THE PROVISION OF NON-AUDIT SERVICES BY AUDITORS
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- Dwight Simmons
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1 22 October 2010 Hazel O Sullivan Project Director Auditing Practices Board 5 th Floor, Aldwych House Aldwych London WC2B 4HN Dear Hazel THE PROVISION OF NON-AUDIT SERVICES BY AUDITORS IMA represents the asset management industry operating in the UK Our members include independent fund managers, the investment arms of retail banks, life insurers and investment banks, and the managers of occupational pension schemes They are responsible for the management of 34 trillion of assets, which are invested on behalf of clients globally These include authorised investment funds, institutional funds (eg pensions and life funds), private client accounts and a wide range of pooled investment vehicles In particular, the Annual IMA Asset Management Survey shows that in 2009, IMA members managed holdings amounting to 40% of the domestic equity market In managing assets for both retail and institutional investors, IMA members are major investors in companies whose securities are traded on regulated markets Thus we have an interest in the requirements governing the audit of companies accounts and auditors reports to our members as users and welcome the Auditing Practices Board (APB) undertaking this consultation and giving us the opportunity to comment Accounts are prepared primarily for investors, the holders of ordinary shares, to provide them with the information they need for the purposes of deciding to buy, sell or hold their shares and to fulfil their responsibilities as owners assessing company management and the strategies adopted, stewardship Quality audits are pivotal to this and for ensuring that markets value the information reported and investors believe what they are told about the financial position of their investee companies The perception of auditor audit quality can be impaired by non-audit services in that the significant revenues generated and the nature of the services can affect auditor independence and lead him to identify himself with the interests of management rather than those of investors We maintain that there does not need to be an 65 Kingsway London WC2B 6TD Tel:+44(0) Fax:+44(0) wwwinvestmentukorg Investment Management Association is a company limited by guarantee registered in England and Wales Registered number Registered office as above
2 overhaul of existing requirements but disclosures around non-audit services are not always consistent or clear making it difficult for investors to engage on the matter Thus we support the consultation paper s proposals for more transparency and disclosure of: a company s policy on non audit services; an analysis of the nature of the non-audit services provided and the associated fees; the safeguards applied; and the reasons why such services were commissioned from the auditor as opposed to another party However, there are areas in the consultation where we do not believe the proposals go far enough We set out in the attached our comments on the detailed questions and below our main concerns The proposal that where fees for non audit services are, or are expected to, exceed the audit fees, this must be discussed with and approved by the Ethics Partner within the firm and reported to those charged with governance 1 does not go far enough Nor does amending the FRC s Guidance for Audit Committees to encourage them to consider fees incurred, or to be incurred, both for individual services and in aggregate, and explain why the auditor should provide specific services As well as the proposed disclosures, we consider non-audit services beyond a certain threshold, say, where the associated fees are a multiple of the audit fee, should have to be formally approved by the audit committee and, as far as possible, this should be in advance and if this is not the case, then the reasons why should be explained A number of the proposals in the paper relate to additional disclosures for companies to whom the services are provided Requirements for companies in this area are covered by statute and are the responsibility of Government Given that the APB s role is to develop standards and requirements for auditors, it is unclear how the APB can ensure companies comply with these proposals and that they are consistently applied Our letter of 22 January 2010 to you referred to investors' concerns about the Rentokil situation where the new external auditors took on internal audit work alongside Rentokil's own internal team in that Rentokil s auditors could in effect audit their own work and take on management functions We do not believe that the proposals in the consultation paper would allay investors concerns in this area and consider requirements should be further strengthened Conflicts of interest arise when the same firm provides both an audit and certain restructuring services to a company in distress It would be difficult to provide sufficient safeguards to ensure that the auditor s decision on, say, going concern, could avoid being influenced when the firm has given substantive advice on restructuring the company, on the company s debt when its covenants are close to breach or when the company s survival is otherwise in doubt Thus a number of investors consider that a company s auditor should be banned from carrying out restructuring services in such a situation (Option 1) Other investors, however, consider that in providing such services auditors awareness of the need for objectivity in assessing the entity s going concern can 1 Paragraph 214 2
3 be enhanced 2 and as the need for restructuring services can be urgent, often the existing auditor can be best placed to assist As opposed to such services being prohibited, they consider it should be sufficient for the more meaningful disclosures proposed to be given so that they can challenge management if necessary Please contact me if you would like clarification on any of the points in this letter or the attached, or if you would like to discuss any issues further Yours sincerely Liz Murrall Director, Corporate Governance and Reporting 2 Auditing Practices Board s Bulletin 2008/10, Going Concern Issues During the Current Economic Conditions sets out such safeguards in paragraphs 52 to 54 3
