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The role of the Auditors in the UK corporate governance

( Télécharger le fichier original )
par N'semy Aubin Mabanza
Cardiff University, Law School - LLM (Master of laws) Commercial Law 2003
  

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CARDIFF UNIVERSITY

LAW SCHOOL

LLM COMMERCIAL LAW

2003/2004

«THE ROLE OF THE AUDITORS IN THE UK CORPORATE GOVERNANCE»

BY

N'SEMY AUBIN MABANZA

«THIS DISSERTATION IS SUBMITTED IN FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF LLM COMMERCIAL LAW »

SUPERVISOR: Dr TIM PRYCE-BROWN

ACKNOWLEDGEMENTS

I would like to thank my Supervisor Dr Tim Pryce-Brown for his guidance and support during this research.

I would like to thank my wife Patricia for her love, care and inspiration, without which this course would not have been possible.

TABLE OF CONTENTS

Chapter 1 Transparency in the UK Corporate Governance

1 .1 Introduction

1.2 The Auditors and responsibilities

1.3 The Independence and Integrity of Auditors

1.4 The Audit Committee in the UK

1.5 The Audit Committee in the USA

1.6 Current position under Common law: English law and US law

1.7 Recent development of Auditors liability

Chapter 2 Concept of «Good « Corporate Governance in the UK

Chapter 3 Harmonisation of the European Company law

Chapter 4 Conclusion

Bibliography

ABSTRACT

This paper traces the role of the Auditors in the UK Corporate Governance.

It analyses the internal control and the responsibilities of the auditors. The paper

identifies the importance of the audit committee under Common law, particularly the

English law, and the US law.

The recent development of the auditors' s liability is outlined. The concept of good

governance since the early period, as well as its evolution within Europe is

illustrated. The implementation of the E C Directives in the UK is also examined.

It is concluded that the role of the auditors need truth, independence and objectivity

for the efficient functioning of UK corporate governance. It is pointed that there

is not a single and perfect system of corporate governance to monitor the audit.

It is also pointed that the current rules are inadequate and unsatisfactory to protect

the interest of shareholders and others. It is proposed that to avoid conflicts of

interest, individual rotation of auditors should be absolute under new standards. It is

also proposed that the auditor should have a permanent contact with all actors

who hold company information.

Chapter 1 Transparency in the UK Corporate governance.

1.1 Introduction

The availability of accurate and up-to-date information on company performance

1

is of fundamental importance. In the absence of reliable accounting data, effective

shareholder supervision of management is impossible, as the accurate pricing of

2

shares which is crucial to market modes of control. The sudden collapse in recent

years of a number of well-known companies which, according to their duly audited

accounts, were thriving, has focused attention on the consideration scope for the

3

distorted presentation of financial information.

However, the modern English Company law contains provisions to promote

transparency. S.384 of CA 1985 provides that every company must appoint auditors

except companies which are exempt from the audit requirement. An auditor is a

person appointed to examine the books of account and the accounts of a registered

company and to report upon them to company members. Normally, the auditor is

appointed by the director' s recommendation. However, the relationship between

the auditor and the director's company is prone to vulnerability. The close nature

of their relationship constitutes an important element which has been implicit

in many debates of auditor independence. For many years, external auditors

have contributed in a decisive way to the development of welfare markets.

Moreover, the audit multidisciplinary links have put on the market, on the edge of

the classic control, some worthy activities of advising from non statutory

( lobbing for tax breaks, IT assistance, representation of the internal audit).

1.J.E.Parkinson,'Corporate Power and Responsibility',p.161

2.ibid

3.ibid

This matter is very considerable. On the other hand, the importance to fee income of

non- audit services has been identified as another factor for criticism. For example,

in the Enron case, it has been widely reported that Andersen received $25m in audit

fees and $27m for non audit services; there have been many criticisms about the

potential conflict of interest faced by audit firms which receive large consultancy

4

fees from their audit clients.

Concerns are expressed about how an auditor with a statutory responsibility to

company shareholders can handle a commercial relationship with the company's

5

management and remain impartial. In the UK, one of the issues called by the

Cadbury Report was the establishment of the Audit Committee and the development

6

of the effective accounting standards. Shaken by the Andersen brutal scuttling,

the statutory dispositions of the profession has strengthened quickly for a

7

better independence necessity, achieved in the USA by the Sarbannes- Oxley Act.

