The measure is welcome in as much as it will help to restore confidence in the integrity of the City and bolster the public's perception of regulators and the auditing profession.
Over the past few years there has been a series of high-profile financial scandals - among them, Maxwell, BCCI, Barlow Clowes and Guinness. The Serious Fraud Office has indicated that the sum lost through management fraud in 1991 was double that lost in household burglaries; the main victims have often been small investors and pensioners. Steps have been taken to find remedies.
The reports of the Goode Committee on pension law and the Cadbury Committee on corporate governance are helping auditors to put their own house in order. Meanwhile, the City's leading regulator, the Securities and Investments Board, has indicated that it wishes to step up regulation - by banning prescribed people from carrying on investment business and by introducing a greater level of monitoring. The Government should also be commended for getting tougher with criminals.
These initiatives will go some way to preventing further scandals. However, an important area remains to be tackled: the business 'playing field' is tilted in favour of the fraudster and against regulators and auditors.
Business is becoming more international. Modern computer and printing technology makes it easier for documents purporting to be from third parties to be forged and to appear as credible documents; the Audit Commission has warned that technology is being used to erase and reprint extracts of documents in a way that is impossible to detect through inspection alone.
Fraudsters coerce, bully or merely request staff or third parties to prepare such documents or to give false explanations. Therefore, regulators and auditors are increasingly exposed to the risk of being misled by fraudsters and their accomplices.
There is a limit to the price companies - and ultimately their customers - are willing to pay for protection against fraud. This puts constraints on the procedures and duties that auditors can realistically perform. A cost-effective solution is therefore required.
The remarkable lack of powers available to auditors is not generally appreciated by the pubic. Auditors cannot, for instance, put people under oath; they have no rights to search the records and premises of third parties; they cannot insist on auditing related-party entities; and they cannot even gain access to the banking system to check where money actually flows from or to.
This is not to suggest that the time is right for auditors to be given such powers. However, they should have rights relating to information given to them by responsible directors and staff of a company. There is already some legal support in the form of Section 389A of the Companies Act and occasionally in equivalent legislation for other types of entity. However, this is limited and has numerous failings.
It does not apply to unincorporated banks or insurers, unauthorised deposit takers, pension schemes or people carrying on investment business but without authorisation.
Nor does it apply to engagements by reporting accountants for Stock Exchange purposes.
The provisions extend only to officers of companies, not staff or third parties who knowingly make statements to or for auditors that are misleading, false or deceptive. The law therefore fails to recognise that it is difficult for a large fraud to be perpetrated by just one fraudster. In reality, fraudsters usually need to persuade others to assist them in their wrong-doing.
But the main failing is that the legislation, weak as it is, is not being enforced and therefore no real deterrent actually exists.
Legislation is needed to extend the scope of the existing provisions to cover not only misleading statements knowingly made by officers of a company that result in material loss, but also such statements by employees of the business or by any third party. It should also extend to the destruction or suppression of accounting or other company records that are relevant to the inquiries of auditors or reporting accountants.
The maximum custodial sentence should be increased from two to five years. A new civil penalty should also be created that provides for a person who knowingly makes a misleading statement to auditors to be liable to the company (without indemnification from any other party) for any damage or loss arising.
Equivalent provisions should be included in the legislation covering investment business, banks, insurance companies, friendly societies, building societies, pension schemes and Lloyd's entities.
Meanwhile, similar legislation should be enacted to deal with those who knowingly mislead regulators, who have an even greater interest in detecting and preventing corporate fraud.
The prosecuting authorities would benefit through the vigorous pursuit of apparent offences under this legislation. In particular, where clear evidence exists that forged documents have been presented to regulators or auditors, cases should be brought in advance of other charges, such as common law fraud, that require lengthy trials and that are frequently very difficult to pursue.
Therefore, instead of calling for an extension of auditors' powers that might make the audit uneconomic, the emphasis would be on taking cost-effective steps to enhance the deterrent effect of misleading regulators and auditors, and to make it harder for a fraudster to involve others.
Unless such steps are taken, the incidence of management fraudsters deceiving auditors and regulators is likely to grow. It's time to tilt the playing field against the crooks.
The author is national audit technical partner with Touche Ross.
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