In the wake of the high-profile corporate failures of Enron and Parmalat, it is possible that auditing profession in the UK will ultimately be subjected to a system of independent oversight by a Government-appointed body.

The present system of statutory self-regulation stems from a series of high-profile business failures in the early 1990s, and has served the profession well. This entry looks at some of the background to those events of a decade ago.

The Audit Factor

The turn of the 1990s was a rude awakening for the auditing fraternity. Chartered Accountancy firms (which audit most of the major organisations) saw themselves as an elite profession. During the decade up to 1990 they enjoyed unprecedented growth and enjoyed the confidence of public and politician alike. The title 'Chartered Accountant' was universally respected by employers. Yet by the end of 1991 the Institute of Chartered Accountants was on the defensive, under attack from politicians, derided by the media and split among its members, many of whom were unemployed; a thing never heard of before or since.

Of all the services provided by accountants, the one that gives it the most prestige is the annual audit. A good auditor needs to be more than clever; there are further qualities required, integrity, objectivity and independence. In fact, these qualities add up to trustworthiness. It is this attribute which reflects well on all accountants, and although less than half of all Chartered Accountants work in audit, any lapse in this field is bound to affect the standing of the Institute membership as a whole.

During the boom years of the 1980s the auditing profession underwent a huge expansion. The Institute grew by some 25% in membership, to over 100,000 members; by far the largest and most powerful united body of professionals in Europe (it has since grown further, to over 125,000 members). These were also halcyon days for the large firms; annual growth rates of 20% to 30% were typical, and they more than doubled their size during this period, becoming truly global enterprises.

There was seemingly no area of finance-related business that they could no enter, and eventually dominate by virtue of sheer size. The large firms built up considerable corporate finance businesses, formerly the preserve of bankers. The lucrative area of receiverships and liquidations was almost completely taken from the lawyers, who might have been expected to be pre-eminent. Some firms had management consultancy arms that rivalled their auditing parents in income. A
few firms even tried their hand at fund management.

In retrospect there was bound to be a collision between the ethos of a profession such as auditing, which demands trustworthiness, and these other services, which are more prone to 'salesmanship'. Alas, the two do not mix very well, and the problems were exposed in a series of spectacular corporate failures.

The collapses of Polly Peck, BCCI and Maxwell Corporation (among others) were traceable to different causes. However, they all raised questions about the role of the auditors, and especially their trustworthiness under pressure. At BCCI, for instance, the auditors had known that the bank's position was precarious, but the audit report did not make clear the full extent of their concerns. Many depositors were ruined, and their anger was directed at the accountancy profession.

Both this case and the Maxwell affair raised the question of the 'expectation gap' with respect to the auditor's responsibility for detecting fraud. In the latter case, it was said that the auditors had for some time been overawed by the gigantic personality of the newspaper magnate. The sudden end of Polly Peck was embarrassing because no warning had been publicised by the auditors.

The effect of this was that auditors, and by implication accountants in general, were easily caricatured as weak-willed, greedy, and essentially no more honest than anyone else. Even their reputation for good judgment suffered; among those who lost money in the BCCI debacle were accountants, although BCCI was known to be a risky investment.

Statutory Regulation

During this time, the Institute of Chartered Accountants – prodded by the Government of the time was alive to the dangers of inaction, and the nature of its work changed. Formerly its sole task was to preserve the standing and value of the title 'Chartered Accountant', which was achieved through high standards of education, training, and the enforcement of professional ethics.

A new phase began in the late 1980s, with statutory regulation. This started with insolvency practitioners and financial services authorisation, and in late 1991 the Institute took on the responsibility of regulating auditors.

This is of course self-regulation, albeit given statutory force by law. In 1991 it was obvious that if it was not seen to stem some of the troubles, it was probable that the task would be taken from the Institute and given to a Government body. As it happened, the Polly Peck debacle occurred almost at once, but too soon afterwards for the new regime to be held to account for it.

As a matter of fact, Auditing Standards had been operating well before 1991, as part of the professional and ethical remit of the Institute. However, they were not previously explicitly backed up by the force of law. It was possible for firms to sign audit reports that referred to these standards, while in practice doing little more than prepare a set of accounts. For such firms the cost of self-regulation would have been high, as staff had to be re-trained to do the job of auditing according to approved norms, or else risk penalties from the profession's watch-dog, the Joint
Monitoring Unit.

There is evidence that many smaller firms of accountants withdrew from audit work to concentrate on accounts instead – a somewhat paradoxical outcome, in view of the fact that the firms associated with the high profile collapses had been among the largest.

However, self-regulation appears to have worked, at least in its most important aspects. The regime has lasted thirteen years, with periodic upgrades, such as the creation of the Quality Assurance Directorate at the beginning of 2004 to carry on the work of the Joint Monitoring Unit, and a web of other regulatory bodies performing various functions. During that period, at least in the UK, there have been no big corporate scandals comparable to the collapses of Maxwell,
BCCI and Polly Peck at the turn of the 1990s.

On the other hand, the USA has undergone the implosion of Enron and Worldcom (both in 2002), while Italy has experienced the unravelling of Parmalat (2003). The revelations at Enron eventually resulted in the worldwide dissolution of its auditors, Arthur Andersen, and that has undoubtedly added fuel to the call for tougher regulatory scrutiny in the UK.

It might be considered ironic that the present UK regulatory regime for auditors may ultimately have to be stiffened to one of independent oversight, not because of any scandal within its sphere of influence, but because of failures abroad.