UK audit cops at the Financial Reporting Council (FRC) have told firms they’re expected to rat themselves out if the firm is in discussions with private equity about handing over ownership, reported FT. Presumably any amount of ownership, not just majority.
Richard Moriarty, chief executive of the Financial Reporting Council, wrote on Thursday to the bosses of the UK’s top accounting firms, saying the regulator was not “in principle” against private equity investment in the sector but there were “important risks that will need to be carefully managed”.
The intervention signals the regulator’s concerns that private equity investment could erode audit firms’ rigour and independence in auditing the accounts of large companies — key to maintaining investor confidence in the accuracy of companies’ accounts.
To be clear, the FRC isn’t wholly against private equity investment. “The FRC is not in principle against a greater participation of external private capital in the UK audit market.” said the letter dated September 26, embedded below in its entirety if you want to read the whole thing. “The FRC’s role is to protect the public interest and support growth. We are primarily concerned with outcomes and behaviors by audit firms such as delivering high quality audits, upholding high standards of ethical conduct, and fostering a culture towards always acting with the public interest in mind.”
“We recognize that access to external private capital could, in the right circumstances, have potential benefits for the UK audit market,” the FRC said. “However, there are important risks that will need to be carefully managed. As with any other major change within an audit firm that has the potential to affect its leadership and culture, a change in ownership structure via external private capital must be able to maintain and enhance over time the important public interest dimension of audit. It must also be able to protect independence as required by law and allow for any threats to that independence as a result of conflicts to be effectively safeguarded.”
On the expectation to rat themselves out, the FRC said that “a firm that is interested in, or considering, a change of ownership to introduce private capital should engage with the FRC (in addition to its Recognised Supervisory Body) at an early stage and with full candor, assured that all such discussions will be treated in strictest confidence.” In other words, the FRC wants firms to come to them well before any deal is struck. “We would also welcome engaging directly and in confidence with any investors considering entering or expanding into the UK audit market to help explain the regulatory framework and expectations,” they said.
Being the ignorant Americans that we are, we’re curious if the FRC can actually require firms to do this without official rulemaking or if this is them overreaching their authority under the banner of “we’re the regulator and we say so”? The letter does mention the public interest — both in fact and appearance — which certainly falls under the jurisdiction of the FRC. “Like for any other significant change relating to a UK firm, any party interested in a change of ownership by introducing external private capital must be able to continue to provide assurance that it will be able to support the public interest, the independence dimensions of audit and all applicable regulatory expectations,” the FRC said. “It is important to demonstrate that the legal requirements, including those pertaining to control, are met both in substance and in form.”
In the US, firms that have taken private equity investment have thus far dodged any independence concerns by forming two entities operating under one banner — the PE-backed one doing advisory and tax work, and a siloed assurance entity that’s independent from outside capital (in theory).
In its annual audit quality report issued last month, the FRC warned that private equity investors “may lack a deep understanding of audit practice objectives, and the public interest incentive to deliver audit quality. A lack of clarity or long-term thinking regarding PE exit strategies also raises concerns about maintaining audit quality and public interest motives over future years.”
