On 5 June 2024, the House of Lords will consider the following question for short debate:

Lord Sikka (Labour) to ask His Majesty’s Government what plans they have to address any external auditing deficiencies highlighted by the collapse of BHS, Carillion, Patisserie Valerie, and London Capital and Finance.

1. Background

The collapses of BHS, Carillion, London Capital & Finance, and Patisserie Valerie all raised concerns about the effectiveness of the auditing process in the UK.

1.1 BHS

Founded in 1928, British Home Stores (BHS) was bought by Sir Philip Green for £200mn in 2000. It was sold for £1 to Retail Acquisitions Limited, owned by Dominic Chappell.[1] In April 2016, it entered administration, with debts of more than £1.3bn and a pensions deficit of £571mn. This led to the closure of its 164 shops and 11,000 job losses. The company was liquidated in December 2016.[2]

In June 2018, the Financial Reporting Council (FRC), which regulates auditors, accountants and actuaries in the UK, announced a fine of £10mn for PricewaterhouseCoopers (PwC) in relation to the 2014 audits of BHS and the Taveta Group (of which BHS was a subsidiary).[3] Additionally, it required PwC to review and amend its policies and procedures to ensure that audits of all non-listed high-risk or high-profile companies (including private companies which employed at least 10,000 individuals in the UK) were “subject to an engagement quality control review”. Among several measures, it also sanctioned the then senior statutory auditor for the Taveta Group at PwC, Stephen Denison, with a fine of £500,000 and a condition not to perform any audit work for 15 years.

1.2 Carillion

Established in 1999, Carillion was a major British company involved in construction, facilities management and maintenance services. In January 2018, Carillion entered administration before collapsing later that month.[4] The company was awarded many major construction contracts, including the building of the high speed 2 rail line. Several media outlets have reported that Carillion collapsed with debts of £7bn (more than its annual sales of £5.2bn) and that the collapse resulted in 3,000 job losses at Carillion and had affected 75,000 people working in its supply chains.[5]

In October 2023, the FRC announced sanctions against KPMG and two of its partners relating to the audits of Carillion between 2014 and 2017.[6] This included a total fine of £30mn against KPMG (reduced to £21mn to “reflect the firm’s co-operation and admissions”) and financial sanctions against two partners at KPMG, with one partner excluded from membership of the Institute of Chartered Accountants in England and Wales (ICAEW).

1.3 Patisserie Valerie

Founded in 1926, Patisserie Valerie is a high street bakery chain. In October 2018, Patisserie Holdings announced that its board had been notified of potentially fraudulent accounting irregularities. In the same month it suspended trading, closing 70 stores, which led to 900 job losses.[7] Following the company suspending trading, the Serious Fraud Office (SFO) launched an investigation into the company’s conduct. In March 2019, KPMG, acting as administrators for the company, reported that Patisserie Valerie’s accounts had been overstated by approximately £94mn.[8] An investigation into the auditors of the company, Grant Thornton, was also opened by the FRC.

In September 2021, the FRC published the findings of its investigation.[9] It stated that the investigation had revealed “a serious lack of competence in conducting the audit work” between 2015 and 2017, and that Grant Thornton had “missed red flags”. The auditor was fined £2.3mn and was ordered to review its audit quality. In addition, it faced additional monitoring relating to bank and cash audit work and was required to issue three annual reports on the impact of those reviews. Further, David Newstead, a partner at the auditor, was fined nearly £80,000 and was banned from conducting audits and signing audit reports for three years.

In September 2023, the SFO charged four individuals, including the former director and chief financial officer at Patisserie Holdings, Christopher Marsh, with conspiring to inflate the cash in the company’s balance sheets and annual reports from 2015 to 2018. This included providing false documentation to the company’s auditors.[10] At a trial preparation hearing in November 2023, the SFO stated that it expected to examine almost 3mn documents relating to the case. A trial date was set for spring 2026.[11]

1.4 London Capital & Finance

Incorporated in 2012, London Capital & Finance (LCF) was an issuer of mini-bonds used to make loans to corporate borrowers to provide capital for further investment.[12] In December 2018, the Financial Conduct Authority (FCA) wrote to LCF ordering the company to immediately withdraw its promotional materials for mini-bonds, stating that the marketing was “misleading, not fair and unclear”. The FCA also imposed certain requirements on LCF to “further protect investors” and because it had “serious concerns” about the conduct of LCF. Requirements included LCF ceasing to conduct all regulated activity and not to communicate any financial promotions. In January 2019, LCF went into administration. In March 2019, administrators for LCF warned that “at best” bondholders could expect to receive around 20 percent of their money back, but that the process could take two years.[13]

