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FRC’s audit enforcement – more remedial action for auditors?

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FRC's audit enforcement - more remedial action for auditors? 1

By Andrew Howell and Georgina Jones.

With recent accounting scandals such as Wirecard, we’re seeing a continuing focus on the role of auditors in detecting fraud and, the importance of confidence in the audit process for corporate reporting.

The Financial Reporting Council (FRC), principal regulator of the profession (and accountants in business), recently published its Annual Enforcement Review 2020. It analyses its enforcement actions and outcomes across the past 12 months, identifying key themes and issues, and sets itself performance objectives for the year ahead.

One of the notable themes coming out of the Review is the FRC’s greater focus on the use of remedial action and non-financial sanctions as a means of driving audit quality within audit firms. It seems to us a sensible development.

Despite being criticised for not being tough enough on audit firms (total fines have come down this year, although the trend of fines in individual cases is on the rise), the FRC has focused on measures aimed at achieving lasting improvements in audit quality. Heavy fines, while inevitable in the more serious cases, mark public censure but do not in themselves change practices, and ultimately can reduce a firm’s resources to invest in audit quality. Audit cases dealt with by the FRC are rarely about intentional conduct by auditors. Far more often, they relate to errors of judgement, points missed in audit work, or inadequate processes. Non-financial sanctions can be a much more direct mechanism to promote investment of time and resource into audit improvement across a firm.

FRC’s enforcement powers

The FRC became the “competent authority” for audit in the UK under the Statutory Auditors and Third Country Auditors Regulations 2016 (SATCAR), which came into force following the EU Audit Regulation and Directive. SATCAR requires that the UK has effective systems of investigations and sanctions to “detect, correct and prevent inadequate execution of statutory audit” – which led to the implementation of the Audit Enforcement Procedure (AEP).

Under the AEP, a statutory auditor and/or statutory audit firm may be liable to enforcement action where there has been a breach of the Relevant Requirements of SATCAR 2016, the EU Audit Regulation or the Companies Act 2006. This creates a very low hurdle for regulatory sanction. Any breach of any auditing standard can be sanctioned, however trivial, although the FRC has increasingly been willing to handle the more minor cases through constructive engagement.

The FRC has a wide remit of sanctions at its disposal, which can be imposed singly or in combination. Possible sanctions include permanent or temporary prohibitions on the auditor performing statutory audits or signing audit opinions; exclusion of the auditor as a member of a recognised supervisory body; financial sanctions; declarations that the statutory audit report did not satisfy the relevant requirements; requiring the auditor or firm to cease or abstain from certain conduct  and ordering a waiver or repayment of client fees.

While the FRC may have a greater remit for enforcement action under the AEP than the former Accountancy Scheme, its purpose in imposing sanctions is not to punish, but to protect the public and the whole public interest. The public is after all better served by higher quality audits which lead to higher investor confidence in the company’s financial statements.

Financial sanctions will continue to have an important role in the FRC’s enforcement strategy, particularly with regard the deterrence of future breaches; however, the use of non-financial sanctions continues to increase significantly. Non-financial sanctions are used at all stages of the enforcement process, whether that is as part of its early resolution of cases via the Constructive Engagement process, settlement, or following conclusion of a Tribunal hearing.

Constructive Engagement and remedial action

Constructive Engagement is a process introduced by the AEP for resolving cases where the audit quality concerns can be addressed without full enforcement action. The FRC’s guidance provides that it will be suitable for cases where there has been a minor, technical breach, and there is no real concern about harm to the public or a loss of confidence in the audit process.

Constructive Engagement is a more flexible process, aimed at ensuring that the breach is rectified quickly, and not repeated. It may take any form including written advice, warning letters, discussions or correspondence with the auditor and/or audit firm. Unless the FRC is satisfied that the conduct leading to the breach has already been sufficiently addressed to prevent the risk of recurrence, the outcome of constructive engagement will usually be for the firm to carry out remedial actions (if a breach is identified).

The remedial actions imposed in each case are bespoke to the particular circumstances of the breach, and will often involve amendments to a firm’s audit procedures and/or training and guidance across the firm. Remedial actions are often firm wide rather than limited to the particular audit process, or team, in order to reduce the risk of reoccurrence of the conduct that lead to the breach.

The FRC dealt with 33 cases in Constructive Engagement over the past year, an increase of 73% compared to 2019.

Remedial actions were imposed in 27 of those cases, and were predominantly focused on ways audit firms could improve audit procedure and technical knowledge in problematic areas. For example, firms were required to implement measures requiring audit teams to consult with a firm’s technical team on particular issues such as:

  • require enhanced work to be carried out by specialists such as tax and actuarial specialists;
  • implement better procedures for communication between audit teams and specialists;
  • implement additional audit procedures and training on complex areas;
  • implement guidance for improving the level of documentation on the rationale for conclusions reached.