4 - AUDIT SERVICES BY ADUITORS IMA s answers to the specific questions raised are set out below 1 Do you support the approach outline in paragraphs 210 to 218? If not, please indicate what, if any, other action should be taken In particular, does the proposal in paragraph 215 present practical difficulties to auditors of small or medium sized entities IMA does not believe there needs to be an overhaul of current requirements but disclosures around non-audit services are not always consistent or clear Thus we support the proposals in the paper for more transparency and disclosure of: a company s policy on non audit services; an analysis of the nature of the non-audit services provided and the associated fees; the safeguards applied; and the reasons why such services were commissioned from the auditor as opposed to another party As noted in the consultation paper, these should provide investor with the tools they need to be more effective in their challenge of management and those charged with governance 3 However, the paper concludes that the quantum of non-audit services is not a widespread issue 4 We believe that when non-audit fees are significant and a multiple of the audit fee then independence can be affected and it is irrelevant whether the practice is widespread or not For example, Deloittes provided audit and non-audit services to MG Rover and its parent company, Phoenix Venture Holdings, and was auditor when the group collapsed in 2005 The then BERR s final report 5 into the collapse showed that from 2002 to 2005 Deloittes received 3065 million in fees of which 2875 million was for non-audit work However, even at the peak in 2002, as these fees only made up 12 per cent of Deloitte s UK fee income, they were well within the limits in the ethical standards 6 In conclusion, we do not consider the proposal that where fees for non audit services are, or are expected to, exceed the audit fees, this must be discussed with and approved by the Ethics Partner within the firm and reported to those charged with governance 7 goes far enough Nor does the proposal to amend the FRC s Guidance for Audit Committees to encourage them to consider fees incurred, or to be incurred, both for individual services and in aggregate, and explain why such services should be provided by the auditor As well as the enhanced disclosures proposed, we consider that non-audit services beyond a certain threshold, say, where the associated fees are a multiple of the audit fee, should have to be formally approved by the audit committee and, as far as possible, this should be in advance and if this is not the case, then the reasons why should be explained 2 Are the correct services included in the list of audit related services (see ES5 (Revised), paragraph [AD])? If not, please identify the changes that 3 Paragraph Paragraph page Ethical Standard 4 only requires the firm to resign when it is expected that the fees for both audit and non-audit services from a non-listed audited entity exceed 15 per cent of the firm s annual fee income (for a listed entity the limit is 10 per cent) 7 Paragraph 214 4
5 - AUDIT SERVICES BY AUDITORS should be made and indicate whether the provision of such services gives rise to threats to auditor objectivity and independence (other than threats which are clearly insignificant) IMA agrees that disclosing services that are audit related or required by statute as non-audit services could be misleading Thus we welcome the banding approach and the inclusion of an additional category of non-audit services termed audit related services where the work is closely related to the audit and threats to the auditor s objectivity are insignificant However, we do not necessarily agree that it is also necessary for the services to be carried out by members of the audit team for them to be audit related First, related work undertaken by the audit team is more likely to affect their objectivity in relation to the audit than if the work was undertaken by a separate team In any event, we do not believe that effective Chinese Walls necessarily exist within audit firms or that the audit team would not contact with any new team carrying out the work In general we consider the correct services have been included and that it is sufficiently restricted 3 Will disclosure of additional information about non audit services in the form of a template (such as that included as an appendix to ES 1 (Revised) reduce the perceived threats to objectivity and independence arising out of the provision of non-audit services? Do you have any suggestions to improve the template? IMA supports disclosure of this additional information and considers the proposed template will aid clarity and improve comparability However, the disclosure requirements on companies in this area are covered by statute and are the responsibility of Government Given that the APB s role is to develop standards and requirements for auditors, we are unclear how the APB can ensure companies comply 4 Will the proposed changes to the FRC s Guidance on Audit Committees reinforce audit committees responsibility for: Determining whether a company s auditor should be permitted to provide particular non-audit services? If not, what further guidance should be given, and Providing information about the non-audit services provided by a company s auditor and therefore reduce the perceived threats to auditor objectivity and independence arising from the provision of non-audit services? We support the proposed changes to the FRC s Guidance on Audit Committees in that they: give more prominence to non-audit services; help the audit committee distinguish those non-audit services which are closely related to an audit and which give rise to a very low threat to auditor objectivity from those where the threat needs more careful consideration; and improve disclosure of the audit committee s policy, with more detail on the nature of the services and the reasons why the audit committee decided to 5