In May 2019, HM Treasury issued a direction to the FCA to undertake an investigation into the events relating to the regulation of LCF.[14] In June 2020, the FCA appointed Dame Elizabeth Gloster to lead the investigation. Dame Elizabeth published her report in December 2020. The report was critical of the FCA, arguing that the regulator “did not discharge its functions in respect of LCF in a manner which enabled it effectively to fulfil its statutory objectives”.[15] Therefore, it made several recommendations. This included calling on the FCA to provide “appropriate” training to relevant teams in its authorisation and supervision divisions on how to analyse a firm’s financial information to recognise circumstances suggesting fraud or “other serious irregularity”.[16]

In the same month, HM Treasury announced it would be setting up a compensation scheme for LCF bondholders. The scheme would be administered by the Financial Services Compensation Scheme (FSCS) on behalf of the government.[17] In May 2021, the government set out the legislative arrangements for the scheme by introducing the Compensation (London Capital & Finance plc and Fraud Compensation Fund) Bill in the House of Commons.[18] The bill gained royal assent in October 2021 to become the Compensation (London Capital & Finance plc and Fraud Compensation Fund) Act 2021. The compensation scheme closed in October 2022. The FSCS reported that it had been able to successfully pay 99.5 percent of customers eligible for compensation, with £115mn paid out from the government’s compensation scheme.[19]

2. How are companies audited in the UK?

2.1 Legislative background

Company law in the UK is primarily set out in the Companies Act 2006. Part 15 (sections 380 to 474) of the 2006 act details the requirements for the preparing, distributing and filing of accounts and reports. For example, section 393 places a requirement on directors of a company not to approve accounts unless they are satisfied that they “give a true and fair view of the assets, liabilities, financial position and profit or loss”.

Part 16 of the act (sections 475 to 539) details the requirements placed on auditing companies in the UK. Section 475 places a requirement on all companies to have their annual accounts audited, unless they are exempt from doing so due to one of the following reasons:

  • Small companies: Section 477 details that small companies are exempt from the requirements of the act relating to audits. Section 382 of the act defines a small company as one that has a turnover of less than £10.2mn annually, a balance below £5.1mn and no more than 50 employees.
  • Subsidiary companies: Section 479A outlines that a company is also exempt from the auditing process if it is a subsidiary undertaking, and its parent undertaking is established under the law of any part of the UK. Subsidiary companies must also meet certain conditions, including that the company must be included in the consolidated accounts drawn up for that year by the parent company.

2.2 Financial Reporting Council

The FRC is responsible for establishing and enforcing high standards in corporate governance, financial auditing and reporting within the UK.[20] It does this by:

  • setting the UK corporate governance and stewardship codes and UK standards for accounting and actuarial work[21]
  • monitoring and taking action to promote the quality of corporate reporting
  • operating independent enforcement arrangements for accountants and actuaries
  • setting auditing and ethical standards, monitoring and enforcing audit quality and oversight of statutory audit regulation in the UK.

Enforcement action by the FRC is taken under its audit enforcement procedure.[22] Under the procedure, it will investigate matters relating to the audits of:

  • public interest entities, being listed entities, credit institutions and insurance undertakings
  • alternative investment market-listed companies with a market capitalisation over €200mn
  • Lloyds syndicates

There are up to four stages to the FRC’s audit enforcement procedure:

  • Initial enquiries: These are conducted by the case examiner and may be referred to the FRC’s board or conduct committee to determine whether the matter should be referred to the FRC’s executive counsel to investigate.
  • Investigation: This is conducted by the FRC executive counsel’s lawyers and forensic accountants, resulting in an investigation report to the executive counsel. At the conclusion of the investigation, the executive counsel will issue a decision notice detailing any findings and sanctions. The subject can accept or reject the findings.
  • Tribunal: If the matter is neither concluded nor settled, the tribunal will hear evidence and determine whether or not to make an adverse finding. Where an adverse finding has been made, the tribunal may impose sanctions.
  • Settlement: At any time after a notice of investigation has been issued or before a tribunal has made its decision, the parties may agree to a settlement. The executive counsel will issue a settlement decision notice if the terms of the settlement are agreed.

The FRC fined auditors £33.2mn in 2022/23. This was a slight increase on the previous financial year, when it fined auditors £32.8mn. Both of these are higher than the value of fines imposed by the FRC in 2020/21, which was £19mn.[23]

3. Recent government measures

In recent years, the government has outlined its intention to reform the audit industry. This includes plans to publish a draft audit reform bill, which, among several measures, would contain provisions to replace the FRC with a new regulator.