A recurring problem with FRC investigations is that they take too long. Constructive Engagement provides the FRC with the flexibility to resolve cases more quickly: the average time taken to conclude a matter through Constructive Engagements is eight months, compared to an average of 48 months for the FRC to conclude a case through to a hearing before the Tribunal. The firm can then implement the remedial actions imposed more swiftly, while the FRC can direct its resources to cases involving more serious breaches which warrant full investigation. We expect the trend towards Constructive Engagement to continue in the coming year.

Investigations resulting in sanctions

Over the past year, the FRC imposed sanctions in nine cases in relation to audit matters, 11 of which were financial, as compared to 27 non-financial sanctions. All but one of the cases resulting in sanctions in the past year was a result of settlements.

The total amount of financial sanctions on audit firms alone (pre-discount) was £15.9 million. Financial sanctions were also imposed against six audit partners, totalling £0.7 million (pre-discount). Where financial sanctions were imposed, 30-35% reductions were applied for early admissions and settlement.

The use of non-financial sanctions is clearly a key part of the FRC’s enforcement strategy. Measures imposed over the last year included increased use of reprimands and severe reprimands, requirements for firms to undertake firm wide training, requirements for firms to produce written reports to the FRC on quality performance reviews, requiring firms to implement an ethics board, and increasing the monitoring and support of regional offices.

If firms carry out enough remedial work prior to the conclusion of the matter, further non-financial sanctions may not be required.

The FRC reminds firms in this Review that a further way that they reduce any financial sanction imposed is by providing an “exceptional” level of cooperation with the FRC’s investigation, for example, by self-reporting.

The year ahead

The FRC remains in a state of flux. Following Sir John Kingman’s review in December 2018 and the Brydon and CMA Reviews in 2019, a number of recommendations have been made to the government for the overhaul of audit profession which, if adopted, will have a significant impact on the regulation of audit in the UK. The FRC itself is due to be renamed as the Audit, Reporting and Governance Authority (ARGA). There has been little progress on the legislative front however, with no shortage of recent other distractions on parliamentary time.

The FRC has been recruiting heavily, notably to increase its ability to monitor audit work, which will then feed into more cases for Enforcement. It has also conducted a review of the AEP, and a consultation on proposed amendments to the procedure is expected later this year. It will be interesting to see what changes are proposed to its enforcement strategy. Beyond that, we may see significant upheaval in audit regulation once we return to normal business.

Finance

Staying connected: keeping the numbers moving in the finance industry

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Staying connected: keeping the numbers moving in the finance industry 2

By Robert Gibson-Bolton, Enterprise Manager, NetMotion

2020 will certainly be hard to forget. Amongst the many changes we have come to live with, for many of us it has been adapting to a new style of working. Whatever your take on it is, remote working, working from home or even agile working, one thing remains clear – for many of us, this could be the new-normal for the foreseeable future. The professional services sector is no different. For example, many finance practices around the world are now allowing staff to work from home part of the time. In addition, a recent KPMG report found that half of the UK’s financial services workforce want to work from home after COVID-19.

Will this therefore become the de facto working practice for the finance industry too? We can’t say for sure, but this agile approach to working has certainly caused a major rethink for many firms. And as they evolve and adapt to meet the demands of a different way of working, firms need to ensure that their workforce can seamlessly interact with each other and their clients – this is key if they want to continue to deliver exceptional client service. Whilst financial services organisations everywhere are busy adopting innovative new technologies to better reflect the ‘work from anywhere environment’, they need to ensure secure access to resources and strive towards enhancing the end user experience. Success will be replicating the office working experience at home or wherever else they may be.

It’s all well and good for a firm to boast about the ability of their staff to work successfully from home, but how do they also establish that their people are just as productive as they were before? Whilst the IT department will have to grapple with security and compliance issues that arise from agile and remote working, they must also ensure that their people can connect securely, without eschewing user experience. And it needs to be completely seamless, without compromising the service level provided to clients.

Why all the fuss?

Which brings us nicely to persistent connectivity. Persistent connectivity effectively allows you to do more. How frustrating for the user when connectivity drops, or when the device that they are working on can’t find a network to connect to (or if the device switches between different networks). When connectivity drops, and re-connection is required then there is that small period where the user is not connected at all. And the user might have to re-authenticate or log into their VPN again (most VPNs are rubbish when they lose connectivity). All of these different scenarios ultimately disrupt the user experience – persistent connectivity provides the flexibility to overcome these challenges. When you enjoy consistent connectivity, you are making sure that the technology works as it was designed to work, allowing staff to rely on optimum user experience, anytime, anywhere – in effect, supplying them with that office-like experience, wherever they are. Just think about how many hours might be spent on a train, in a hotel or even on a client site. Consistent connectivity is key here – consistent in any of these locations.

Connectivity will be a fundamental component for successful remote working as firms try to meet the demands of an increasingly mobile workforce. Ultimately, they need encrypted and reliable connections that enable them to quickly and easily reach business applications and services. Working in a disconnected environment can lead to frustrated workers, hardly fitting given all the new remote working policies in place.

