Financial Reporting Council Annual Enforcement Review – 2023/2024

On Thursday, 25 July 2024, the Financial Reporting Council (“FRC”) published its Annual Enforcement Review (“the Review”) for the year to 31 March 2024, one day after the publication of its Annual Report and Financial Statements for that same period (the Annual Report”).

The Review, as always, contains a wealth of statistical information, and is a useful tool for monitoring themes and trends in enforcement practices.   

The headline point is that the number of new enforcement investigations opened has fallen once again, continuing the trend we began to see last year. One difference from last year however is that the number of new Case Examination (now called Case Assessment) enquiries opened in the year has also dropped significantly, by nearly 50%, having remained fairly static for a number of years. While the Review does not really speculate on the reasons for this, we note that the Chief Executive’s Report in the Annual Report comments that it is too early to tell whether this is due to the improvements in audit quality seen in the larger firms. One area where there has not been a fall is in relation to the number of matters that are resolved through Constructive Engagement, as the FRC says that it continues to focus on developing this “as an effective and efficient alternative to investigation”. This is consistent with what seems to be the theme of this year’s Review, focusing on the proportionality of enforcement action. 

In the remainder of this note we have summarised what we see as being some of the key points from the Review and our thoughts.  

The key statistics

New investigations opened

As trailed in the introduction, the number of new investigations opened in the year has again fallen, this time by just over a third, from 10 to six. This follows from a similar fall last year, when the 10 investigations opened in the year to 31 March 2023 was itself down one third from 15 in the prior year.  

Of the six new investigations that have been opened, four are investigations into audits and two are investigations into members in business. Interestingly, only two of the six new investigations have been announced publicly (one of the audit matters and one of the accountant in business investigations). In our equivalent article last year, we noted that 33 of the 38 open investigations, including the eight new audit investigations opened in that year, had all been publicly announced, suggesting a possible shift towards publishing the fact of an investigation in most cases. This was also something which we had observed from matters we had been involved in over recent years. The statistics from this year seem to suggest the opposite, but in reality perhaps the key takeaway here is that this statistic is particularly open to being skewed by the specific circumstances of each case and the relatively small population of cases.  

Three other cases were referred to the Conduct Committee for consideration as to whether to open an investigation, but were returned for Constructive Engagement/no further action. This is consistent with the prior year, when a third of the cases referred to the Conduct Committee (five of 15) did not move into investigation, demonstrating that the Conduct Committee does apply scrutiny to the cases presented to it, a theme which is picked up in the Review, in a chapter on proportionality to which we refer further below. 

Cases concluded in the year  

A total of nine cases were concluded in the year, one of which was closed with no further action, with the remaining eight concluded with settlement. While this is quite a drop on the prior year, when a record 19 cases were concluded, the trend of more cases being concluded than opened in the year has continued, meaning that the overall number of active cases has decreased from 38 as at 1 April 2023, to 35 as at 1 April 2024. 28 of these current investigations relate to audits (with two under the Accountancy Scheme, and the remainder under the Audit Enforcement Procedure (“AEP”)), with seven relating to accountants in business. 

Case Assessment¹

The number of cases opened by the Case Assessment (“CA”) team (being the team responsible for undertaking the initial enquiries, up to the decision whether to refer to the Conduct Committee) had remained fairly static for the past two years, at around 70 new cases opened each year (although of course a large number were closed with no action). There has however been a significant fall in the year to 31 March 2024, down from 70 to 40 new cases opened. The Review suggests that this fall is largely attributable to a decline in the number of referrals from other teams within the FRC, particularly from the Corporate Reporting Review and Audit Firm Supervision teams.  In percentage terms, in the year to 31 March 2023, just over 58% of the cases opened by the CA team were referrals from other teams within the FRC.  In the year to 31 March 2024, that was down to 45%. Conversely, the number of cases arising from horizon scanning increased from approximately 29% to 53%.  

