The Insolvency Practitioner & Auditors
It should come as no surprise that an enquiry has been announced by the Financial Reporting Council into EY’s role as Auditor of Thomas Cook.
Politicians are already announcing conclusions about aggressive accounting being a contributing factor to the demise and Liquidation of the travel agency group.
However, it is worth taking a step back and considering the auditor’s role in all of this. Audit firms have been under increased scrutiny over recent years. There is a growing discomfort about the ability of advisory firms to offer independent audit at the same time as earning huge fees from the same corporate clients who are being audited.
The Big 4 Audit Firms have responded by creating separation between their audit and consulting businesses. They emphasise their detailed risk management system for dealing with conflicts.
It remains to be seen how government will decide to deal with this issue. It may be that the voluntary separation of audit and consulting capabilities by the Big 4 will stop government from enforcing constitutional separation.
In any event, Auditors who breach the stringent FRC standards can be subject to fine, restriction or removal.
However, meantime, of particular interest to Insolvency professionals is the effect the public and political loss of confidence in the UK audit system is having on Administrations and Liquidations.
Firstly, there is an impact on the Insolvency market. For good conflict reasons Big 4 firms can rarely sue each other. Although theoretically competent to appoint a conflict Liquidator or Administrator to deal with claims and investigations, that can add to duplication of cost. It is not desirable if an auditor investigation or claim is going to be a large part of the case. Therefore, where it is likely that company auditors are going to be in the firing line post Insolvency, specialist independent restructuring practices are being appointed more and more in preference to the Big 4. That leads to interesting market disruption and distortion.
However, there is an additional impact in a wider variety of cases. Creditors and stakeholders now generally will expect Administrators and Liquidators to conduct thorough investigations into the role of auditors, if it is established that financial statements have been previously misstated. It is expected that auditors will be asked difficult questions about their knowledge and role. This is a task Insolvency Practitioners can no longer avoid.
At its most basic, the auditor provides an independent checks and balance to shareholders and other stakeholders. An auditor does not guarantee that every statement is correct but the system should ensure that there is proportionate and rigorous auditing of financial statements before publication.
Is there then a risk for auditors in a subsequent Insolvency if the Company has misstated its position, or reported in an irregular fashion? In short, yes.
Auditors owe a duty of care to members of the Company. If they breach that duty by acting in a way that no ordinarily competent auditor would, they are considered to have been negligent. It is conceivable that members, and perhaps other stakeholders such as lenders, may have a claim against the auditor if they can show that negligence caused loss. The Liquidator of the Company may similarly have a claim if the Company (and therefore the members) lost out because of auditor negligence.
It is also possible that there would be a separate claim against audit firms, on a co-conspiracy basis, if actually audit partners were seen to consent or approve irregular, fraudulent accounting. This is much less common but it does occur and BBM are acting for Joint Liquidators in one such case at present.
Given the political climate we suspect that Insolvency investigations and claims into company auditors will continue to rise in the short to medium term. That will also likely have a market impact on the cost (for example, professional indemnity insurance) of doing audit work. Audit fees may no longer be a loss leader and fees may therefore increase.
It will be interesting to see the result of the FRC probe, but also the wider direction of travel for audit firms in due course.