surely welcomed as money is the key to improving many of the regulatory functions. It is clear that the FRC is under-resourced in terms of the numbers and skills of staff.

In summary, most of the recommendations in the Kingman review are being taken forward.

Comment: These long-overdue reforms are certainly welcomed and the Government does seem to be applying some urgency to them, although with a log-jam in Parliament at present it may take time to get some of the needed statutory law changes in place. But cultural changes in organisations are never easy. Old bad habits in the FRC may persist, while it remains to be seen whether adequate funding will be put in place for the ARGA. There is also a lot of detail yet to be worked out. Let us hope it is a case of welcome to ARGA and not AARGH when we learn the details.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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