FRC Consultation on reforms to the Audit Enforcement Procedure
5 August 20215 August 2021
On 22 July 2021, the Financial Reporting Council (FRC) launched its long-awaited consultation on reform to the Audit Enforcement Procedure (AEP). The AEP was introduced in June 2016 and is the enforcement and disciplinary regime that applies to investigations commenced by the Financial Reporting Council after that date. Whilst numerous investigations have been conducted under the AEP, as yet none has gone to a contested Tribunal hearing. In large part this may be a reflection of the change in the burden of proof from the test of ‘misconduct’ under the Accountancy Scheme (“the Scheme”) to the comparatively low test of a ‘breach of a Relevant Requirement’ under the AEP.
Following its consultation which closes on 7 October 2021, the FRC is proposing a number of amendments to the AEP. It is unclear when the new AEP rules may be introduced. It should be noted that the changes proposed deal with the existing regulatory framework for auditors of PIE entities and do not address the regulatory and investigations framework envisaged in the Government’s recent White Paper on corporate reform (e.g. the regulatory framework that will apply to investigations involving non-accountant company directors alongside auditors).
Clyde & Co’s accountants’ liability and regulatory team have advised and continue to advise firms, on a daily basis, on some of the largest investigations under the AEP and Scheme. In this bulletin we summarise some of the key changes being proposed:
Investigatory stage and role of the Enforcement Committee
A number of proposals are directed towards streamlining the final steps in the investigatory stage and removing the role of the Enforcement Committee in that phase. In particular:
It is proposed that the Initial Investigation Report be dispensed with, so that the Executive Counsel proceeds directly to issuing a final Investigation Report to the respondents on which they may make submissions within the 56 day period currently prescribed for responding to an Initial Investigation Report. Respondents may be concerned that this development could reduce the likelihood of their submissions impacting on the conclusions that are reached by Executive Counsel, but it remains the case that Executive Counsel must consider their submissions before preparing a Decision Notice.
The current requirement that “any relevant accompanying papers” be served at the same time as the Initial Investigation Report is now altered to a requirement to “disclose the key evidence that Executive Counsel considers relevant” when serving the Investigation Report. Whilst this might mean that disclosure is not limited to material specifically referenced in the Initial Investigation Report, it might also mean that not all of the material referenced is provided. It could mean that witness interviews are not disclosed in full, and that insufficient material is disclosed to enable the respondent auditors to understand the nature and extent of suspected fraud that has been uncovered since the audit, where that is relevant. In our view, although Executive Counsel has tended to adopt a sensible approach to disclosure in the AEP in these respects, it would be preferable for there to be greater detail in the disclosure obligation.
At present, Executive Counsel refers cases to the Enforcement Committee after issuing her Decision Notice, and that committee then proceeds to issue its Decision Notice. The intention is that the Enforcement Committee stage will be abolished. The draft revised AEP proposes instead the issuance of a Proposed Decision Notice by Executive Counsel to respondents, who (as in the current AEP) will be given 28 days to accept the proposed findings, sanctions and costs. Where a respondent agrees the Proposed Decision Notice, an Independent Reviewer will now be appointed to review and (if appropriate) approve Executive Counsel’s Proposed Decision Notice. The Independent Reviewer is a new role, and will be a lawyer drawn from amongst the individuals who are on the panel of Tribunal members from which Tribunals are appointed. The consultation paper notes that the Enforcement Committee has not yet performed its role in any investigation to date, due to matters being resolved before reaching that stage, and states that an Independent Reviewer will ensure “a suitable degree of independent oversight following the conclusion of the investigation” in place of the Enforcement Committee.
A respondent would be able to agree to the case being referred to a Tribunal for consideration under rule 29(d); it is not clear in the draft revised AEP how early this right could be utilised (for example, without there being any Investigation Report or Proposed Decision Notice).
If the Proposed Decision Notice is not accepted, it would be Executive Counsel (not, as currently, the Enforcement Committee) who would refer the matter to a Tribunal. A new provision states that the Proposed Decision Notice could not be shown or referred to the Tribunal until findings have been made by the Tribunal on the allegations of breach of relevant requirements (draft rule 36). Helpfully, the revised draft AEP no longer speaks of Executive Counsel setting out “adverse findings” - a notion which creates potential difficulty for handling reporting obligations that are triggered by regulatory findings - but the Proposed Decision Notice would still be required to set out “breaches of relevant requirements” and by the same token, therefore, it would be best for the rules to stipulate that when issuing the Proposed Decision Notice, Executive Counsel should state that these are her proposals for the contents of a Final Decision Notice if the respondent is prepared to accept them and are subject to the approval of the Independent Reviewer.
