FRC Annual Enforcement Review
Legal Development 28 July 2022 28 July 2022
UK & Europe
Insurance & Reinsurance
The FRC has today published its Annual Enforcement Review (the Review) for the year to 31 March 2022. As many of you will now be familiar, the Review typically provides an overview and analysis of enforcement action for the prior year and sets out their thoughts and areas of focus for the year ahead. This note provides a summary of what we see as being some of the key points from the Review, and our thoughts.
The key statistics
Cases concluded in the year
- The FRC has certainly had a busy year when it comes to concluding investigations. 17 investigations were concluded in the year, including five that are described as legacy cases (defined as opened pre 31 March 2018). This is a significant increase on the 10 concluded in 2020/2021.
- Of these 17 cases, one was a non-audit case concluded through a tribunal (the KPMG/Silent Night matter), 13 were audit investigations concluded through settlement (up on six in the prior year) and the remaining three were closed with no further action taken. The increase in number of cases concluded in the year is solely attributable to the number of cases concluded through settlement, and reflects the fact that many of those cases that were opened in the year or so after the introduction of the Audit Enforcement Procedure (AEP), and represented a significant increase in the number of cases being investigated, have been coming to a conclusion in the last year.
Case Examination and Enquiry activity
- Where things have perhaps been a little quieter is in respect of the number of cases opened by the Case Examination and Enquiry team (CEE). A total of 69 cases were opened by CEE, a drop of 27% on the prior year (95 cases were opened in 2020/2021, and 88 in 2019/2020). The fall in number of cases opened is attributed to fewer cases being identified through the CEE team’s ‘horizon scanning’. The largest source of cases referred to CEE is now other teams within the FRC (largely the Audit Quality Review (AQR) and Corporate Reporting Review (CRR) teams). 24 of these cases were resolved through constructive engagement. In absolute terms that is down from the prior year, but as a proportion of the total number of cases, does not seem to indicate any particular change in approach. 23 cases were closed with no further action.
- The number of new investigations opened has remained largely consistent with prior years. 15 investigations were opened in the year to 31 March 2022 (16 were referred to the Conduct Committee by the CEE team), slightly up from 14 in the prior year, and 15 in the year before that.
- As at the year end, there were 47 open investigations; 38 are investigations into audit firms and individuals for audit work, one is into individuals and a firm for non-audit work, and eight are into professional accountants working in business (all of which are linked to audit investigations). 28 of these investigations have been announced publicly, and are listed in an appendix to the Review. The average age of these cases is 24.5 months (see further comments below on the timeliness of investigations).
- Total financial sanctions imposed in the year have hit an all time high of £46.5 million (before discount, £34.6 million after discount). This is a significant increase from £16.7 million (pre discount) in 2020/2021 and £16.5 million (pre-discount) in 2019/2020. It is not however that surprising given both the number of cases concluded in the year, and the significance and seriousness of some of those matters. For some context, the Review draws a comparison with 2018/2019, a year in which 12 investigations were concluded, and fines reached £42.9 million (pre discount).
- That total figure breaks down as follows:
- £31.8 million - fines imposed on firms for audit related matters
- £1.1 million - fines imposed on audit partners for audit related matters
- £13 million – a single fine imposed on a firm for a non-audit matter; and
- £650,000 – fines imposed on individuals for non audit matters.
- Unsurprisingly, given the number of investigations concluded in the year, and the FRC’s increased focus on them, the number and range of non-financial sanctions has continued to increase.
- The total number of non financial sanctions imposed in the year (which does include reprimands, severe reprimands, exclusions and declarations, as well as those conditions and requirements aimed more directly at improving audit quality) was 62, a significant increase on 28 in the prior year. Conditions and/or requirements accounted for 15 of this total, up from 12 the year before. Given that only 14 matters were concluded with sanctions in the year, it seems clear that non-financial sanctions in the form of conditions and requirements are now essentially considered as an automatic part of any sanctions package.
- While the rationale for the use of these conditions and requirements as non financial sanctions, namely to drive improvements in audit quality, cannot really be argued against, it is clear that this type of non-financial sanction can end up being very onerous for firms, potentially extending over a number of years, and requiring a significant investment of time and money. The Review provides details of the conditions and requirements included in sanctions in the past year, including (a) requirements to report to the FRC in respect of audit work in specific areas; (b) appointing independent reviewers to conduct root cause reviews, reviews of policies, procedures and training plans, or a review of policies and procedures in respect of specific areas of an audit; (d) reporting to the FRC on an annual basis (of up to three years in some cases) on the impact of remedial measures taken by a firm or on monitoring programmes put in place (e) a review of an audit practice’s culture relating to challenge; (f) and requirements to undertake thematic reviews.
Discounts and cooperation
- The range of discounts offered by the FRC appears to be increasing, and was between 25% and 45%, reflecting the varying degrees of cooperation, including early admissions. Full and frank cooperation has of course been something which the FRC has been seeking to encourage for some time. In the Overview section of the Review, Executive Counsel notes that progress in this area has been slower than they had hoped, but that they have seen some positive changes (as reflected in the fact that discounts of up to 45% have been awarded in some cases).
- On the converse, the potential consequences of a failure to cooperate are highlighted in the Review through a spotlight on the Silentnight case. The Review notes that in deciding what sanctions to impose (a £13 million fine for the firm), the Tribunal made findings as to the behaviour expected of Members and Member Firms when responding to regulatory investigations. This included examples of failure to cooperate and the advancement of a defence which the Tribunal concluded the partner did not believe to be true. As the Review notes, Executive Counsel will take a robust approach to parties who do not provide the level of cooperation she considers is required, and will call out and out and pursue it.