On the other hand, the auditing firms themselves have come up with the same

conclusion such as the rotation of auditors, the splitting of their businesses

( non audit services and audit work), the powers of the audit committees.

However, in the light of all these reports we have to note that some problems remain

unsolved. This is not a unique issue. The auditors, like solicitors, have to work

under rules adopted by the profession. However, transparency by companies

management and auditors firms is important to ensure impartiality in an audit

process, especially where auditors supply other activities.

4.The Financial Times ,2001.

5.ibid

6.Cadbury Report ,1992 ,p.38 , para ,5.7

7.The Sarbannes- Oxley Act (SOA) is a US law passed in 2002 to strengthen corporate governance and restore investor confidence. Act was sponsored by US senator P. Sarbannes and US Representative M.Oxley (see http:// six signatutorial.com/Sox/Sarbannes-Oxley).

As in the case of directors, a company may by ordinary resolution at any time remove

an auditor from office notwithstanding anything in any agreement between it and him.

However, in accordance with the law, for the removal of an auditor, special

safeguards are needed not only to protect him, but to protect the company from being

deprived of an auditor whose fault in the eyes of the directors may be that has

8

rightly not proved subservient to their wishes. In other words, a company cannot

remove an auditor against his will without facing a serious risk of a row at the

general meeting (and in the case of a listed company, adverse press publicity)

9

and probably payment of compensation.

As a result of the encouragement from the Audit and Accounting Issues Group and

the EC Commission professional guidance was changed to require the rotation of

the audit engagement partner for listed firms at least every five years and of other

10

key audit partners of listed firms every five years. Finally, a breakdown in relations

between the auditor and the management may reveal itself not in the removal,

11

but in the resignation of the auditor.

1.2 The Auditors and responsibilities.

Fundamental to Financial Statements, an audit is the division of responsibility

between the management and the independent auditors. Although the audit may

act as a deterrent, the auditor is not responsible for preventing fraud or

12

errors. If the auditor identifies weaknesses in the client's accounting

systems and internal controls which might result in fraud not being detected, the

13

auditor should report these to management.

8.Gower and Davies , » Principles of Modern company law » .

9.ibid

10.ibid

11.ibid

12.D.Walters and J . Dunn ,» Student ' s Manual of Auditing the Guide to UK Auditing Practice ».

13.ibid

Under the Statement of Auditing Standards (SAS) 1101, it is stated that 'Auditors

should plan and perform their audit procedures and evaluate and report the results

thereof, recognising that fraud or error may materially affect the financial statement'.

In practice, these provisions illustrate the limits of the audit, also the division of

responsibility between the auditor and the audit clients. The audit cannot be expected

14

to detect all errors or instances of fraudulent or dishonest conduct.

The likelihood of detecting errors is higher than that of detecting fraud, because

fraud is usually accompanied by acts specifically designed to conceal its existence,

such as management introducing transactions without substance, collusion between

15

employees or falsification of records.

One of the most important tasks of a total audit is to report to the shareholders

significant matters that arise during an audit. The work of the auditors carries out, and

the experience of the audit firm's partners, managers and staff , is potentially a

source of greater value to clients; the auditors should be positive and

constructive in conveying views and opinion to clients; it is only through

16

effective reporting to management that this value can be realised.

The audit report must include a statement of the auditor's responsibility for

17

expressing an opinion on the financial statements, this should be as follows:

«It is our responsibility to form an independent opinion, based on our audit, on the financial statements and to report our opinion to you».

14. D . Walters and J . Dunn ,' Student `s Manual of Auditing : The Guide to UK Auditing Practice `.

15. D . Walters and J . Dunn , » Student ' s Manual of Auditing the Guide to UK Auditing Practice ».

16. Gower and Davies , » Principles of Modern Company law » .

17. Statements of Auditing Standard (SAS 100).

According to the Auditing Practice Board, audit of financial statements is an

exercise whose objective is to enable auditors to express an opinion whether the

financial statements give a true and fair view...of the entity's affairs at the period

end and of its profit or loss ... for the period then ended and have been properly

prepared in accordance with the applicable reporting framework or, where statutory

or other specific requirements prescribe the term, whether the financial statements'

18

present fairly'.