An entirely new section of the AEP deals with Settlement (Part 6 of the draft revised AEP). This enables settlement discussions to take place at any stage after a Notice of Investigation up until the Tribunal issues a Final Decision Notice. The draft revised AEP states that “where, following settlement discussions, Executive Counsel is minded to agree terms of a settlement with the Respondent, Executive Counsel shall issue a Proposed Settlement Decision Notice to the Respondent”. A Proposed Settlement Decision Notice is required to include details of agreed sanctions and costs as well as adverse findings, and so would not be issued where adverse findings have been agreed but a dispute remains over sanctions (such cases would presumably proceed on the basis of allegations of adverse findings that were admitted). An ‘Independent Reviewer’ must be appointed to review the Proposed Settlement Decision Notice that has been agreed between the Executive Counsel and a Respondent; if the Independent Reviewer does not approve the settlement then he or she must give reasons and invite written representations; if the Independent Reviewer then continues to decline to approve the settlement then the Executive Counsel may either resume settlement discussions or proceed with enforcement.
The scope of an investigation and details of the “allegation”
The draft revised AEP has redefined the term “Allegation” so that in the AEP it refers only to the matters raised in the particularisation of the complaint served by Executive Counsel at the start of the Tribunal process following an investigation.
Currently “Allegation” is used in the AEP rules to refer to issues being investigated and pursued in the Tribunal process at various stages of the procedure from the case examination stage onwards, including before any allegations are actually presented, and is therefore a potential source of controversy and confusion (not least because the issues actually alleged in the Tribunal process may differ markedly from, or be only a subset of, the issues that were initially considered at the case examination stage). Abandoning the current use and meaning of the term “allegation” in the AEP is to be welcomed.
The current definition of “Allegation” relates to information which raises a question as to whether there has been a breach of a relevant requirement; the same concept is retained as the test that still applies at the case examination stage, so that the abandonment of the use of the defined term should not in itself make any difference to case examination outcomes.
However, the draft revised AEP continues to maintain vagueness in describing what issues are the subject of the Board’s deliberations when it decides whether to investigate: draft rules 6 to 11 refer to “the matter”. It seems likely, based on a reference to “the matter” in draft rule 5(d), that “the matter” is intended to correspond to the issues considered by the Case Examiner that raise a question as to whether there has been a breach of a relevant requirement, but the lack of clarity on this point is undesirable. This would mean that new issues which were not raised during the case examination stage may be introduced at the point when a referral is made to investigation, which weakens the value of the case examination stage and adds potential uncertainty. There should be greater transparency as the nature of the issues that are under consideration by the Board for referral to Executive Counsel for investigation, so that respondents have a proper opportunity to respond to issues before that decision is taken.
On a related note, the draft revised AEP does not meaningfully alter the obligation on the FRC to identify the scope of its investigation, which remains expressed in unhelpfully generalised terms (but has changed the obligation from being a requirement to “outline” the scope, to a requirement to “state” the scope). Similarly, the power to require information from a respondent is still not limited to issues within the scope of the investigation but extends to information relating to the audit that is the subject of investigation. There is a proposed new provision for the FRC to amend the scope of the investigation by notice (rules 12 to 13).
Tribunal procedural changes
New proposed rules provide for:
the appointment of a Tribunal following a referral;
service by Executive Counsel of the allegations in the disciplinary proceeding within 56 days of the Tribunal’s appointment;
attempts to agree case management directions within 21 days of service of the allegations, failing which a case management hearing will be held;
a requirement that case management hearings and interim order hearings are heard in private;
minimum time periods ahead of hearings for service of Notice of hearing by the Tribunal;
the ability to call expert evidence where permitted by the Tribunal;
allegations of breach of relevant requirement to be dealt with at a Liability hearing, with a separate Sanctions and Costs hearing to be convened after any Adverse Finding is made by the Tribunal;
the making of closing submissions at a Liability hearing including submissions in reply by Executive Counsel;
confidentiality to attach to any information disclosed by any representative of the FRC to any person that is not already in the public domain.
The current rules are silent on these steps and matters.
The draft revised AEP clarifies that the FRC has the power to require respondents to provide information in the form of newly created documents, and that its information-gathering powers that are exercisable against various categories of persons include the right to require individuals to attend for interview.
One of the additional rules that the new draft revised AEP would introduce is a provision that would treat any findings “or court-approved statement of fact” by certain other judicial bodies or quasi-judicial bodies as prima facie evidence of fact, including findings in reports of an inspector appointed under the Companies Act 1985, findings in civil or criminal proceedings in UK courts, and findings in any proceedings before, or report by, any regulatory, professional, supervisory or disciplinary body in or outside the United Kingdom (or any predecessor or successor body or similar body that performs additional similar functions).
