EU exec says will propose auditing sector reform

LONDON (Reuters) - The European Union’s executive said on Wednesday it would propose reforming the auditing sector next year after the financial crisis uncovered failings in how it operated.

“The status quo is not going to be an option for the European Commission,” the bloc’s financial services chief Michel Barnier told a news conference. “We are happy in 2011 to produce legislation in this respect,” Barnier said as he launched a two-month consultation on his ideas for changing the sector.

Regulators are turning their attention to whether auditors were proactive enough in questioning what was going on at banks before the crisis unfolded and sparked a string of bailouts.

Britain’s Financial Services Authority and Financial Reporting Council (FRC) published a consultation paper in June saying there may be a need for new rules forcing auditors to “blow the whistle” on suspect practices.

The FRC is already probing how Ernst & Young audited the books of Lehman Brothers, the U.S. bank whose failure in 2008 brought the world’s financial system to its knees.

“The crisis highlighted failings in the audit sector. We want to strengthen this profession and its credibility,” Barnier said.


Possible “no taboo” reforms could focus on several areas:

-- is it wise that auditors have the same customers for decades?

-- how to tackle potential conflicts of interest where an auditor checks the book of a company it also conducts consultancy work for

-- are auditors independent enough to question companies?

-- are investors placing too much reliance on audits?

-- the sector is dominated by the “Big Four” -- PWC, Deloitte, KPMG and Ernst & Young which represent 70 percent of the European market. Is there a risk to the broader financial system if one of them failed?

-- could more competition be introduced by a smaller auditor conducting joint audits with one of the Big Four?

-- should smaller firms have less onerous auditing rules?

-- how best to build European supervision?

Matthew Lawson, a partner at law firm Mayer Brown said Barnier did not address the question of allowing audit firms to limit their liability in a meaningful way.


BDO, the world’s fifth biggest auditor, urged Barnier to tackle sector concentration by stopping “anti-competitive practices” such as “Big Four only clauses” imposed on a company by a bank that is giving it a loan, as noted by the Commission.

BDO Chief Executive Jeremy Newman said BDO research showed such clauses being applied in over half of the EU’s 27 states.

Jeremy Jennings, European head of regulation and public policy at Ernst & Young, said some parts of the consultation, such as on whether companies should regularly “rotate” which auditor they use, may contain dangers.

“Our experience in Italy, where they have had rotation, is it has reduced the quality of audits and increased the concentration of the audit market,” Jennings said.

The European Commission is seen as wanting to lead the audit reform debate which has yet to be taken up by the world’s leading economies (G20) that have been spearheading the global regulatory response to the crisis.

“It’s important that we don’t come up with something that works in the EU but it’s going to be difficult trying to manage audits of international companies with operations outside Europe,” Jennings said.

Michael Izza, chief executive of the ICAEW, a London-based accountancy body, said reforms must be seen in a global context.

The ACCA, another accountancy body, agreed that auditors also needed to give opinions on a company’s internal controls, corporate governance and financial assumptions underlying its business model but that Barnier skirted round the need for auditor liability reform.

Editing by Stephen Nisbet