Bonuses targeted in U.K. crackdown on audit scandals

Top executives at companies hit by accounting scandals could lose their bonuses under U.K. proposals for beefed-up regulation after a wave of corporate collapses including Carillion and travel firm Thomas Cook Group.

The government proposed creating a new regulator with the power to wield a range of sanctions, including reprimands, fines and even temporary bans from directorships, signaling it's serious about cracking down on questionable accounting practices.

Importantly, the government said, the sanctions shouldn't apply only to directors who happen to be qualified accountants, but also chief executives, finance chiefs, board chairmen and audit committee chairmen.

The U.K. government's focus on directors and their compensation is a shift after years of reviews into the role of the Big Four auditors in the collapse of companies like outsourcing contractor Carillion in 2018. Putting more pressure on directors to ensure the accuracy of financial statements also echoes the Sarbanes-Oxley accounting reforms introduced in the U.S. after the high-profile collapse of Enron in 2001.

The proposal for the new regulator, the Audit, Reporting and Governance Authority, was unveiled Thursday in a 232-page report, "Restoring trust in audit and corporate governance." The report provides the basis for further consultation with the industry and eventual reforms will be presented to the U.K. Parliament for approval.

Current rules for FTSE 350 companies don't do enough to dissuade reckless management, the government said. It wants the new regulator to add minimum clawback conditions that would be valid for at least two years after an award is made.

Prem Sikka, an accounting professor at Sheffield University, said the government is trying to address issues that previous attempts at audit reform have failed to tackle.

"If you look at the recent scandals these were auditing problems and the directors would not have faced prosecution," said Mr. Sikka, who drafted the opposition Labour Party's audit reform proposals before the last election. "This is basically saying the problems are the company directors' fault."

The U.K. Financial Reporting Council, the current regulator, has told the Big Four firms — PricewaterhouseCoopers, EY, KPMG and Deloitte — to split their consulting and accounting arms by mid-2024 to reduce the scope for conflicts of interest and to improve the rigor of their audits. By then, ARGA should have replaced the FRC.

The U.K. government in its March report acknowledged that it's "not healthy for audit quality" that 97% of FTSE 350 audits are undertaken by the Big Four, especially when those same firms offer lucrative consulting services.

The FRC last month introduced fresh recommendations to put further distance between the two. The audit side of the firms' business shouldn't get paid for introducing customers to their consulting arms and accounting partners shouldn't be "incentivized" for sales passed to other parts of the firm, the FRC said.

The Chartered Institute of Internal Auditors, which represents the profession in the U.K., welcomed the proposals, but added the reforms should be implemented with urgency.

"It is disappointing that there is no detailed legislative timetable in the white paper and we need to see a clear roadmap for reform without delay or else we risk further corporate collapses," the group said.

EY's U.K. chairman Hywel Ball said in a statement that the "the introduction of a new regulator alongside tighter accountability for directors" is "essential." Deloitte called for wider consultation on the proposals.

"It is critical that input into the consultation is given not just by audit firms and policymakers, but investors, company directors, audit committee chairs and industry bodies at large," Stephen Griggs, U.K. managing partner at Deloitte, said in a statement.

The U.K.'s Institute of Directors called on the government to create a code of conduct for directors which would be a "less legalistic" approach, the institute's head of policy, Roger Barker, said in a statement.

"It would be counterproductive if the legal and financial liabilities piled onto directors make the role excessively unattractive or risky for any capable individual to undertake," Mr. Barker said.