3.1 White paper and consultation on audit and corporate governance

In March 2021, the Department for Business, Energy and Industrial Strategy (BEIS) published a white paper outlining proposals to reform the audit industry and corporate governance.[24] In the white paper, the department stated that stakeholder and wider public trust in the credibility of directors’ reporting and the statutory audit had been “shaken by a succession of sudden and major corporate collapses which have caused serious economic and social damage, including the insolvencies of BHS in 2016 and of Carillion in 2018”.[25] Alongside that, it noted that the FRC had “in recent years found up to a third of audits carried out by the seven largest audit firms to be in need of improvement or significant improvement”. In addition, it said that there were “more long-standing concerns” about a lack of competition and resilience in the statutory audit market covering the largest companies in the UK and a “perceived failure of the audit product to meet the growing expectations of its users”.

Therefore, BEIS proposed several measures aimed at improving the audit, corporate reporting and corporate governance systems in the UK.[26] This included:

  • Directors: Describing the current framework as “inadequate”, BEIS noted that the FRC did not have any powers to enforce directors’ duties other than when a director is a member of a professional accountancy body. Therefore, the department proposed new reporting requirements for directors, which covered internal controls, dividend and capital maintenance decisions and resilience planning. Additionally, the FRC would be given enforcement powers to “hold to account directors of large businesses which are of public importance for breaches of their duties in relation to corporate reporting and audit”.
  • Audit, auditors and audit firms: The department highlighted that “the experience of recent corporate failures and the audit regulator’s ongoing findings of sub-standard work in a significant minority of audits of public entities each year” had “seriously called into question whether the statutory audit is performing the public interest function expected of it”. Therefore, it planned to introduce a “new corporate auditing profession”, which would operate independently of the professional accountancy bodies. It would also place a new duty on auditors to take a wider range of information into account when reaching audit judgments, including whether financial statements give a “true and fair view”.
  • Shareholders: BEIS stated that although shareholders do not manage companies, they have a “vital role to play” in the corporate governance framework. To improve stewardship by giving shareholders “better opportunities to engage with companies, particularly on audit matters”, the department proposed that companies should be required to outline their approach to audit by having an audit and assurance policy, whereby shareholders would have an advisory vote.
  • Audit regulator: The department proposed legislation to establish a “strengthened regulator”, the Audit, Reporting and Governance Authority (ARGA), to replace the FCR. The new regulator would be established as a company limited by guarantee. Its general objective would be to protect and promote the interest of investors, other users of corporate reporting and the wider public interest. The ARGA would be governed by a simplified board with “strengthened oversight”, and non-executive members, including the chair, would be public appointments. The department stated that the regulator would be accountable to Parliament, with “strategic direction” from the government. It would be funded by a statutory levy from market participants. The government also proposed giving ARGA new powers of enforcement, including giving the regulator the power to impose more detailed requirements as to how certain statutory duties relating to corporate reporting and audit were to be met by directors.

The government ran a consultation on the white paper from March to July 2021.[27] In May 2022, the government published its response to the consultation. The government stated that the “overall positive response” to its reforms in the white paper confirmed its view that “reform is necessary”.[28] However, it also noted that it had made changes to some reforms in the white paper, including to the reporting requirements placed on directors. In the consultation response, the government said that in light of consultation responses it believed that “a more incremental approach to strengthening the UK’s internal control framework would be appropriate”.[29] The government stated that it would invite the regulator to strengthen the UK corporate governance code to provide for “an explicit director’s statement about the effectiveness of the company’s internal controls and the basis for that assessment, and to work with companies, investors and auditors to develop appropriate guidance”.

Outlining its next steps, the government said that it would legislate, when parliamentary time allowed, to create ARGA. It also stated that primary legislation would set out the objectives, powers and duties of the new regulator and new legal obligations on other parties and “set a solid basis for other reforms”.[30] The government also noted that some reforms, such as changes to the UK corporate governance code, could be made in secondary legislation.

The response by the government to its consultation was welcomed by some organisations. However, concerns were raised regarding the delivery of such proposals and the removal of some proposals from the white paper. The Chartered Institute of Internal Auditors welcomed the proposals in the white paper, including putting an audit regulator on a “statutory footing”.[31] Despite this, it said that it “remained concerned” that there was no “detailed timetable” as to when the government planned on publishing a draft audit reform bill or when legislation would be passed. Additionally, the chief executive of the FRC, Jon Thompson, criticised the government for removing the proposals placing obligations on directors, arguing that it was a “missed opportunity, to improve internal controls in a proportionate, UK-specific manner”.[32]

3.2 Draft audit reform bill

In the background briefing notes to the 2022 Queen’s Speech, the government outlined its plans to introduce a draft audit reform bill.[33] It stated that the purpose of the draft bill was to:

  • rebuild trust in the UK’s audit, corporate reporting and corporate governance system and the insolvency regulatory framework
  • ensure accountability for those with key roles in that system
  • increase resilience and choice in the statutory audit market—reinforcing the UK’s reputation as a world-leading destination for investment

The main elements of the bill were detailed in the government’s white paper. This included establishing ARGA and giving the new regulator “effective powers” to enforce directors’ financial reporting duties, supervise corporate reporting, and oversee and regulate the accountancy and actuarial professions.