The draft revised AEP includes a substantially expanded section on Interim Orders, now to be dealt with in Part 5 of the Rules, which sets out how and when Interim Orders can be made in advance of a Liability Hearing, the content that must be included in any application for an Interim Order by Executive Counsel, and the factors that will be taken into account by a Tribunal when considering whether to make an Interim Order. Interim Orders may be made where required in the public interest or where necessary for the protection of the public.
The section of the AEP dealing with appeals has been expanded and now proposes that:
the right of appeal shall be extended to circumstances where the Tribunal decision was “based on a material misstatement of fact”. It is not clear whether the misstatement is required to have been made by the Tribunal itself, or by one of the parties (or any non-party giving evidence of fact)
an application for permission for appeal would now be dealt with by a member of the Tribunal panel who is a member of the judiciary or a Queen’s Counsel and will no longer be a person who is a member of the Appeal Tribunal that will hear the appeal if leave is given;
appeals may be dealt with on paper without a hearing if the Appeal Tribunal considers that is fair in all the circumstances;
admissions may be made during the appeal;
further evidence may be adduced with the leave of the Appeal Tribunal if it is satisfied that there is good reason why this evidence was not adduced previously; however, the appeal as a whole is to be a review rather than a rehearing.
the Appeal Tribunal may consider “any significant and relevant evidence” even if that evidence would not be admissible in a court
As we have previously commented, our view is that it is important aspect of any regulatory regime that any right of appeal of a decision by a Tribunal should be to a body out with the existing regulatory regime in order to (a) guard against the risk of creating an echo chamber; (b) improve quality of decision making; and (c) ensure confidence in regulatory regime. This role is performed admirably by the High Court in respect of the solicitors profession and in our view auditors should be afforded the same right of appeal.
Proposed provisions on sanctions have aligned the ability to impose reprimands with the power created by SATCAR, correcting an existing anomaly in the AEP, and have removed the 3 year ceiling on bans that may be imposed on carrying out statutory audits and signing audit reports. Also, it is proposed that a Tribunal or Appeal Tribunal may order the Respondent to pay all or part of the Tribunal’s Costs in respect of the Hearing. It is unclear what these costs would include (e.g. fees for time spent).
The existing provision for a joint hearing of allegations under the AEP against different respondents is to be extended under these proposals to cover allegations arising from related circumstances (and so will no longer be limited to “the same circumstances”).
Paragraphs 153-160 of the draft revised AEP make provision for Executive Counsel to have the discretion to cause a Joint Tribunal to be convened to hear disciplinary allegations under the AEP and under the Accountancy Scheme or the Actuarial Scheme, where there is a common question of law or fact; some or all of the acts or omissions which form the subject matter of the different sets of allegations arise wholly or in part out of the same event or events or circumstances; or there is a compelling reason in the opinion of Executive Counsel why the allegations should be heard jointly.
Where such joinder takes place, the allegations will be determined in accordance with whichever disciplinary scheme applies to the allegation in question. Appeals by multiple respondents from a Joint Tribunal may be heard by a Joint Appeals Tribunal.
Finally, it should be noted that there is provision for respondents to object to a Joint Tribunal hearing of matters being pursued under different FRC disciplinary schemes where this is not desirable or would be inconsistent with dealing the matters justly and at proportionate cost. There is however no specific provision for respondents to apply for a Joint Tribunal to hear matters against them and respondents to proceedings under other FRC disciplinary schemes, or for an AEP Tribunal to make an order for a Joint Tribunal of its own volition.
The draft revised AEP includes Transitional Provisions which are relatively complex in that the changes introduced will apply to some existing matters depending on the stage that has been reached. The general rule stated, which is subject to exceptions set out in the Transitional Provisions, is that “all matters relating to the alleged breach of a Relevant Requirement are to be conducted in accordance with the provisions of the AEP in force at the time of the proceedings”; it is not quite clear but it appears that this means “currently in force” rather than “in force at the time of commencement of the proceedings”. Matters where Executive Counsel has issued an Initial Investigation Report or Decision Notice under existing rules, but have gone no further by the time that the new AEP rules come into force, are subject to deeming provisions which will treat these documents as the equivalent of a step in the new AEP rules.
Nothing in the consultation paper refers to the need to make similar changes to the Accountancy scheme (or the Actuarial scheme) but clearly there will need to be in order to introduce the potential for Joint Tribunals and to align rules on matters such as Case Management Hearings being held in private.
Over the coming weeks, we will be seeking views on the FRC’s proposed reforms as well as more general changes in line with our own experiences on a number of investigations under the AEP together with those received in response to our survey last year on areas for reform in the AEP. In the meantime, if you would like to discuss anything arising from the consultation, then please do contact us.