Those statistics do not of course address the root cause of why there are fewer cases being considered for possible investigation by the FRC. We speculated last year that one of the reasons why we had seen a fall in the number of new investigations was that we were starting to see the impact of the investment that has been made by audit firms, particularly the largest firms, in improvements to audit quality. While Richard Moriarty, CEO of the FRC, suggests that it is too early to tell whether the fall in new investigations is due to improvements in audit quality², it seems to us that this must be having some impact.  

Of the 60 cases closed by the CA team in the year to 31 March 2024 (which level has remained fairly consistent over the last few years), putting aside the six that were referred to the Conduct Committee and ultimately to investigation, there was a relatively equal split between cases closed with no further action (26) and cases referred to Constructive Engagement (28). That number of cases referred to Constructive Engagement is actually up significantly from 16 in the prior year. 

Constructive Engagement

The FRC’s focus on the use of constructive engagement as an alternative to investigation has continued apace, as demonstrated by the increase in the number of cases closed by the CA team through referral to Constructive Engagement.  As noted above, in the year to 31 March 2024, 28 CA cases (or 47%) were closed through referral to Constructive Engagement, compared to 28% in the prior year.  

The Constructive Engagement process was concluded for 13 cases in the year to 31 March 2024 (down slightly from 16 in the prior year), with the average time taken to complete the Constructive Engagement process being just over 8 months. This is slightly up on the average of 7 months in 2022/2023. One of the advantages of the Constructive Engagement process is that it allows for timely intervention and relatively swift resolution of matters. It is to be hoped that this slight increase in time taken to conclude matters is not indicative of a trend, as this could begin to detract from the success and usefulness of the Constructive Engagement process. 

Sanctions

The number of sanctions (financial and non-financial) issued in the year to 31 March 2024 is down from the prior year, but that is of course to be expected given that the number of cases closed, other than by way of no further action, was down from 12 to 8. The total financial sanctions imposed on firms in the year reached its highest point to date (£48.2 million before discount), but this figure was skewed by one very significant financial sanction on one of the matters closed in the course of the year.    

The level of discounts applied ranged from 25% to an impressive 39.9%.  

Non-financial sanctions continue to be a significant tool used by the FRC in their role as an improvement regulator, and the Review this year includes a spotlight on them. The range of such sanctions imposed in the year varied quite widely, as is often the case, including requirements to review a sample of other completed audits; requirements to report to the FRC on whether changes made to audit procedures were sufficient to prevent recurrence of the breaches of relevant requirements; reporting to the FRC on the root causes of breaches; and two instances of exclusion from membership of the ICAEW, in one case for a period of 10 years and in the other, for life. 

Timeliness

As the FRC announced in the 2022/2023 review, it intended to change the way in which it measured performance against KPIs, such that it would be reporting on:

• Meeting the two year KPI from commencement of the investigation to service of an investigation report in 50% of cases; and
• Meeting a new, three year KPI from commencement of the investigation to service of an investigation report in 80% of cases.

While the FRC has met these revised targets, meeting the two year KPI in 53% of cases, and the three year in 88% of cases, it remains the case that these investigations can, and usually do, take on average three years to conclude³. That said, there has been a positive development in the average time from commencement of the investigation to issue of an Investigation Report/Proposed Formal Complaint which was 25 months, down from 34 months in the prior year (and 33 months in 2021/2022). 

Key themes from concluded cases

The most common accounting areas which arose on matters closed through constructive engagement were impairment and financial instruments and investments. The most common audit failings were lack of professional scepticism, insufficient audit procedures and insufficient technical knowledge. 

In relation to concluded investigations, failure to obtain sufficient and appropriate audit evidence, insufficient audit documentation and a lack of professional scepticism continued to feature heavily amidst the most common audit failings. A number of concluded cases also involved failures adequately to understand the entity (ISA 315), resulting in failures in relation to the identification and assessment of the risks of material misstatement and, consequently, in the design and implementation of audit procedures to address those risks. The audit of long term contracts and going concern also featured in a number of the cases concluded in the year.  

