Executive Bonuses, Directors, Targeted in U.K.’s Audit Crackdown

(Bloomberg) -- Top executives at companies hit by accounting scandals could lose their bonuses under U.K. proposals for beefed-up regulation after a wave of corporate collapses including the demise of Carillion Plc and travel firm Thomas Cook Group Plc.

The government proposed creating a new regulator with the power to wield a range of civil sanctions, including reprimands, fines and even temporary bans from directorships, signaling it’s serious about cracking down on companies with questionable accounting practices.

Importantly, the government said, the sanctions shouldn’t apply only to directors who happen to be qualified accountants, but also chief executives, finance chiefs, board chairs and audit committee chairs.

The proposal for the new regulator, the Audit, Reporting and Governance Authority (ARGA), was unveiled Thursday in a 232-page report entitled “Restoring trust in audit and corporate governance.” The report provides the basis for further consultation with the industry and eventual reforms are to be presented later to the U.K.’s Parliament for approval.

Current rules in place at FTSE 350 companies don’t do enough to dissuade reckless management, the government said. It wants the new regulator to add minimum clawback conditions that would be valid for at least two years after an award is made.

“Whilst most companies have clawback triggers for misstatement of results or an error in performance calculations, far fewer companies have conditions for other provisions including for reputational damage or failure of risk management,” the government said.

Sarbanes-Oxley

The U.K. government’s focus on directors and their compensation is a shift after years of reviews into the role of the Big Four auditors in the collapse of companies like outsourcing contractor Carillion in 2018. Putting more pressure on directors to ensure the accuracy of financial statements also echoes the Sarbanes-Oxley accounting reforms introduced in the U.S. after the high-profile collapse of Enron in 2001.

The U.K.’s Financial Reporting Council has mandated the Big Four firms --PricewaterhouseCoopers, EY, KPMG and Deloitte -- to split their consulting and accounting arms by mid-2024 to reduce the scope for conflicts of interest and to improve the rigor of their audits. By then, ARGA should have replaced the incumbent watchdog, the Financial Reporting Council, as the U.K’s accounting regulator.

Prem Sikka, an accounting professor at Sheffield University, said the government is trying to address an area that previous attempts at audit reform have failed to tackle.

“If you look at the recent scandals these were auditing problems and the directors would not have faced prosecution,” said Sikka, who drafted the Labour Party’s audit reform proposals before the last election. “This is basically saying the problems are the company directors’ fault.”

The U.K. government in its March report acknowledged that it’s “not healthy for audit quality” that 97% of FTSE 350 audits are undertaken by the Big Four, especially when those same firms offer lucrative consulting services.

Read more: U.K. Watchdog Puts More Space Between ‘Big Four’ Units

The FRC last month introduced fresh recommendations to put further distance between the two. The audit side of the firms’ business shouldn’t get paid for introducing customers to their consulting arms and accounting partners shouldn’t be “incentivized” for sales passed to other parts of the firm, the FRC said.

The Chartered Institute of Internal Auditors, which represents the profession in the U.K., like the Big Four, welcomed the proposals, but added the reforms should be implemented with urgency.

“It is disappointing that there is no detailed legislative timetable in the White Paper and we need to see a clear roadmap for reform without delay or else we risk further corporate collapses,” the group said.

Deloitte called for wider consultation on the proposals presented in the report.

“It is critical that input into the consultation is given not just by audit firms and policymakers, but investors, company directors, audit committee chairs and industry bodies at large,” Stephen Griggs, U.K. managing partner at Deloitte, said in a statement.

Holding company directors to account may clash with U.K. case law though, said Tim Bush, head of corporate governance at shareholder advisers Pensions & Investment Research Consultants. Directors should be able to rely on expert auditors for figures, he said.

“To make the auditor’s opinion on the figures an option downgrades the audit to an inferior product,” said Bush. “It’s reminiscent of a fruit shop trying to sell banana skins with the banana taken out.”

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