The fight against fraud can be likened to doing a crossword puzzle in the dark. Clues exist but they cannot be seen. Sadly, the situation is exacerbated because even when regulators have suspicions that fraud has occurred or is currently being perpetrated, they are so obsessed with secrecy and bound up with red tape they do not pass their suspicions on to the auditors. This ignores the facts that auditors exist to help to protect shareholders, and one of the essential features of audit work is confidentiality. Also, regulators hide behind the law - they claim it would be contrary to the Official Secrets Act or similar legislation for them to pass on information received in pursuance of their duties to auditors.
This, of course, is markedly different from the situation when a scandal finally comes to light. Then everyone, including the regulators, assumes that there must have been failure on the part of the auditors; the auditors are accused of not seeing the warning signs that, with the benefit of hindsight, were so clear. Of course, when an audit fails to uncover a material fraud there should be an investigation, but it is inequitable that auditors should take all the blame when information held by regulators would have assisted the auditors and perhaps led to the earlier detection of the fraud.
Failure by regulators to pass on tip-offs to auditors produces only one set of winners, the fraudsters. Auditors are kept in the dark and are unable to focus their attention on the very areas where regulators have concerns, and as a result the effectiveness and efficiency of the audit as a tool in the fight against fraud suffers. Meanwhile, regulators wait until they have firm information, and they allow auditors to continue their work in ignorance of key facts. Regulators may have regulatory visits, but by the time they have sufficient evidence to act it is far too late - the fraudsters have continued to steal and mislead the financial markets, sometimes for a number of years.
Occasionally, tip-offs are passed on. Sometimes "bi-partite meetings" between regulators and auditors take place, and in this regard the Bank of England supervisors should be commended. Examples also exist in other countries, notably the United States, of regulators who have a greater willingness to take auditors into their confidence. But the general rule in the UK seems to be that information should flow in one direction - from auditor to regulator.
In his report following the closure of BCCI, Lord Justice Bingham recognised the need for direct communication by auditors to regulators in order to protect the public interest. The law was changed for a wide variety of financial institutions and a new regime became effective in the summer of 1994 under which a legal duty is placed on the auditors in certain circumstances to report to regulators. However, the public interest would be better served by new laws requiring regulators who have a strong suspicion of fraud or other serious irregularity to inform the auditors, but the regulators should not be required to reveal their sources. It could be made a criminal offence for an auditor to pass on a tip-off to a fraudster.
My message, therefore, is that any alleged public interest need to keep regulators' information secret is made subservient to the greater public interest needs to stop major fraud earlier and to put criminals behind bars.Changes need to be made to make life as difficult as possible for fraudsters in the UK.
The writer is partner in charge of the London audit division of Touche Ross.Reuse content