The Financial Reporting Council ("the FRC") has published the much anticipated report of the review of its sanctions regime for accountants under the Accountancy Scheme (contained in the Sanctions Guidance) and the Audit Enforcement Procedure ("AEP") (contained in the Sanctions Policy) ("the Report").
The review was carried out by an independent panel chaired by the recently retired Court of Appeal Judge Sir Christopher Clarke and heard submissions from a wide range of interested parties.
In its Report, the Review Panel have made 17 recommendations to the FRC for consideration. Below is a summary of some of the key points arising from the Report:
1. Aims of sanctions: The Report recommends that the purposes of sanctions as articulated in the Sanctions Policy (under the AEP) and Sanctions Guidance (under the Accountancy Scheme) are amended to properly reflect that the primary objective of the sanctions regime is to uphold and enforce proper standards of conduct and reflect the basic principle that maintaining public confidence is at the heart of the sanctions regime. This thread can be seen reflected in many of the other key points outlined below.
2. Approach to be taken when determining sanctions: The Report acknowledges criticism of the lack of practical assistance under the current regime to enable those affected to assess what level of penalty they should expect for what conduct and the absence in the current framework of any reference to a 'bottom up approach' (i.e. that a tribunal should impose the lowest penalty that is needed in the circumstance of the case). The Report concludes that:
- The current requirements for there to be an explanation at each stage of the sanctions determination process (under paragraph 16 of the Sanctions Guidance and paragraph 19 of the Sanctions Policy) is unnecessarily formulaic and should be replaced by a requirement that Tribunals ensure that their decisions give reasons which indicate more generally, although by reference to the above paragraphs, what view they have reached and why.
- The requirement for the Tribunal to identify the range within which any fine might fall should be removed.
- The Sanctions Guidance and Sanctions Policy should be amended to ensure that when assessing the nature and seriousness of the wrongdoing, additional factors, including the level of co-operation of the Member or Member Firm with the FRC (or other body); the impact on the Member or Member Firm of involvement in the investigation; and any remedial actions taken by the Member or Member Firm are included in the current factors contained at paragraph 18 of the Sanctions Guidance and paragraph 21 of the Sanctions Policy (and that the Guidance and Policy are in line with each other).
No amendments are required to the existing framework with regard to a 'bottom up approach' as the Sanctions Guidance and the Sanctions Policy expressly refer to the principle of proportionality and thus "A sanction that exceeds what is necessary is by definition disproportionate". The Report does however go on to state that "A sanction or combination of sanctions that is proportionate will be that which is no higher than is required to meet the objectives of the Schemes/the AEP and is commensurate with the seriousness of the case."
3. Tariffs and guidelines: The Review Panel considered a number of different examples of sanctions guidelines with regard to the level of penalties to be applied, in particular those issued by bodies such as the ICAEW and the FCA. However, in circumstances where every case before the FRC is different, it concluded that the introduction of strict guidelines or tariffs for penalties, bandings or metrics would not be helpful and instead approved the approach espoused by the US Public Company Accounting Oversight Board ("the PCAOB") which avoids prescriptive formulas and looks to decide each case on its own set of facts/merits.
4. Calculating fines/financial penalties: Consistent with the above, although it considers in some detail how the calculation of any penalty or fine might be determined, the Report declines to make any formal recommendations for a change in the current rules in relation to calculating the level of penalties or calculating fines by reference to revenues, audit fees or profit. It concludes that the existing framework at paragraphs 31 and 45 of the Sanctions Guidance/Sanctions Policy which sets out that "the relevant decision maker should aim to impose a fine that is proportionate to the Misconduct/breach of Relevant Requirements and the circumstances of the case; which will act as an effective deterrent to future Misconduct/breach of Relevant Requirements; and which will promote public confidence…" is sufficiently broad as to allow the Tribunal scope to impose what it considers the correct level of sanction(s).
