EU Looks at Stricter Audit Rules

In a recent speech, a senior European Commission official warned accountants that a drastic tightening of auditing rules in the European Union is under consideration in Brussels, including possible segregation-of-service rules on client auditing and accounting services, and requiring auditors to give "an unencumbered opinion of a situation", as opposed to the current "historical review."

At a mid-December meeting the European Federation of Accountants, or FEE, in Brussels to discuss a European Commission public consultation process on audit policy, members heard Jonathan Faull, a director general at the commission, refer to "complacency" in the auditing sector, which he described as "out of tune with the present times".

Faull reports directly to Commissioner Michel Barnier, the head of the department that proposes much of the new financial legislation for the European Union, who launched the current move to scrutinize auditing with a "green paper" on audit policy in the fall of 2010.

Faull went on to elaborate on the present spirit of the Brussels institution: "The crisis may have been global, but it did start in the financial sector, and it is causing misery all over Europe".

Hence, the commission's position was that today's "status quo is not acceptable".  Faull said that there are still gaps in the regulatory system that need filling, adding, "We hope to have a new set of regulations which we hope will remain in place for a generation."

Later, during question time, when some of the questioners exhibited a decidedly barbed reaction to Faull's approach, he noted a link between the financial crisis and auditing lapses in the banking industry.

In his main discourse, Faull fleshed out a series of radical proposals now under consideration by the commission. These included rules governing the independence of the auditor. (In an explanatory paper elsewhere, the commission expands on this theme, noting its investigation into possible "conflicts of interest" when a firm both audits a company's results and offers it consultancy services to the same firm. In the U.S., the Sarbanes-Oxley Act of 2002 explicitly listed the services that auditors could not offer clients.)

At the Brussels meeting, panelists suggested that the auditors should be appointed by company audit committees, rather than by the main board of directors. However, Faull went further, airing the possibility that the right to appoint an auditor should perhaps be placed with an independent organization. This would remove the right of appointment from the firm subject to audit.

The possibility, described later by one delegate to the meeting as "aggressive", was defended by Faull as "necessary" in the light of "professional skepticism" from investors. (In its paper, the commission refers similarly to an "expectation gap" between auditors and stakeholders.)

Faull's comments came as part of the commission's intention to a review its Statutory Audit Directive of 2006. This legislation was mandated for transposition into the national codes of the EU's 27 member states by 2008. In fact, some countries delayed adoption until this year. 

The current assessment started off with Barnier's "green" policy paper, issued in the fall of 2010. Among the more radical possibilities raised in the paper were a blanket prohibition on non-audit services, mandatory rotation of auditors, and having a third party assign auditors. An astonishingly high number of comments, estimated at 800, illustrates the heat building up from some stakeholders. A commission digest of the responses is due in February 2011.

This is to be followed by a formal commission position, expected by mid-2011. Its proposals would then be debated, and, no doubt, amended, by the European Parliament, during the rest of the year. Any lobbying could normally be expected during this period. Any revised legislation, which would also require clearance by national governments, could be in force in 2013, or later, depending on resistance.

Some reactions to the policy paper have been made public. One instance is FEE's own answer to the green paper's question, "Are audits fit for purpose?" Interestingly, FEE noted that audits are "currently not explicitly providing comfort on companies' financial health, which seem more future-oriented."

A comment letter from the U.S.-based Center for Audit Quality also noted a disconnect between what financial statement users think auditors are providing, and how auditors themselves view their role - but warned the commission not to go too far with radical measures to boost auditor independence, and not to revise auditors' reports to the point where they diverge significantly from those in other parts of the world.