Shattered professions rebuild

By Tim King

Date: 19/05/05

The reputation of the auditing and accountancy professions has been battered over the last five years as never before. A succession of corporate scandals on both sides of the Atlantic inflicted damage from which the professions are still struggling to recover.

US lawmakers had to respond to corporate catastrophes on the scale of WorldCom, Enron and Tyco. But whereas the US response, primarily the Sarbanes-Oxley Act, was both immediate and demanding, in Europe legislators took a more measured response even after the Parmalat, Ahold, Vivendi and Adecco scandals.

In a communication last year, the European Commission set its face against additional EU legislation, arguing that the measures foreseen in the Financial Services Action Plan and the Action Plan for Company Law and Corporate Governance would suffice.

"There is no need to significantly change or add to these action plans; rather to press ahead with their timely implementation and ensure strict oversight and effective control of the application of legislation," the document said.

In the Commission's analysis, the lines of defence against corporate malpractice are fourfold. In the first line are the internal controls of the company, particularly the members of the board. Second come the external scrutineers: the auditor's independent opinion of company accounts, the lawyers, investment banks and rating agencies. Third are the supervisors and regulators. The fourth line of defence is the enforcement of law by the police, the courts and other public authorities.

The Commission's approach has been to strengthen the first line with measures to improve corporate governance. Listed companies must be more transparent about their use of potentially risky intra-group transactions. They must publish an annual statement on corporate governance. The accountability of board members must be increased.

The second line of defence is to be strengthened by the directive on statutory auditing, the revised 8th company law directive. There are also measures to combat money-laundering and terrorist financing.

The Commission sees improvements to the third line of defence from the creation of committees of European securities regulators, insurance and banking supervisors. The 8th company law directive also requires independent public supervision for all statutory auditors. There are a number of measures proposed to improve co-operation between law enforcement authorities to strengthen the fourth line.

Against this background, the professions have been fighting a rearguard action to restrain European legislation, arguing the merits of continued self-regulation.

The FEE, the European federation of accounting experts, argued in a recent paper on internal controls that European shareholders did not necessarily need to follow the US in resorting to legislation for improvements in risk management and internal control.

The accountancy institutes have been trumpeting their greater efforts to train practitioners, arguing that this should ensure better quality.

Which does not mean that the accountancy and audit professions have entirely escaped the aftermath of Enron and Parmalat.

Some of the fall out is still discernible in the discussions on the 8th company law directive. Are audit firms inclined to take a forgiving line with their clients because of the money they derive from selling other services? If so, should they be banned from offering such services? Should the liability of audit firms be limited, for fear that one of the Big Four firms might go the way of Arthur Andersen and reduce the four to an uncompetitive three? If it is wrong that an auditor and client should stay together too long, what are the possibilities for rotating the audit firm? Or should regulators be content with rotating the lead partner inside the firm?

It is a truism of EU regulation that very often laws are passed to fight the last war, to cope with the last crisis. What both the professions and the lawmakers are trying to hold on to is an assessment of risk. The aim is to balance the acceptable risk against the regulatory burden. The difficulty for the accountants is that one more scandal would tilt the scales, perhaps irrevocably.

Analysis feature in which the author looks at the European Commission's strategy against corporate malpractice.