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Draft Code of Practice for Auditor-Regulator Interaction Set Out by UK FSA

By Jim Hamilton

The UK Financial Services Authority has proposed a draft Code of Practice to enhance the relationship between the outside independent auditor of a firm?s financial statements and the regulator of the firm. The Code is composed of principles focusing on open and regular dialogue, confidentiality, and the fulfillment of statutory duties. In a preamble, the Code sets forth the basic tenet that the external auditor has an important role to play in the regulatory framework, which requires a constructive relationship between the FSA and the auditor so that they can both provide effective input to the regulatory process.

It is important, therefore, that the terms and scope of this relationship are clearly defined and understood by both parties. While the high level goal of the Code is to contribute to quality audits by promoting an effective relationship between the auditor and the FSA, this does not detract from the auditor?s independent role in forming judgments and opinions on the firm?s financial statements for the benefit of investors and other users of the financial statements.

The Code provides that there should be an open and constructive dialogue between the auditor and the regulator through formal meetings and informal channels such as telephone calls. In terms of formal meetings, there should be a bilateral meeting once a year between the auditor and the regulator. There should be an annual trilateral meeting for high impact firms attended ideally by the lead audit partner, the regulatory team leader, and the chair of the firm?s audit committee. Additional bilateral meetings between the regulator and auditor of very high impact firms will be needed around the time the annual report is planned and concluded.

Another principle is that auditors and regulators must share all information relevant to carrying out their respective statutory duties in a timely fashion. The overriding consideration here should be to disclose information that the lead audit partner judges to be of aid to the FSA in performing its functions, and such information should be timely disclosed by the auditor directly to the FSA. The auditor should not rely on the audited firm to notify the FSA.

Conversely, the FSA should disclose information to auditors relevant to the fulfillment of their statutory duties. Subject to restrictions, the presumption should be that the FSA will want to share any information likely to contribute to higher quality audits. The Code provides for the confidential treatment of shared information between the FSA and the auditor, as well as information received from the regulated firm.

Full post as published by Jim Hamilton's World of Securities Regulation on February 22, 2011 (boomark / email).