Time for a reformed regulatory framework – auditing included


The economic collapse is merciless in its revelations of failure, whether evidencing spineless regulation, ignorant policy-making, ineffective auditing, incompetent rating or wimpish governance. There’s nowhere to hide – as Warren Buffett puts it, when the tide goes out you can see who’s been bathing naked.

Now we have the government’s threat to penalize banks if they pay excessive bonuses in future. Does our legislature still not recognize that inflicting savage penalties on the companies themselves punishes the shareholders, whose investments have already taken a severe beating? Every transgression, whether pensions mis-selling, bank-charge profiteering or just plain lawbreaking, is met by the FSA’s bizarre obligation to impose swingeing fines on the company rather than guilty executives.

In every scandal a presiding chief condones or turns a blind eye to irregular practices designed in pursuit of greater profit. Our compromised regime should now require the FSA to identify and name the culpable characters and declare them “unfit and improper” persons to hold those positions. Employment contracts for senior people in regulated industries should, by law, provide that, in the event of such a ruling, the employment of the individuals concerned is immediately terminated without compensation. It’s so obvious, really.

 Inspiring fear

When the Governor of the Bank of England was asked by the Treasury Select Committee for his views on the collapse of the financial system, he too pointed a finger at useless regulation, stating in effect that regulators are far too scared to stand up to those they regulate. The former Director of Public Prosecutions, Sir Ken Macdonald, wrote last month that we need a “new financial regulatory and law enforcement authority that inspires respect and, when it’s needed, fear.”

 A potent regime to replace the “light touch” charade should put a spotlight on the grey zone between recklessness and criminality by re-coding the penalty system. In the US, by contrast, participators in high-risk market activity have a far clearer grasp of penalties for breaking the law. It is doubtful that Conrad Black or Martha Stewart would be serving time had they been tried in Britain.

an exchequer facing a mountain of public debt and a diminishing tax take

Accountants and auditors have always displayed a powerful instinct for survival in troubled times and we are now experiencing one of those defining moments. If the recession moves closer to depression, unemployment could rise to 15% of the working population, or 4.5 million people. With an exchequer facing a mountain of public debt and a diminishing tax take, any rebuilt regulatory framework will be deaf to the litany of caveats we trot out so defensively. Protesting, ritually, that detection of serious fraud is someone else’s problem will signal the death of auditing.

 Swallowing the assumptions

Gone are the days when it was considered acceptable to authenticate figures predicated on rosy but untested assumptions. Can you imagine the reception an auditor would get today if he explained that he had no duty to challenge the inherently unsustainable business model that signaled the company’s subsequent demise?

Four years ago (see March 2005) I spelt out the features of irresponsible lending practices that generated billions in paper profit for the likes of Bradford & Bingley and Northern Rock. If columnists could see where it was leading, what on earth were their auditors looking at?

The cosy cabal which cocoons management and auditors has failed us. Take HBOS: the “independent” experts selected by the bank to review its risk manager’s allegations concerning its insane business model just happened to be the bank’s own auditors, who concluded, after vetting compliance (but not strategy), that there were no serious failings in corporate governance. Their fees under all heads are reported to have exceeded £100 million in the past eight years.

The profession has been fudging the independence issue for decades. If that is not sorted soon, someone else will have to do the work – but properly.