Accountancy & Management: Turning auditors into policemen: Roger Trapp reports on making a duty of a right

WHEN the Government proposed that auditors of banks, building societies and other financial organisations should have a duty rather than a right to report suspicions of wrongdoing direct to the regulators there was little dissent.

The consultation paper issued jointly in March by the Treasury and the Department of Trade and Industry was prompted by last October's report by Lord Justice Bingham into the collapse of the Bank of Credit and Commerce International.

Among the report's recommendations was that the duty of bank auditors to report their concerns to the regulatory authorities already imposed by the Institute of Chartered Accountants in England and Wales and other professional bodies should be made statutory.

Even Price Waterhouse, which is subject to a number of lawsuits and investigations over its role in auditing the collapsed bank, said it had 'no problems' with the proposal. 'As far as we are concerned, it won't change the existing situation,' it said.

This accords with the view of Lord Justice Bingham, who said in his report that 'it does not appear that any formal or professional impediment to communication between auditors and the Bank (of England) had any influence on the course of events in this case'.

But he added that it was desirable that the position should be 'made very plain for the future'.

This certainly is the intention of Bill Morrison, chairman of the Auditing Practices Board, which last week issued an exposure draft of its proposed statement of auditing standards (SAS) on the matter. Converting a right into a duty of this kind was 'very important', he said.

It is unusual for a paper like this to appear before the final form of the legislation is known. Such a deviation from normal practice had resulted from 'the importance of the proposed legislation', Mr Morrison said. This step had been taken in order to ensure that the necessary guidance was available to practitioners in readiness for the legislation coming into effect by the end of the year.

For this reason, too, there is a shorter-than-usual consultation period; all comments must be in by the end of September. Mr Morrison does not see a problem with this since 'following the Bingham report, people must have know something was coming'.

But the government paper widened the scope of the Bingham recommendation by saying that the legislation would cover building societies, insurance companies, friendly societies and investment businesses as well as banks.

This will be reflected by APB practice notes containing guidance on the application of the law to each separate area. The proposed SAS is there because Mr Morrison's organisation felt - in what looks like a recognition of the public's desire to see something being done - there was a need for an 'overall generic standard'.

Although he accepts that some people might not think it defines matters clearly enough, and therefore encourages them to report more than they need to, Mr Morrison insists that the draft standard is unequivocal.

It makes auditors report relevant information that comes to their attention in the course of their work without delay. It also requires them to do so in a form and manner that will enable the regulators to take appropriate action.

But it emphasises that there is no duty on auditors to act as bloodhounds and search out matters for report and that the proposed legislation does not alter the responsibility of directors of regulated organisations to ensure that information is made available to regulators.

Nevertheless, even those who feel unaffected by the move suggest that it might make the relationship between the auditor and client 'more brittle' because of the latter's fear that the former will be reporting everything.

Leaving aside the debate over who is the real client - the directors or shareholders - this is bound to create some discomfort since auditors of all kinds constantly complain that they do not receive enough credit for the persuading and cajoling work they do with managers behind the scenes.

While it was likely that the Bank of England and other regulators would receive more ad hoc reports under the new system, there was a danger that they would just be receiving bad news, one prominent auditor said. In the past, when auditors were not obliged to report every misdeed, they could convince the directors that they had a situation that needed sorting out. As a result, they were often able to go to the regulator after two to three days and report a solution as well as the problem.

There is also concern that auditors will have to report to every regulator involved rather than the one taking the lead role and that there will not be a sufficiently free flow of information between each other and between them and the auditors.

Such possible damaging side-effects of mere tinkering with the rules are leading Martyn Jones, national audit technical partner at Touche Ross, to call on the authorities to step back and decide on the overriding objective. If it is agreed that the aim should be to prevent another Maxwell or BCCI, then efforts must be made to counter the limits on auditors' powers by tilting the playing fields a little in their favour, he says.

Some help is provided by section 389 of the Companies Act, which makes it an offence knowingly to mislead an auditor. But it only applies to companies, and many financial organisations do not fit this description. They can be branches of overseas entities, partnerships or even sole traders.

Since auditors of financial institutions have a number of items to check on in addition to those for regular companies, they could be given significant help by extending the scope of the section to other organisations. Moreover, the increasing use of sophisticated technology and the fact that most management fraudsters are able to obtain help through engendering a climate of fear meant that introducing a general offence of deceiving auditors 'would really deal with the problem', Mr Jones claims.

(Photographs omitted)