In practice, the auditor's potential civil liability for negligence arises in contract or

Tort. When acting for the client, an auditor performs his duties under a contractual

relationship with his company; if he is negligent in the performance of his contractual

19

duties he may be liable to the company for loss arising from negligence. If the

company is in liquidation, proceedings may be brought by way of misfeasance

20

summons under section 212 of the Insolvency Act 1986. In the UK, the duties of

21

auditors depend on the terms of the articles as well as on the statutory provisions.

Under English law, the earlier cases discussed extensively the auditor' s duties.

22

In Leeds Estate Co. v Shepherd, Stirling J. pointed that :

`The duty of the auditor ...[is]...not to confirm himself merely to the task of verifying

the arithmetical accuracy of the balance sheet, but to inquire into its substantial accuracy, and to ascertain that it...was properly drawn up, so as to contain a true and correct representation of the state of the company's affairs'.

18.APB was established in 1991 to advance Standards of auditing and to provide a framework of practice for the exercise of the auditor ' s role ( See D . Walters & J . Dunn ) .

19.Boyle & Birds ' Company Law , p . 450 , 4 t h edition 2000.

20.ibid

21. C .Worth and Morse Company Law.

22 . (1887) 36Ch.D.787 at p.802.

23

In the Kingston Cotton Mill Co, Lopes LJ defined an auditor's duties as follows:

`It is the duty of an auditor to bring to bear on the work he has to perform that skill,

care and caution which a reasonably competent, careful and cautions auditor would

use. What is reasonable skill, care and caution must depend on the circumstances of

each case. An auditor is not bound to be a detective, or as was said, to approach his

work with suspicion. He is watchdog, but not a bloodhound. He is justified in

believing tried servants of the company in whom confidence is place by the

company. He is entitled to assume that they are honest, and to rely upon their

representations, provided he takes reasonable care. If there is anything calculated to

excite suspicion, he should probe it to the bottom, but in the absence of anything of

that kind he is only bound to be reasonably cautions and careful.'

Moreover, an auditor may be liable for negligence to persons relying on his report and

with whom he does not stand in a contractual or fiduciary relationship. The Court of

Appeal in Candler v Crane Christmas had held that a firm of accountants was not

liable in negligence to someone who had relied on a report negligently prepared

by them and which they had known would be acted on by him, and suffered loss as

24

a result, because there was no contractual relationship between the parties.

However, more recently there is a tendency to restrict the liability. In Caparo

Industries plc v Dickman, the House of Lords considered the auditor's duty of care

25

to shareholders and potential shareholders. It held that the purpose of the audit report

was to enable shareholders to exercise their property powers as shareholders by giving

them reliable intelligence on the company' s affairs, sufficient to allow them to

scrutinise the management' s conduct and to exercise their collective powers to

26

control the management through general meetings.

23 .[1896]2 Ch279 ,also Re Equitable Fire Insurance Co [1925]Ch 407.

24. [1951]2 K.b.164,CA

25. [1990]1 All ER 568.

26. R . Wareham , ' Tolley ' s Company Law'.

27

However, the Deloitte Haskins & Sells v National Mutual life Nominees judgement

instead, the House of Lords confined the Common law duty of care within the

statutory framework set by the Companies Act for company accounts and their audit,

28

which by itself is a policy which has much to commend it.

In Electra Private Equity Partners v KPMG Peat Marwick,a crucial initial issue is

that the special relationship does not require that the auditor should consciously have

29

assumed responsibility. The Barings PLC v Coopers & Lybrand case illustrate that

30

a number of different situations have been considered in this light in the case law.

First, within groups of companies, the Courts have accepted that it is arguable that the

auditors of a subsidiary company owe a duty of care to the parent company, since

the auditors will be aware that the parent will rely on the audit of the subsidiary

31

to provide accounts which reflect a true and fair view of the group as a whole.

A second area of tortuous duty to «third» parties involves the directors of the

32

Company by which the auditors have been engaged. Although the Act presents the

compilation of the accounts by the directors and their audit as consecutive and

separate events, in practice the two overlap, with the directors finalising the accounts

33

at the same time as the audit is in progress on the basis of draft accounts.

27.[1993]A.C.774,PC.

28.Gower and Davies , ' Principles of Modern Company law ' , p . 584.

29.[2001]1 B.C.L.C.589,CA.

30.[1997]2 B.C.L.C.427,CA.