The Report goes on to recognise that there is "no evidence that an inadequate level of fines has caused or contributed to a continuance of, or rise in, misconduct" and that there is a "serious risk" that large regulatory fines could lead to audit firms, particularly small or medium sized ones, declining to undertake audit work at all, "particularly in relation to those companies most in need of robust auditing." The Report recognises that this would not be in the public interest at all, and "counterproductive and defeat the FRC's role to promote good financial reporting."
Having concluded as above, and as has been reported in the press, the Report goes on to ask (and answer) the hypothetical question "what should be the sort of maximum fine for a major firm in a serious case." The Report states that in circumstances where a Big 4 firm is found guilty of "seriously bad incompetence, in respect of the audit of a major public company, where the errors were measured in nine figures or more and there had in consequence been either widespread actual loss or the risk thereof, a financial penalty of £10 million or more (before any discount) could be appropriate as being (a) commensurate with the seriousness of the wrongdoing; (b) a meaningful deterrent; and (c) sufficient to meet the primary objectives of sanctions." It is important to note that the Review Panel is here giving only a view (and make no specific recommendation) on a possible maximum figure for a fine on those particular firms in that combination of circumstances. The Report goes onto state that the above "assumes that the failings did not involve dishonesty or conscious wrongdoing. If they did, the figure could be well above that."
5. Dishonesty: The Report recommends that in cases where an individual has been found to have been dishonest, that individual should be excluded from the profession for at least 10 years.
6. Inadvertent wrongdoing versus dishonesty: The Report accepts that there is a distinction between cases involving fraud, dishonesty, deliberate error or recklessness on the one hand and those which have none. However, the Review Panel considered that the deterrent effect of a fine would still be a relevant consideration in cases that did not involve dishonesty or deliberate fault. The Report goes on to state that the "absence of dishonesty does not mean that a substantial financial penalty may not be needed to mark the seriousness and significance of the wrongdoing" and thus to act as a deterrent.
The Report concludes that the prospect of significant financial penalties for errors is likely to: (1) be one of the factors that encourage improved training and review/compliance procedures, thus contributing to "enhanced diligence"; and (2) maintain public confidence in the profession in the knowledge that those who are guilty of serious failings will be dealt with appropriately.
7. Non-financial sanctions: The Report recommends that greater attention should be given than has been in the past to the use of non-financial penalties particularly in circumstances where the AEP applies the low hurdle of a breach of Relevant Requirements which include failings that would not constitute Misconduct under the Accountancy Scheme.
In particular, the Report recommends consideration as to whether the objectives of the Scheme can be achieved without a financial penalty, or with a lesser financial penalty, by the use of financial sanctions such as a Reprimand or Severe Reprimand and the acceptance of undertakings or the giving of directions such as those contained in the Sanctions Guidance (paragraph 27) to improve the quality of work with supervision or monitoring or other quality assurance measures or restrictions.
8. Insurance arrangements: One much-anticipated area of the Report was whether any recommendations would be made in relation to whether insurance provisions ought to affect the level of sanction imposed on an individual. The Report concludes that no changes are required to the existing framework and sets out that "We do not think that no fine should be imposed on an individual because the firm will pay it; nor that it should be increased because the firm will do so... If the individual is not going to have the fine paid by his firm, and would be in difficulty in paying what is prima facie the appropriate fine, that is potentially a good ground for a reduction."
9. Sanctions imposed by another regulator: The Review Panel acknowledged that there is an inconsistency between the Sanctions Guidance and the Sanctions Policy in whether other regulatory sanctions are to be considered when assessing the appropriate level of fine. The Report recommends that due regard be paid to sanctions imposed by another regulator, to avoid the FRC fine being disproportionate. The Report recognises the difficulties in implementing this approach in practice in circumstances where there may be other regulatory sanctions imposed in future, but ultimately makes no formal recommendation to address this issue.
10. Compensation: The Review Panel considered whether the Sanctions Guidance/Sanctions Policy should be amended so as to encourage Tribunals to require the payment of compensation. The Report rejects this proposal recognising that the payment of compensation is a matter for the civil courts and a well-established line of case law exists as to whom, as a matter of law, obligations are owed by accountants and auditors.
