17 Jan 2018

Investigation and enforcement: the FRC and FCA enter into a Memorandum of Understanding

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Introduction

On 20 December 2017, the Financial Reporting Council ("FRC") and the Financial Conduct Authority ("FCA") entered into a Memorandum of Understanding ("MoU"). The purpose of the MoU, although not legally binding, is to "assist co-operation and co-ordination" between the two regulators in relation to the exchange of information in the carrying out of their respective regulatory responsibilities.1 In addition to a likely increase in FRC investigations, the MoU represents a further step by the FRC to overhaul the way it investigates suspected accountancy and audit misconduct as it more closely aligns itself with the FCA's model of misconduct investigation and enforcement.

Context

The FRC has faced increasing public scrutiny on how it fulfils its investigation and enforcement objectives.

Following its investigations into the 2007 and 2008 audits of HBOS, in November 2017 the FRC published a report setting out the lessons it had learnt from that process.2 One of the key lessons was that it should have adopted a more proactive approach to its enquiries in relation to HBOS rather than relying heavily on other regulators. The FRC was concerned that the limitations on its powers to secure information meant it was sensible to await the conclusions of the financial services regulators which had full access to information and whose conclusions would enable the FRC to identify what to focus on. However, those other investigations took much longer than initially expected leading to a substantial gap in inquiries in relation to audit being opened whilst the FCA work was underway.

That has lead the FRC to conclude that it should align itself more closely with the work of the financial regulators generally and that its investigations should be conducted in parallel so that there is no unnecessary delay in reaching conclusions, and so its evidence can be fed into other inquires if appropriate. It has also questioned the high threshold it has to pass in order to bring a successful prosecution under the Accountancy Scheme, raising the prospect of legislative reform.

Cooperation in enforcement investigations

As well as setting out provisions providing for the reciprocal exchange of information to assist each regulator discharge their regulatory objectives, the MoU includes the following important provisions concerning cooperation in enforcement investigations:

  • Before commencing enforcement action, the FCA will inform the FRC if an investigation that it intends to conduct or is conducting may include the conduct of an FCA-supervised firm's accountants, actuaries or auditors.3 The FRC will do likewise in respect of FCA-supervised firms.
  • Where the issue affects the advancement of the objectives of both regulators and both have the power to appoint investigators or commence an investigation, they will seek to agree whether any investigation should be carried out by the FCA, FRC or both.
  • Where an investigation is to be carried out by both regulators, it will usually be appropriate for the investigation to proceed in parallel. In certain circumstances, they will consider whether the particular facts suggest one regulator's investigation should proceed before the other's.
  • Where the parties determine that both should carry out an investigation, the parties will use their best endeavours to agree if the investigations, and any subsequent proceedings, should be co-ordinated (including with respect to obtaining and sharing of information, interviews of witnesses and what coordination mechanisms should be).

Other noteworthy provisions concerning cooperation more generally include the following:

  • Information received by one regulator from an external source which is legally privileged cannot be shared with the other regulator unless that privilege has been or is specifically waived by all those benefiting from it.
  • The FRC and FCA agree to exchange views on matters concerning the behaviour and performance of accounting, actuarial, and auditing professionals working with and for those FCA-supervised firms which are subject to FRC regulation.
  • The regulators will cooperate in relation to arranging staff secondments.

What effect is this likely to have?

If implemented (informed by the information available to it on request from the FCA and the emphasis on cooperation) the MoU is likely to result in an increase in FRC investigations, and investigations commenced at an earlier stage. It may also mean a swifter conclusion to those investigations. Although the FRC and FCA may choose to designate a lead investigator to carry out the bulk of the investigatory work, that does not preclude there being separate investigations run in parallel, stretching the resources of the subjects of those investigations. Perhaps in anticipation of this, the FRC announced in November 2017 a significant increase in the size of its Enforcement team.

We may be starting to see the beginning of this trend. The FCA has increased its investigatory and Enforcement focus on the issuers of primary listed securities and the timeliness and content of financial disclosures made by those companies.4 In the last 18 months, it has launched investigations into Rio Tinto Plc, Cobham Plc, Mitie Group Plc and Carillion Plc.

Conclusion

The FRC is increasingly modelling its investigation and enforcement powers on those of the FCA; the MoU is further proof of that and of closer cooperation between the two regulators.


1 https://www.frc.org.uk/getattachment/e035c8c3-1d11-4d85-94b2-e090e2e3be61/FRC-FCA-MOU-20-DEC-2017-Final.pdf 

2 https://www.frc.org.uk/getattachment/646bb35a-f39f-4d75-a12e-6d2480e0b2a7/HBOS-Report-Nov-2017-FINAL.pdf

3 "FCA-supervised firms" is defined in the MoU as "firms authorised and regulated by the FCA, including companies with securities admitted to trading in the UK".

4 The FCA has jurisdiction over primary listed firms by virtue of its role as the UK Listing Authority, responsible for regulating the issuers of primary listed securities.

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