31.Gower and Davies , ' Principles of Modern Company law'.

32.ibid

33.ibid

In addition, auditors who come into possession of information about wrongdoing

during the course of their audit may be obliged to report it to the relevant

authorities; auditing standards require auditors to consider whether the public

34

interest requires such action. On the other hand, the Court of Appeal,

in Sasea Finance Ltd v KPMG held that on the basis of this professional

guidance, the auditor' s duties to the company could embrace, as last resort,

35

a duty to inform relevant third parties of suspected wrongdoing. For example,

where the auditors discovered fraud on the part of those in control of the

company so that simply warning the company was likely to be ineffective.

In practice, the test of the public interest is used in order to give auditors

in such cases a defence to an action at Common law by the company for

36

breach of confidence. However, the concern about the independence and integrity

of auditors is based on the influence of non audit services principally to the recent

corporate collapses.

1.3 The Independence and Integrity of Auditors.

The external auditor plays a critical role in lending independent credibility to

published Financial Statements used by investors, creditors and other shareholders as

37

a basis for making capital allocation decisions. Indeed, the public's perception of the

credibility of financial reporting by listed entities is influenced significantly by the

perceived effectiveness of external auditors in examining and reporting on financial

Statements; while any consideration of the effectiveness of external auditors involves

a wide variety of issues, it is fundamental to public confidence in the reliability of

34 . A P B , Statement of Auditing Standards No.110.

35. [2000]1 All ER 676,CA.

36. Gower and Davies , ' Principles of Modern Company law ' .

37. '.Principle of Auditor Independence and the Role of Corporate Governance in

Monitoring an Auditor' Independence'. International Organisation of Securities

Commissions (IOSC),) October 2002.

financial statements that external auditors operate, and are seen to operate, in an

environment that supports objective decision-making on key issues fraying a material

38

effect on financial statements. In other words, the auditors must be independent in

39

both fact and appearance.

The current English law for securing the independence of auditors from management

have focussed to date mainly on placing the appointment, remuneration and removal

40

of auditors in the hand of the shareholders. Everyone concerned accepts the principle

that auditors must be objective and thus remain independent from company

management. The regulatory framework in the UK in respect of non-audit services

requires listed companies and other large companies to disclose in the annual report

the amount of non audit services fees paid to their incumbent auditor.

On the other hand, The Eighth Directive requires that Company Auditors should

conduct audits with professional integrity and independence. Moreover, the recent

Recommendation on Statutory Auditors' Independence suggests that non audit

services disclosure should be further broken down into assurance, tax advisory and

41

other, with details being provided as to the composition of `other'. When acting,

auditors should comply with the ethical guidance issued by their relevant

professional Bodies; each professional body has published detailed guidance on

maintaining professional independence.

38 .'.Principle of Auditor Independence and the Role of Corporate Governance in

Monitoring an Auditor' Independence'. International Organisation of Securities

Commissions (IOSC),) October 2002.

39 .ibid

40 .ibid

41 .European Commission , 2002.

Solomon argued that the desire for auditors to compete on price in offering a number

of services, as well as their desire to satisfy their client's wishes, can lead to

42

shareholders interests being sidelined. Auditing companies offer consultancy

43

services and IT services to the companies that they audit . However,

as the Cadbury Report comments, such a prohibition could increase corporate

costs significantly, as their freedom of choice in the market would be restricted.

Consequently, the Cadbury Report stated that companies should disclose full

details of fees paid to audit firms for non- audit work, such as consultancy.

In 2003, the Smith Report was reluctant to deal with the issue in a proactive manner,

44

the report stated that:

`... we do not believe it would be right to seek to impose specific restrictions on the

auditors' s supply of non services through the vehicle of Code guidance. We are

sceptical of a prescriptive approach, since we believe that there are no clear-cut,

universal answers ... there may be genuine benefits to efficiency and effectiveness

from auditors doing non-audit work'.

In the light of the Smith Recommendations, responsibility for auditor independence

and objectivity is transferred on to the audit committee. The audit committee plays a

key role in the financial reporting process in modern company. The recent scandal

frauds in the UK and in the USA illustrated that there are some common points

between the two systems.

42. J. Solomon and A . Solomon ,' Corporate Governance and Accountability',2004.

43. ibid

44 . Smith Report,2003,p.27,para.3.5

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