11. Settlement: The Report sets out that "the FRC Enforcement Division was strongly of the view that ranges of percentage discounts should be reviewed to ensure that there are far greater incentives for early settlement." The Report addresses the issue of settlement in some detail concluding and/or recommending that:
- A greater incentive should be provided for timely settlement; and so the period in which the discount of 20% - 35% is available if settlement takes place should be extended to one month after the delivery of a Formal Complaint under the Schemes or up to the issuance of an acceptance of Executive Council's Decision Notice (in accordance with Rule 17 of the AEP); in addition the discount should ordinarily be 35%.
- The discount of up to 20% in the case of the Schemes and of up to 15% under the AEP should not be available if settlement has taken place only in the month before the hearing. In each case, the discount available in the month before the hearing should be a reduction of up to 10%;
- The full discount should not only be available if the Member or Member firm admits substantially all the heads of complaint of the formal Complaint/all the Adverse Findings in the Decision Notice;
- An appropriate level of discount should be allowed where the Member or Member Firm agrees the facts and liability but not the level of financial sanction or discount, but it does not follow that the level of discount should be the same as the discount applicable if those matters had been agreed;
- Any discount should not apply to any part of the proposed penalty which equates to the disgorgement of a profit made or loss avoided or the repayment or waiver of a fee, on the basis that such elements are largely restitutional in character and a discount on them is considered inappropriate;
- It be borne in mind that "...a regulator has public duties to perform; and is not in the business of bartering a reduction in what he regards as the necessary basic level of sanction in exchange for early settlement." In circumstances where the Review Panel had been informed that the Enforcement Division endeavours to give information as to the type of sanction that it has in mind at an early stage and is prepared to have sensible settlement discussions provided that it has been able to investigate matters to its satisfaction, the Report concludes that no changes to current framework are required save to encourage this approach;
12. Co-operation: Although no formal recommendations are made, the Report suggests that the FRC and the Executive Counsel should consider whether further examples could be given in the Sanctions Guidance/Sanctions Policy as to what "co-operation" may include. The Report also sets out that "there may be cases where a discount of up to 50% of any financial penalty is appropriate. This might arise, for instance, where no dishonesty or want of integrity was involved; where a firm had reported itself to the FRC; had shown insight into what went wrong; had carried out all necessary remedial measures speedily; and had co-operated fully at every stage and had agreed the facts and its liability very early on."
13. Costs: The Review Panel considered submissions made to it for a system which would place the FRC at risk on costs if it rejected a proposed settlement (similar to that in the Civil Courts under Part 36 of the Civil Procedure Rules). The Report rejects this on the basis that the FRC in conducting disciplinary investigations and enforcement proceedings, is not in the position of a civil litigant and therefore "should not have to pay costs if it has pursued allegations which a reasonable person could think it right to pursue." However, the Report recommends that consideration should be given to situations where, for example, the Tribunal concludes that a large proportion but not the whole the Formal Complaint is dismissed and it was unreasonable to pursue that (failed) portion. The Report therefore recommends that the FRC should reconsider the current terms of paragraph 9(9) of the Schemes.
14. Delay: Although the issue of causes of delay and recommendations as to steps to address this are outside of the scope of the Review Panel, the Report highlights the often considerable time taken to complete the disciplinary procedure and acknowledges that "…significant delay in the initiation and conclusion of disciplinary proceedings is highly prejudicial to the satisfactory working of the regulatory regime and has deleterious effects on individuals and firms".
The Report sets out that the Review Panel understands that "the current aim is that no more than two years (and preferably considerably less) should elapse between the start of an investigation and a Proposed Formal Complaint or Initial Investigation Report."
The Report concludes that "substantial delay potentially affects the fairness of proceedings; limits the range and effectiveness of sanctions; prevents lessons from being timeously learned and acted upon (and audit quality thereby improved); and does nothing to promote, and may well reduce, public confidence in the profession and its regulations." It therefore recommends that as much as can possibly be done should be done to accelerate the process of initiation and resolution of disciplinary proceedings.