FRC: The watchdog that barked too late

sundaytimes.co.uk:  After a string of corporate collapses, has the accounting regulator finally found its teeth? 

The accountancy boss did not hide his disdain. “It’s reacting like a caged animal,” he said of his industry’s regulator, the Financial Reporting Council (FRC). “The chained-up dog, after being prodded with a stick, is now thrashing around.” He was referring to the perception that the watchdog – recently branded “chronically passive” by MPs – is trying to save itself by at last flexing some muscle. 

Last week, the FRC revealed that it was looking into KPMG’s audit of Bargain Booze owner Conviviality, which went into administration in April. That news followed a £325,000 fine and 15-year ban for Steve Denison, the PwC auditor who handled the department store chain BHS. Also, in March, FRC boss Stephen Haddrill called for an inquiry into whether the big four auditors (EY, KPMG, Deloitte and PwC) should be broken up, creating audit-only firms – an idea the FRC once opposed. 

Both the regulator and the profession are in the line of fire after a succession of scandals. KPMG and Deloitte have been lambasted for missing red flags at Carillion, with the FRC criticised for failing to follow up concerns about the construction giant’s accounts. MPs, keen for their pithy putdowns at select committee show trials to go viral, gave Haddrill a particular savaging on the company’s collapse. 

“The FRC is now showing a wish to live,” said the Labour MP Frank Field, who chairs the Commons work and pensions committee. “When he appeared before us, the minister [business secretary Greg Clark] thought it was in the departure lounge. This shows that ministers can have an effect by publicly voicing their disappointments with a regulator.” 

The committee has also called for the FRC to publish its report on PwC’s audit of BHS, which went into administration in 2016. PwC, whose British revenues were £3.6bn last year, was fined a record £6.5m over the audit. However, the FRC has long been viewed as a soft touch, having let KPMG off the hook over its auditing of HBOS and closing an investigation into PwC’s failure to spot that Barclays had put £16.5bn of client assets at risk. 

In April, Sir John Kingman, chairman of the insurer Legal & General, was picked to lead an independent review of the regulator. It will examine the FRC’s powers, governance and efficacy, and finish by the end of the year. 

Critics reel off a catalogue of complaints for Kingman to address. They highlight a lack of clarity around the FRC’s purpose. They claim it lacks powers (it regulates auditors, accountants and actuaries, not directors); it fails to ensure the industry learns from its mistakes; and it has too light a touch overall. The watchdog has also been accused of dragging its heels on investigations, although it may be constrained by resources. It employs just 12 lawyers and eight forensic accountants in the enforcement department. Last year its total expenditure was £29.3m. 

The body has drifted into spheres where it lacks the experience – and sometimes the legal authority – to be effective. A partner at a big four firm said the FRC was scrutinising senior appointments more, but likened its attempts to widen its remit to “someone who bakes bread suddenly being asked to make a Michelin-starred meal”. 

The regulator’s independence has also been questioned. Melanie McLaren, executive director for audit and actuarial regulation, previously spent a decade at PwC. She is due to leave soon. Her exit comes amid concerns that the FRC is dominated by accountants who previously worked for big four firms, which could make its rulings too generous towards other bean-counters. A joint report by the Commons business and work and pensions committees into Carillion said that making the regulator more aggressive would “require a significant shift in culture”. That is likely to require a change at the top. 

Haddrill, 62, a Crystal Palace season-ticket holder, is a former civil servant. Industry insiders expect the chief executive, paid £486,000 last year, to be ousted to help the FRC regain credibility.  One accounting boss extended his criticism to the watchdog’s 77-year-old chairman and banking grandee, Sir Win Bischoff. “He’s a statesman – but you need more than that,” said the boss. He raised questions about the staff more broadly, too: “No one hires them – these are people rejected by our firms.” 

Industry insiders say there are two avenues Kingman could take. The first would be to split the FRC in two, in a similar vein to the creation of the Prudential Regulation Authority and the Financial Conduct Authority from the corpse of the Financial Services Authority. A second regulator would need extra funding. 

“The FRC is judge, jury and executioner – it sets standards, it investigates and it punishes,” said Jonathan Riley, head of quality and reputation at the accountancy firm Grant Thornton. “It doesn’t feel right to us that all the power is in one place. 

“We believe Kingman will also call for stricter sanctions. The issue has gone beyond the profession. I’m reminded of the environment around tax about five years ago. The public, media and MPs wanted things to change and the tax profession was slow to wake up to it. The audit profession needs to get to grips with it, otherwise solutions will be imposed.” 

The second avenue would be to beef up the FRC – giving it more powers in law, a clearer purpose and extra funding. Haddrill has called for greater powers himself. Some of his organisation’s problems stem from an attitude that regulation should be principle-based, not rule-based. 

Paul George, director of corporate governance and reporting at the FRC, said he expected Kingman to look at “our status and degree of statutory powers. The FRC’s responsibility has grown relatively piecemeal. Quite often, it has been willing to take on additional responsibilities without the powers to deliver them fully.” 

The regulator denied that Kingman’s review had spurred it into action. George emphasised that investigations such as the one into BHS are complex, sometimes involving millions of documents, and that they are often extensively challenged at independent tribunals — so the cases being completed now are the result of three or four years’ work. 

He also claimed that accountancy firms were now more inclined to settle with the regulator than let it go to tribunal. The FRC has introduced new measures, including viability statements, and fines are higher on average following a review last year, said George. 

Accountants, admittedly speaking from self-interest, argue that the FRC has become overly focused on the cane, at the expense of schooling. Central bankers often joke that they are preventing the last crisis, but critics of the FRC say it does not even do that – it simply doles out punishments, rather than proposing how to fix problems. This leads to the same issues repeating themselves, they say. 

“They [people at the FRC] felt they hadn’t been tough enough, hadn’t fined us enough,” a senior accountant said. “They think they have failed because of that, but they have failed because they haven’t protected capital markets. When HBOS collapsed, what came out of it? They didn’t say, ‘This is how to make financial reporting better.’ They just review you after the event.” 

The question now for the FRC is whether Kingman will let the watchdog off the leash – or replace it with a new hound with real teeth. “I say keep the FRC on death row,” said Field – “and make sure it will be regularly reviewed.”