Regulatory and political focus on the auditing profession has been intensifying in recent months, writes RACHEL SANDERSON

MICHEL BARNIER, the new internal market commissioner at the European Commission, recently put auditors on high alert.

While the role of banks, hedge funds and credit-rating agencies had been called into question following the financial crisis, Barnier was now “convinced” it was the turn of the auditors to be put under the European regulatory microscope.

“This conviction is reinforced by the questions recently raised in the context of the audit of the US bank Lehman Brothers,” he said.

Until the publication of US prosecutor Anton Valukas’s report into the collapse of Lehman, some auditors had liked to say that compared with the post-Enron turmoil, the past two years had been a “good crisis”.

But since Valukas’s report in March criticising Lehman’s auditor Ernst Young (EY), regulatory and political focus on the auditing profession has intensified. Auditors are facing inquiries from the commission, the UK financial reporting council and the new Con-Lib coalition. An investigation prompted by criticism from the former UK government’s treasury select committee is also reaching its conclusion.

Moreover, unrelated to the financial crisis but likely to intensify focus on the profession, the UK joint disciplinary scheme is due shortly to hand down its expected verdict on one of Britain’s most contentious and long-running corporate sagas: the collapse of Equitable Life a decade ago and the role played again by EY, its auditor.

As a result, senior executives at the big four accounting groups – PwC, Deloitte Touche Tohmatsu, KPMG and Ernst Young – which together audit more than 90 per cent of the world’s biggest businesses, say they are expecting a more intense focus on their activities in coming months than at any time since the aftermath of the accounting scandals at Enron, WorldCom and Parmalat.

Jeremy Newman, head of BDO International, one of the world’s largest six accounting groups, says this “renewed scrutiny” is also bound to revive earlier debates on what users can expect from an audit, and the so called “expectation gap” existing between auditors and many investors.

“We need to recognise that the nature of business has changed. It is quicker, more connected and more global, and very different to the nature of business in the last century, and it is right to ask if audit has kept pace with this change. The answer may be ‘yes’ or ‘no’ but it is a valid question to ask.”

The broadest issue under debate today is one familiar from the post-Enron era. Do auditors, like rating agencies, suffer from a potential conflict of interest because they are paid by those they judge, and can still tout for other work from them?

That question was raised by the Lehman examiner’s report, which revealed the now infamous accounting “gimmick” called Repo 105 that allowed Lehman to window-dress its accounts at its quarter-end out of sight of investors. EY, which earned $31 million (€25 million) from Lehman, has denied any wrongdoing, and appears to have been in line with US accounting rules.

With such big fees available, politicians and regulators are considering whether auditors face a temptation to sign off practices that meet the rules but that might also present a misleading picture of a client’s financial health.

The profession’s failure to highlight problems in the banking sector has raised doubts about exactly how useful audit is, and whether the entire audit report requires overhauling to be more forward-looking.

Auditors respond that they have done what is required of them within the laws that govern their profession, and the debate has arisen from a fundamental misunderstanding of what an audit involves. It is not a detailed prediction of the future, they say.

Michael Izza, chief executive of the Institute of Chartered Accountants in England and Wales, says: “I think there are things that we can do better as a profession. The value of audit in today’s modern capital markets is still very important, but if there is something that we need to discuss that would make audit service product more useful, then the dialogue should happen in the open.”

Accountants are also aware that if the industry is found wanting this time it could face calls for more stringent international or pan-regional regulation, a move favoured by Brussels.

Experts do not rule that out, but say a more probable outcome is that auditors will end up providing more information to investors, in return for some relaxation of liability laws.

Guy Jubb, of Standard Life Investments, which has £138.7 billion (€163.4 billion) in assets under management, says if market forces do not deliver change “then the case for regulatory intervention to address the structure of the audit market becomes even more compelling.” – (Copyright The Financial Times Limited 2010)