The proposed bill was welcomed by several organisations. The director of policy and corporate governance at the Institute of Directors, Roger Barker, said that he was “relieved to see that the government will be publishing an audit reform bill, even if only in draft form”.[34] He further noted that “recent scandals, such as Carillion, BHS and P&O Ferries, have shown that there are gaps in our corporate governance framework, reducing trust in British business”. Similarly, the director of professional insights at the Association of Chartered Certified Accountants, Mike Suffield, stated that the organisation “welcome[d] this next step, especially with the overdue commitment on the part of the government to put the proposed replacement for the FRC—the Audit, Reporting and Governance Authority—on a statutory footing”.[35]

In November 2023, the government was asked in a written parliamentary question when it planned on introducing the draft audit reform bill in Parliament.[36] Responding, the minister for enterprise, markets and small business, Kevin Hollinrake, said that the government had “not set out a timescale for introducing legislating relation to audit reform” and that it was committed to legislating “when parliamentary time allows”. The draft legislation was not mentioned in the 2023 King’s Speech which took place in the same month.[37]

3.3 Draft reporting regulations

In July 2023, the government laid the draft Companies (Strategic Report and Directors’ Report) (Amendment) Regulations 2023 in Parliament. If approved by Parliament, the draft regulations would have created the following corporate reporting requirements for very large companies in the UK, defined in the draft regulations as companies with 750 employees or more, and an annual turnover of £750mn or more:

  • An annual resilience statement to be included in a company’s strategic report, in which companies must explain the steps they are taking to build or maintain their business resilience over the short, medium and long term. This would include summarising the company’s strategic approach to managing risk and building or maintaining business resilience.
  • An annual distributable profits figure, to be included as a note to the accounts, and an annual distribution policy statement, to be included in the directors’ report, requiring disclosure of information such as a distributable profits figure.
  • An annual material fraud statement, included in the directors’ report, providing a summary by the directors of their assessment of the risk of material fraud occurring and the main measures in place and any new steps to prevent and detect material fraud.
  • A triennial audit and assurance policy statement, to be included in the directors’ report. This would detail a description of the company’s internal audit and assurance capabilities and its plans for obtaining internal assurance over information in the company’s annual accounts and reports over the next three years, an explanation of whether the company plans any external (third-party) assurance of any information in its annual accounts and reports over the next three years, and an annual update covering how the audit and assurance policy has been implemented in the year.

In October 2023, the government announced in a press release that it was withdrawing the draft regulations. It stated that this followed consultation with businesses, which had raised concerns about imposing additional reporting requirements.[38] The government said that the draft regulations would have “incurred additional costs for companies” by requiring them to include “additional layers of corporate information in their annual reports”. It also noted that it “remains committed to wider audit and corporate governance reform”, such as establishing ARGA to replace the FRC. It said it would bring forward legislation to deliver the reforms “when parliamentary time allows”.

The decision to withdraw the regulations was welcomed by several financial organisations.[39] The chief executive officer of UK Finance, David Postings, said that he “welcomed the news” that the government had withdrawn the regulations and stated that “this is an important step in terms of making the UK an attractive place for businesses to grow and list”. Similarly, the chief executive officer at TheCityUK, Miles Celic, described the decision as “a significant step which will reaffirm the UK’s reputation as a business-friendly destination”.

However, the decision was also met with criticism. Iain Wright, the managing director of reputation and influence at the ICAEW, warned that the withdrawal of the draft regulations “appears to signal an end to the UK process of audit and corporate governance reform initiated after the demise of Carillion, and it is to be regretted”.[40]

4. Read more

4.1 House of Commons Library briefings

4.2 Parliamentary debates and questions


Cover image by fabrikasimf on Freepik.

