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Trouble follows the audit trail

Criticism of self-regulation mounts
THE CONCLUSION of the Institute of Chartered Accountants in England and Wales last month was cryptic. It admitted three of its members had a case to answer after they signed audits for Petersham House Kensington Residents Association, a property company liquidated in 1992, saying it was dormant when in fact it was actively trading. But it then denied any action was necessary. How it arrived at that contradiction it will not say.

Some laymen reading that letter might detect a whiff of whitewash. It is not the first instance when investors and the public have been left wondering what really went on after auditors are called to account - other examples include Polly Peck and the Mirror Group pension scheme.

Even if a disciplinary committee's decision is justified, the gap between reality and the public perception of an old-boy network taking care of its own is damaging to the profession, according to Nick Land, senior partner-elect at Ernst & Young - the accountancy firm that last week launched an unprecedented attack on its professional body's self-regulatory regime.

"There is a danger that it's seen to be a secret society with secret handshakes and all that stuff," Mr Land said. "Even if you can make self- regulation work, no one will believe you've made it work." The solution proposed by Ernst & Young is to hand regulation over to an independent organisation, sitting in public and using due process. One possible candidate for taking on the duty is the Financial Reporting Council.

If Ernst & Young succeeded in overturning the system for auditors, other professions would come under pressure to make similar changes, Mr Land said. "I don't think it will necessarily lead to better decisions, but it will lead to less suspicion."

Other critics go further. Roger Hussey at the Bristol Business School said firms should be barred from doing both audit and non-audit work for the same company, because auditors might be tempted to give a more favourable report if lucrative tax and management consultancy contracts were at stake. He also called for mandatory rotation of auditors after five years and for the DTI, rather than boards of directors, to appoint them.

Auditors were too close to management, said Christopher Napier, a senior lecturer in accounting at the London School of Economics. "The audit process gives management the benefit of the doubt."

Unsurprisingly, company managers, who like their auditors compliant, tend to support self-regulation. In a survey of almost 800 finance directors last summer by Professor Hussey, 59 per cent thought auditors should regulate themselves.

Many of those opposed to self-regulation had strong feelings on the subject. "Higher echelons of the profession are blatantly unable to operate self- regulation," said one finance director. "Stronger action needs to be taken by the relevant institutes against auditors and company directors in cases where negligence is proven," said another. One accountant described disciplinary committee hearings as a "kangaroo court".

Of the six professional bodies that represent accountants in the UK, only two - the Institute of Chartered Accountants in England and Wales, and its Scottish counterpart - have members that audit a lot of listed companies. Each has its own disciplinary committee, but their rules are set by the Auditing Practices Board, a sub-committee of the umbrella organisation for all six bodies. Another sub-committee monitors auditors.