Getting the user experience spot-on

When you fine-tune connection performance so that essential business applications run reliably across networks, you are essentially talking about traffic optimization. Mobile traffic optimization ensures that applications, resources and connections are tuned for weak and intermittent network coverage and can roam between wireless networks as conditions and availability change. When connections aren’t performing well, applications that are crucial for job performance can experience packet loss, jitter or latency that can make working on the hoof extremely tricky. Compared to wired networks, wireless networks operate under highly variable conditions, including such factors as terrain or congested mobile towers. When you optimise the flow of traffic, you are helping to manage packet loss. Effectively, packet losses are data loss, which happens very regularly when you’re on the move or transitioning between different networks. Applications that require a lot of data tend to become fairly unusable when you hit even minor packet loss, which can be a common occurrence for many on residential broadband or on local Wi-Fi. conversely, NetMotion can enable critical applications to work and prevent disruptions at over 50% packet loss – in this way, employees can rely on technology performing well in situations and locations where it simply could not before. That is incredibly powerful for firms.

The finance industry is facing many of the same challenges presented to other industries. It is a question of balancing the requirement for more sophisticated ways to ensure secure access to resources with the need to enhance the end user experience (key team members in particular). For finance firms everywhere, adopting the right technologies will ensure that their people can enjoy a ‘work-from-anywhere’ environment.

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Hong Kong’s Cathay Pacific warns of capacity cuts, higher cash burn

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Hong Kong's Cathay Pacific warns of capacity cuts, higher cash burn 3

(Reuters) – Cathay Pacific Airways Ltd on Monday warned passenger capacity could be cut by about 60% and monthly cash burn may rise if Hong Kong installs new measures that require flight crew to quarantine for two weeks.

Hong Kong’s flagship carrier said the expected move will increase cash burn by about HK$300 million ($38.70 million) to HK$400 million per month, on top of current HK$1 billion to HK$1.5 billion levels.

Hong Kong is set to require flight crew entering the Asian financial hub for more than two hours to quarantine in a hotel for two weeks, the South China Morning Post reported last week, citing sources.

“The new measure will have a significant impact on our ability to service our passenger and cargo markets,” Cathay said in a statement, adding that expected curbs will also reduce its cargo capacity by 25%.

The airline, in an internal memo seen by Reuters, requested for volunteers among its crew who could fly for three weeks, followed by two weeks of quarantine and 14 days free of duty, adding it will be a temporary measure and not all its flight will require such an operation.

“We continue to engage with key stakeholders in the Hong Kong Government,” the memo said.

The government did not immediately respond to a request for comment.

Separately, a company spokeswoman said the airline could not detail the impact on vaccine transport specifically in terms of cargo shipments.

The aviation industry has been hit hard by the COVID-19 pandemic as many countries imposed travel restrictions to contain its spread.

In December, Cathay’s passenger numbers fell by 98.7% compared to a year earlier, though cargo carriage was down by a smaller 32.3%.

($1 = 7.7512 Hong Kong dollars)

(Reporting by Shriya Ramakrishnan in Bengaluru; Additional reporting by Jamie Freed in Sydney and Twinnie Siu in Hong Kong; Editing by Bernard Orr and Arun Koyyur)

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Travel stocks pull FTSE 100 lower as virus risks weigh

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Travel stocks pull FTSE 100 lower as virus risks weigh 4

By Shashank Nayar

(Reuters) – London’s FTSE 100 fell on Monday, with travel stocks leading the declines, as rising coronavirus infections and extended lockdowns raised worries about the pace of economic growth, while fashion retailers Boohoo and ASOS gained on merger deals.

The British government quietly extended lockdown laws to give councils the power to close pubs, restaurants, shops and public spaces until July 17, the Telegraph reported on Saturday.

The blue-chip FTSE 100 index dipped 0.1%, with travel and energy stocks falling the most, while the mid-cap index rose 0.1%.

“Stock markets are crawling between optimism around the rollout of vaccines and worries that a jump in virus infections and fresh local lockdowns could further affect recovery prospects,” said David Madden, an analyst at CMC Markets.

Britain has detected 77 cases of the South African variant of COVID-19, the health minister said on Sunday while urging people to strictly follow lockdown rules as the best precaution against the country’s own potentially more deadly variant.

Prime Minister Boris Johnson had earlier warned that the government could not consider easing lockdown restrictions with infection rates at their current high levels and until it is confident that the vaccination programme is working.

The FTSE 100 shed 14.3% in value last year, its worst performance since a 31% plunge in 2008 and underperforming its European peers by a wide margin, as pandemic-driven lockdowns battered the economy.

Online fashion retailers Boohoo and ASOS surged 4.8% and 5.9%, each. Boohoo bought the Debenhams brand, while ASOS was in talks to buy the key brands of Philip Green’s collapsed Arcadia group.

Recruiter SThree Plc gained 0.9% after its profit, which nearly halved, still managed to beat market expectations and the company said it had resumed dividends.

(Reporting by Shashank Nayar in Bengaluru; editing by Uttaresh.V)

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