6 - AUDIT SERVICES BY AUDITORS purchase non-audit services, other than audit related services, from the auditor rather than another party 5 Do you support: the approach taken to the provision of extended audit services in ES 5 (Revised), paragraphs [AH] and[ai]? the additional guidance on the threats and safeguards approach in ES 5 (Revised), paragraphs [AH] and[ai]? the strengthening of the role of the Ethics Partner in ES 1 (Revised), paragraphs 21 to 24 and ES 5 (Revised), paragraph [AA]? the amended definition of affiliate and significant affiliate? the application of the remuneration and evaluation policies to all members of the engagement team in ES 4 (Revised), paragraph 38? the other amendments referred to in Section 5? If not, please explain your reasons and the approach that you think the APB should take IMA supports: the additional guidance on the threats and safeguards approach in ES 5 (Revised); the strengthening of the role of the Ethics Partner in ES 1 (Revised), and ES 5 (Revised); the amended definition of affiliate and significant affiliate ; and the application of the remuneration and evaluation policies to all members of the engagement team in ES 4 (Revised); and; the other amendments referred to in Section 5 As regards, internal and external audit services, our letter of 22 January referred to investors' concerns about the Rentokil situation where the new external auditors took on internal audit work alongside Rentokil's own internal team in that Rentokil s auditors could in effect audit their own work and take on management functions We have not been party to the exchanges of information referred to in the consultation paper 8 but we do not believe that the proposals would allay investors concerns in this area and consider requirements should be further strengthened 6 Are there any reasons why the revisions to the Ethical Standards proposed by the APB in Sections 2, 4 and 5 will be difficult to implement for audits of financial statements for periods commencing on or after 15 December 2010? If so, what further transitional arrangements might be necessary? This question is outside IMA s scope 7 Which of the options (to address the self review threat arising from the provision of restructuring services) set out in paragraph 614 should the APB adopt? Should the option that you have chosen apply to all entities, or only to listed entities? 8 Paragraph 57 6
7 - AUDIT SERVICES BY AUDITORS Conflicts of interest arise when the same firm provides both an audit and certain restructuring services to a company in distress It would be difficult to provide sufficient safeguards to ensure that the auditor s decision on, say, going concern, could avoid being influenced when the firm has given substantive advice on restructuring the company, on the company s debt when its covenants are close to breach or when the company s survival is otherwise in doubt Thus a number of investors consider that a company s auditor should be banned from carrying out restructuring services in such a situation (Option 1) Other investors, however, consider that in providing such services auditors awareness of the need for objectivity in assessing the entity s going concern can be enhanced 9 and as the need for restructuring services can be urgent, often the existing auditor can be best placed to assist As opposed to such services being prohibited, they consider it should be sufficient for the more meaningful disclosures proposed to be given so that they can make informed decisions 8 Does the revised definition of a contingent fee basis give rise to any practical issues? We welcome the definition of a contingent fee being amended to ensure that variable fee arrangements are addressed 9 Which approach do you consider that the APB should adopt in relation to contingent fees and why? On the basis that contingent fee arrangements can compromise an auditors independence, in principle, we consider they should be prohibited However, we recognise that contingency fees can be applied to a variety of services, many of which can be comparatively routine in nature, and they can permit smaller entities to access professional advice that they may not otherwise have Thus a prohibition could be a barrier to certain entities entering into transactions and prevent their development and growth which would not serve the best interests of the entity or its shareholders Thus we support the proposal in paragraph 712 (ii) such that only contingent fees that are material, as defined, or where the outcome is dependent on an audit judgement that is material to the accounts should be prohibited 10 Does the definition of a connected party give rise to any practical issues? If so, how could those practical issues be addressed? What are the relative advantages and disadvantages of the alternative approach suggested in paragraph 86? We welcome the recognition of the impact of relationships with connected parties more overtly We understand that this would address certain circumstances where we had concerns, for example, MG Rover where there were all manner of connected parties However, the APB is proposing a broader definition so that as well as affiliates and management, a connected party includes anyone with the potential ability to exert influence in relation to their responsibility for or approach to any matter or judgement that is material to the entity s financial statements Whist we 9 Auditing Practices Board s Bulletin 2008/10, Going Concern Issues During the Current Economic Conditions sets out such safeguards in paragraphs 52 to 54 7
8 - AUDIT SERVICES BY AUDITORS welcome this in principle, it is likely to require costly procedures to be maintained If an auditor is unaware that a party is in a position to be able to exert influence, that party is unlikely to pose a threat, and we support the alternative approach in 86 such that an audited entity s connected parties include related parties of the audited entity and its significant affiliates as opposed to those with the ability to exert influence 11 Would the adoption of any of the approaches discussed in Sections 6, 7 and 8 give rise to any significant costs that would not be outweighed by the benefits of the relevant proposal? If so, please describe and, to the extent possible, quantify the costs that you think would be incurred and why the benefits would not outweigh the costs Such is the importance of ensuring a quality audit to the users of the accounts, we consider the benefits of these proposals, except as noted elsewhere in this response, outweigh the costs 8
9 May
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