Timeliness of investigations
- The FRC reports no increase in the proportion of cases meeting the KPI of two years from commencement of an investigation to issue of an Investigation Report, achieving this in 40% of cases. However, there has been a 23% increase in the size of the enforcement team. The Review notes that the FRC recognises the importance of timely investigations and that this remains a key priority.
- The average length of time to service of an Investigation Report, Proposed Formal Complaint or settlement has increased to 33 months (up from 26 months, and 23 months in 2019/2020). The Review seeks to attribute this (in large part) to three legacy investigations. One of these is the Sports Direct investigation, which was delayed by parallel litigation; another is one that has not been announced; and in the third, service of the Proposed Formal Complaint was also delayed by related litigation. Without these cases, the average is said to be 27 months, still a slight increase on the prior year. The time to complete cases resolved through settlement, as the majority now are, has also increased to 39 months (up from 31 months, and before that 23 months). This figure is no doubt skewed a little by some of the very long running ‘legacy’ cases that the FRC has managed to conclude in this past year, but is still not particularly encouraging.
- There has been a significant reduction in the time taken by the CEE team to investigate and refer matters to the Conduct Committee, with an average of 2 months (down from 4.5 months in the prior year).
Key themes from concluded cases
As they have done in previous years, the FRC has reviewed the cases concluded in the year and provided a summary of the key themes arising.
The Review identifies three common audit failings, which were present in all of the cases concluded in the year (albeit that two of the cases did not include scepticism failings):
- Failure to obtain sufficient appropriate audit evidence
- Lack of professional scepticism; and
- Failure to prepare appropriate audit documentation (which was also identified as an area of focus in the 2020/2021 Annual Enforcement Review)
In terms of audit areas, the FRC identifies the audit of management’s estimates and judgements as giving rise to many of the breaches seen in the cases concluded in the year, and notes that such areas require greater scrutiny. Specific examples given are:
- Contract accounting
- Loss-making contracts
- Accounting for goodwill
- Supplier rebates
- Incomplete information from management
- Compliance with laws and regulations
The Review notes that the current economic environment (including impact of inflation, the geopolitical situation and the withdrawal of Government support provided during the pandemic) and the increased pressures on management mean that the preparation of financial statements will continue to be challenging, and that auditors will need to be alert to greater risks in respect of management’s integrity and objectivity.
In terms of the areas of focus for the Enforcement team, it is said that they will be paying particular attention to deficiencies in areas where other parts of the FRC have issued guidance (AQR’s 'What makes a good audit' and 'Key Findings from the 2020/2021 inspection cycle', the CRR’s Reviews of Corporate Reporting and Regulatory Standards’ Professional Judgement Guidance). The Review also highlights the following key areas:
- Going Concern – given the economic climate and ongoing uncertainties, auditors will need to think widely about events and uncertainties that may affect companies, beyond the obvious.
- Judgements and accounting estimates – uncertainty makes it more difficult to make estimates and to provide support for those estimates. Auditors will need to remain alert to indicators and risks of management bias. The Review notes that challenge of management remained a feature in enforcement cases in the year, and while such challenge may have improved generally, it will remain a priority for auditors to appropriately challenge management and ensure that this is properly recorded in the audit file.
- Integrity and objectivity – it is noted that this was highlighted in the last Annual Enforcement Review in the context of accountants working in business and that it has continued to be a theme in enforcement investigations in the year, for both auditors and accountants in business. The FRC will continue to pay close attention to ethical issues in its monitoring of published financial statements and the conduct of audits through the CRR, AQR and Audit Firm Supervision teams, as well as the Enforcement team continuing to horizon scan and respond to information in the public domain, to identify issues that may require further examination.
- ESG reporting, in particular relating to climate – the Review refers to the fact that there is growing interest in how companies report the impact of their activities on the environment, and on the wider environmental and social challenges, but that reporting on environmental impact and mitigations is complex, and it has been difficult to create clearly defined and comparable benchmarks as, for example, gender pay gap reporting. Auditors’ focus on this area will continue to be challenged and to be challenging, but ultimately the principles underpinning the audit of environmental reporting are the same as for all audit work. The difference, and difficulty, is the lack of standardised data and the absence of a mature and benchmarked financial reporting framework.
As always, the Annual Enforcement Review provides a useful overview of the Enforcement team’s activity over the year, and a steer for what they may be focusing on in the year ahead, even if the content does not come as much of a surprise to those of us and you who are involved with the FRC on a regular basis. Some key takeaways from us are:
- The continued use of the constructive engagement process to resolve matters is encouraging, as is the improvement in time taken to close out these matters.
- We can expect to see the FRC continuing to encourage full and frank cooperation. While it will not be appropriate or possible in all cases to proactively go to the FRC with early admissions and the like, it is clear that if firms do go down that route, the FRC is willing to reflect that in some relatively significant discounts in financial penalty.
- Similarly, where audit failings are identified, it is increasingly important for firms to be on the front foot in terms of remedial action. Not only is this helpful in terms of discounts to the financial penalty, but it may also help put the firm on the front foot when agreeing non-financial sanctions, and potentially to avoid some of the more onerous and ongoing commitments.
- The average time taken to conclude matters continues to increase, notwithstanding the growth of the FRC's staff resources. It is not possible to glean from the Review to what extent this is a function of the complexity of matters under investigation, the result of under resourcing, or a product of some investigations being held up by disputes over the merits of the FRC's allegations. It will be interesting to see if this improves over the coming year, as most of what are referred to as legacy cases, have concluded.
 A summary of each of the concluded cases is included in the Review, along with more detail in Appendix D