References

  1. Sky News, ‘The demise of BHS: A timeline of events’, 15 June 2016. Return to text
  2. Graham Ruddick, ‘How attempts to save BHS, and 11,000 jobs, were doomed by chaos and mistrust’, Guardian, 31 December 2016. Return to text
  3. Financial Reporting Council, ‘Sanctions against PwC and former audit partner in relation to BHS’, 12 June 2018. Return to text
  4. Noor Zainab Hussain, ‘Carillion collapse timeline: How the construction company fell under debt pile’, Independent, 15 January 2018. Return to text
  5. Rob Davies and Rupert Neate, ‘Carillion collapse: Two years on, ‘government has learned nothing’’, Guardian, 15 January 2020. Return to text
  6. Financial Reporting Council, ‘Sanctions against KPMG LLP, KPMG Audit plc and two former partners’, 12 October 2023. Return to text
  7. Sarah Butler and Zoe Wood, ‘Patisserie Valerie falls into administration as bank talks fail’, Guardian, 22 January 2019. Return to text
  8. Zoe Wood, ‘Patisserie Valerie accounts black hole now £94m, says KPMG’, Guardian, 15 March 2019. Return to text
  9. Financial Reporting Council, ‘Sanctions against Grant Thornton UK LLP and David Newstead’, 27 September 2021. Return to text
  10. Serious Fraud Office, ‘SFO charges four individuals behind Patisserie Valerie collapse’, 13 September 2023. Return to text
  11. Joseph Draper, ‘Alleged Patisserie Valerie fraudsters will not face trial until 2026’, Standard, 7 November 2023. Return to text
  12. Financial Conduct Authority, ‘London Capital and Finance plc’, updated 2 February 2022. Return to text
  13. BBC News, ‘Compensation unlikely for London Capital & Finance investors’, 30 March 2019. Return to text
  14. Dame Elizabeth Gloster, ‘Report of the independent investigation into the Financial Conduct Authority’s regulation of London Capital and Finance plc’, 10 December 2020. Return to text
  15. As above, p 31. Return to text
  16. As above, p 295. Return to text
  17. House of Commons, ‘Written statement: Financial services update (HCWS678)’, 17 December 2020. Return to text
  18. UK Parliament, ‘Compensation (London Capital & Finance plc and Fraud Compensation Fund) Act 2021: Stages’, accessed 26 April 2024. Return to text
  19. Financial Services Compensation Scheme, ‘London Capital & Finance plc (LCF)’, accessed 29 April 2024. Return to text
  20. Financial Reporting Council, ‘Framework document between Department for Business, Energy and Industrial Strategy and the Financial Reporting Council’, 11 May 2022. Return to text
  21. Financial Reporting Council, ‘UK corporate governance code January 2024’, 22 January 2024; and ‘The UK stewardship code 2020’, 23 October 2019. Return to text
  22. Financial Reporting Council, ‘Audit enforcement procedure’, 25 September 2023. Return to text
  23. Maria Ward-Brennan, ‘Financial Reporting Council fines against auditors nearly doubled in two years’, City AM, 8 January 2024. Return to text
  24. Department for Business, Energy and Industrial Strategy, ‘Restoring trust in audit and corporate governance: Consultation on the government’s proposals’, 18 March 2021, CP 382. Return to text
  25. As above, p 14. Return to text
  26. As above, pp 15–18. Return to text
  27. Department for Business, Energy and Industrial Strategy, ‘Restoring trust in audit and corporate governance: Government response to the consultation on strengthening the UK’s audit, corporate reporting and corporate governance systems’, May 2022. Return to text
  28. As above, p 18. Return to text
  29. As above, p 10. Return to text
  30. As above, p 21. Return to text
  31. Chartered Institute of Internal Auditors, ‘Position paper: Government response to white paper consultation ‘Restoring trust in audit and corporate governance’’, accessed 30 April 2024. Return to text
  32. Stephen Bouvier, ‘UK waters down plans for Sarbanes-Oxley law to tackle failing audit market’, Investments and Pensions Europe, 31 May 2022. Return to text
  33. Prime Minister’s Office, ‘The Queen’s Speech 2022: Background briefing notes’, 10 May 2022, p 49. Return to text
  34. Institute of Directors, ‘Relief that audit and corporate governance reform not completely overlooked’, 10 May 2022. Return to text
  35. Association of Chartered Certified Accountants, ‘ACCA statement: The Queen’s Speech’, accessed 30 April 2024. Return to text
  36. House of Commons, ‘Written question: Audit: Reform (2941)’, 29 November 2023. Return to text
  37. Prime Minister’s Office, ‘The King’s Speech 2023’, 7 November 2023. Return to text
  38. Department for Business and Trade, ‘Burdensome legislation withdrawn in latest move to cut red tape for businesses’, 16 October 2023. Return to text
  39. As above. Return to text
  40. Institute of Chartered Accountants in England and Wales, ‘Government withdraws draft corporate reporting regulations’, 18 October 2023. Return to text