The FRC's sanctions against the three audit firms involved in the LCF audits serve as a stark reminder of the vital role that auditors play in maintaining market confidence and protecting investors.
The Financial Reporting Council (FRC), the UK’s accounting watchdog, has taken decisive action against three audit firms – Oliver Clive & Co Limited (OCC), PricewaterhouseCoopers LLP (PwC), and Ernst & Young LLP (EY) – for their failures in the audits of London Capital & Finance plc (LCF).
The sanctions, which range from hefty financial penalties to severe reprimands, were the result of the FRC’s comprehensive investigation into the audits of LCF, a company that later went into administration owing £237m to over 11,000 individual bondholders.
The FRC’s findings reveal a concerning pattern of breaches in fundamental audit requirements, casting a spotlight on the critical role auditors play in safeguarding the interests of investors and the broader public.
OCC, acting as LCF’s accountants, prepared the financial statements for the one-month period ended 30 April 2015 and then proceeded to audit them. The FRC’s investigation found that OCC and its audit engagement partner, Emma Benjamin, admitted to ten breaches of Relevant Requirements in relation to this audit.
These breaches included failures to identify and guard against threats to objectivity, as well as numerous contraventions of fundamental requirements affecting several key areas of the financial statements. Despite LCF being a small company at the time, with a loan book of only £1.25m and 36 bondholders, the FRC deemed the breaches to be serious.
As a result, OCC was issued a financial sanction of £42,000 (after a 30% discount for admissions and early disposal), a severe reprimand, and a declaration that the April 2015 audit report did not satisfy the Relevant Requirements. Emma Benjamin, the audit engagement partner, received a financial sanction of £14,000 (after a 30% discount), a severe reprimand, and a similar declaration regarding the audit report.
PwC was brought in to audit the full year’s financial statements for the period ending 30 April 2016. During this time, LCF had issued a further £9.2m in bonds and was growing rapidly.
The FRC’s investigation found that PwC and its audit engagement partner, Jessica Miller, admitted to eight breaches related to identifying and assessing the risk of material misstatement, exercising professional skepticism with regard to the risk of fraud, and the auditing of various financial statement areas.
The most significant failure was the lack of understanding of LCF’s business and internal controls, as well as the insufficient application of professional skepticism. PwC resigned as LCF’s auditor in October 2017.
The sanctions imposed on PwC include a financial penalty of £4.9 million (after a 30% discount), a severe reprimand, a declaration that the 2016 audit report did not satisfy the Relevant Requirements, and an order to report on the root causes of the breaches and implement measures to prevent recurrence. Jessica Miller, the audit engagement partner, received a financial sanction of £105,000 (after a 30% discount), a severe reprimand, and a similar declaration regarding the audit report.
EY audited the financial statements for the financial year ending 30 April 2017, during which LCF issued a further £53.4m in bonds.
The FRC’s investigation found that EY and its audit engagement partner, Neil Parker, admitted to six breaches related to identifying and assessing the risk of material misstatement, exercising professional skepticism with regard to the risk of fraud, and the auditing of various financial statement areas.
Again, the FRC identified a significant failure to gain a proper understanding of LCF’s business and internal controls, as well as the inadequate application of professional skepticism.
The sanctions imposed on EY include a financial penalty of £4.41 million (after a 10% discount for mitigating factors and a further 30% discount for admissions and early disposal), a severe reprimand, a declaration that the 2017 audit report did not satisfy the Relevant Requirements, and an order to report on the measures taken to address the root causes of the breaches and assess their effectiveness.
Neil Parker, the audit engagement partner, received a financial sanction of £47,250 (after a 10% discount for mitigating factors and a further 30% discount for admissions and early disposal), a severe reprimand, and a similar declaration regarding the audit report.
The sanctions imposed by the FRC highlight the critical importance of audit quality and the exercise of professional skepticism by auditors. In each of the three audits, the auditors failed to identify and assess the risks of material misstatement through a proper understanding of LCF’s business, despite the fact that the company was engaged in selling unregulated financial products to retail investors.
This failure is particularly concerning given that the potential investors might have placed reliance on the clean audit opinions. The FRC’s Deputy Executive Counsel, Jamie Symington, emphasized the gravity of these breaches, stating that they were “made considerably more serious by the fact that all of the auditors knew they were auditing an expanding business which was engaged in selling unregulated financial products to retail investors.”
The FRC’s decisive actions in this case send a clear message that it will not tolerate substandard audit practices that undermine market confidence and investor protection. The significant financial penalties, severe reprimands, and declarations that the audit reports did not satisfy the Relevant Requirements underscore the regulator’s commitment to holding audit firms and engagement partners accountable for their failings.
Moreover, the orders requiring PwC and EY to report on the root causes of the breaches and implement measures to prevent recurrence demonstrate the FRC’s proactive approach to ensuring that the lessons learned from this case are applied to strengthen the audit profession as a whole.
The sanctions against the three audit firms come at a time when the FRC is undergoing a transformation under the leadership of its new Chief Executive, Richard Moriarty. Moriarty has emphasized the need for the FRC to be “a more engaging, open, accessible, responsive organisation” that regulates in a manner that has “a net benefit for UK PLC.”
Moriarty’s comments suggest a shift in the FRC’s approach, with a greater focus on balancing regulatory oversight with supporting the growth and competitiveness of UK businesses.
This aligns with the recent changes to the FRC’s remit, which now require it to embed growth and competitiveness within its objectives, similar to the adjustments made at the Financial Conduct Authority (FCA) and Prudential Regulation Authority.
The FRC’s actions in the LCF case have significant implications for the audit profession as a whole. Auditors must recognize the need to enhance their understanding of client businesses, exercise greater professional scepticism, and ensure the quality of their audit work to uphold the integrity of the financial reporting system.
The substantial penalties and public reprimands serve as a stark reminder that audit failures can have severe consequences, both for the firms involved and the individual engagement partners. This, in turn, underscores the importance of continuous professional development, robust quality control measures, and a culture of accountability within audit firms.
The FRC’s evolving priorities, as highlighted by Moriarty’s comments, also reflect the broader regulatory landscape in the UK. With a growing emphasis on supporting the growth and competitiveness of British businesses, regulators are being tasked with striking a delicate balance between effective oversight and fostering an environment conducive to economic prosperity.
This shift in regulatory focus presents both challenges and opportunities for the audit profession. Auditors must adapt their practices to meet the evolving expectations of regulators, while also ensuring that their work continues to provide the necessary assurance and investor protection.