Proportionality in enforcement cases

As noted in the introduction, a theme which seems to run through this year’s Review (and can also be seen in the Chief Executive’s Report in the Annual Report and Financial Statements) is proportionality.  

The Review includes a chapter which seeks to explain how the concepts of proportionality and consistency are embedded in the FRC’s enforcement work and processes.  It summarises the FRC’s regulatory scope and who can be investigated, explains how the decision to investigate is made, including the different stages from Case Assessment through to the Conduct Committee and the considerations at each stage.  It also discusses how proportionality is applied during the investigation process, the decision as to which matters should proceed to enforcement and concludes with some guidance on how decisions are made in relation to financial sanctions and decisions to publish. 

While much of what is in this chapter will not be new to those familiar with dealing with the FRC, it is a useful overview and brings together content from a number of different FRC publications, for example the guidance to the Conduct Committee on opening investigations, and the sanctions and publication policies.  Some of the key messages which the FRC seeks to emphasis include: 

• The small (and declining) percentage of cases considered by the Case Examiner which are referred to the Conduct Committee for consideration whether to open an investigation (23% in 2023/2024). 
• The ‘robust and independent’ function performed by the Conduct Committee when considering whether to open investigations, highlighting that in the past three years, 10 of the 41 cases referred to it have been returned for Constructive Engagement or to be closed with no further action. 
• The significant increased use of the Constructive Engagement process, as an alternative to investigation, with three times as many cases referred to Constructive Engagement than referred to investigation.
• That when compared to the number of statutory audits conducted each year (which they estimate to be approximately 2,600 for the Big Four alone), the number of investigations opened is very small; 
• That their objective is to identify those breaches which are serious or significant (individually or collectively) (consistent with comments by Richard Moriarty earlier this year, shortly after he took on the role of CEO of the FRC); and
• That it is rare for individuals other than those in senior positions to be subject of FRC investigations.  

While it is not reflected in our experience, the Review also indicates that the Enforcement team will take into account the size and resources of those under investigation when making requests for evidence. 

Key takeaways

• The main takeaway seems to us to be the significant decrease in matters being considered by the FRC, both in terms of new enforcement investigations opened and cases being considered by the Case Examiner and Case Assessment team. There are no doubt a number of factors contributing to this, but the significant investment made by firms to improving audit quality, particularly the larger firms who have been on the receiving end of a significant proportion of the FRC’s sanctions over the past decade, must be at least one of those factors. 
• Notwithstanding the fall in current enforcement activity, we note that the Enforcement team has continued to grow, with two new lawyers (taking the total to 32) and one additional forensic accountant joining the team in 2023/2024. 
• We noted last year that it seemed that Constructive Engagement continued to be seen as a useful process for resolving matters at an early stage. This year has seen a significant increase in cases referred to Constructive Engagement, and the FRC is clear in the Review that this is now seen as a key and central part of their regulatory regime. While the use of Constructive Engagement is generally to be encouraged, we note that there are some early indications that the time taken to conclude a matter through this process is increasing. If that trend continues, it could begin to detract from the usefulness of the process, in particular the fact that it allows firms to take prompt, remedial action to seek to prevent similar issues arising again in the future.  
• Ultimately, following the King’s Speech, and the new Government’s confirmation that it will be pushing ahead with audit reform, including the transition of the FRC to a new regulator, ARGA, it is difficult to predict what the coming year will have in store. It will be interesting to see how those changes will have an impact. The expectation or assumption has perhaps been that the introduction of ARGA will result in an increase in investigations and enforcement activity as the scope of companies (and auditors) within the FRC’s (or ARGA’s) remit expands considerably, but that very much remains to be seen. 

¹Previously Case Examination and Enquiry (CEE).

²Chief Executive’s Report, FRC Annual Report and Financial Statements for the year ended 31 March 2024

³The average length of case concluded by settlement in 2023/2024 was 42 months, but would have been 35 months if a very large, complex, investigation which concluded in the year was removed from the calculation.