Guidelines on enforcement measures against recognised supervisory bodies and recognised qualifying bodies

Comments from ACCA to the Financial Reporting Council
February 2015

Overall comments

The current consultation appears to flow directly from the joint consultation issued in October 2011, which acknowledges within its case for reform of the FRC that regulators should ‘do more to reduce the costs of regulation and to focus on risks and outcomes rather than processes’. We continue to support that focus, although we believe that the current proposals would give rise to excessive costs of imposing and defending enforcement measures – costs that are ultimately met by accountants and their clients.

A chapter of the October 2011 consultation focused on proportionate regulation. ACCA maintains its response to the proposals within that chapter. We continue to recognise the potential benefits to be achieved through the FRC gaining intermediate-level enforcement powers, and being seen to have those powers. But we also continue to assert that the professional bodies already take the FRC’s findings and recommendations very seriously. As stated in our response, in January 2012, ‘The transparency of the regulatory procedures of the FRC and the professional bodies (particularly regarding the issue of public reports) is a significant factor in that willingness to cooperate’.

With regard to the current consultation, ACCA’s greatest concern relates to the manner in which financial penalties have been included within the enforcement framework. The main purpose of a financial penalty should be to bring about compliance, and this would usually occur through the threat that a fine may be levied, together with accompanying publicity. Together, directions, compliance orders and financial penalties provide three levels of enforcement, which should be addressed in that order. Any formal enforcement measure must only be taken under circumstances in which a Recognised Body has failed to engage with the regulatory framework, which includes effective and proportionate oversight by the FRC. Therefore, any of these enforcement measures should only be used in extreme and exceptional circumstances.

They represent three progressive stages, with each stage having more serious repercussions for the Recognised Body concerned. Therefore, the Guidelines must clearly require each enforcement measure – direction, compliance order and financial penalty – to be considered in turn, in order to determine the single measure that is sufficient to achieve compliance (and is therefore proportionate).

The FRC’s power to remove a body as a Recognised Qualifying Body or Recognised Supervisory Body is a further enforcement measure available (although its primary objective would, of course, be the protection of the public). We appreciate that the FRC is seeking a more nuanced set of enforcement measures. However, we believe that the circumstances in which financial penalties might be appropriate are so rare that, in fact, removal of recognition would perhaps be more appropriate at that stage. In short, the draft Guidelines do not provide transparency concerning when financial penalties would be appropriate. In addition, significant risks arise from the Guidelines being open to a significant degree of judgement and subjective decision-making.

Specific issues

In this section of our response, we address the five questions set out on page 5 of the consultation paper.

Question 1: Do you consider that the proposed guidelines provide a clear framework to guide the decision-making of the Board when imposing enforcement measures?

We agree with the need to have a clear framework to both guide the Board’s decision-making and (as stated clearly in the introduction to the consultation document) ‘to ensure transparency and consistency in the determination of Enforcement Measures’. There is also the claim in the introduction that the proposed Guidelines are ‘principles based, rather than tariff based’. It is not clear that this claim has been achieved.

The introduction to the consultation document refers back to the BIS consultation of 2011/2012, which covered the reform of the FRC generally. The relevant question in that consultation was whether the FRC should be able to take a more proportionate, nuanced action against a Recognised Body, and so be given a wider range of enforcement powers. ACCA’s response is reproduced here, and is still relevant:

“ACCA takes the FRC’s findings and recommendations very seriously. The transparency of the regulatory procedures of the FRC and the professional bodies (particularly regarding the issue of public reports) is a significant factor in that willingness to cooperate. It also serves to demonstrate the effectiveness of the professional bodies within a largely self-regulating profession.

Nevertheless, we acknowledge the potential benefits to be achieved through the FRC gaining intermediate-level enforcement powers (so long as those determining which actions are proportionate are appropriately informed and competent to make those assessments). Any such powers afforded to the FRC must be accompanied by proper due process and an effective appeal mechanism. Clear procedures must be established and published, including clarity regarding the thresholds for intervention and the types of serious breaches and failings that might give rise to such intervention proceedings. We note the statement in paragraph 5.4:

‘Whilst the recognised bodies generally take the FRC’s findings and recommendations seriously, a more graduated range of powers should sharpen their responses, in particular, the timeliness of actions…’

We believe that there are more effective ways of improving the timeliness of actions by the recognised bodies, and it is hoped that the efficiencies brought about by streamlining the FRC would reduce the time between an FRC inspection of a recognised body, the issue of the ensuing report by the FRC, and the agreement of actions, based on that report, between the FRC and the recognised body.”

The objective of transparency is highlighted throughout the consultation document and the proposed Guidelines. Therefore, proposed paragraph 5 of the Guidelines is fundamental, and should articulate clearly the aims and objectives when applying enforcement measures. It states that an aim is to deter future non-compliance, but goes on to state that measures are not intended to be punitive. In practice, it may be difficult to establish a financial penalty as an enforcement measure that would be a deterrent to future non-compliance without it having a significant negative impact on the professional body concerned. Therefore, any such enforcement measure is likely to be perceived as punitive.

The draft Guidelines do not state which part of the FRC will drive the enforcement process. The relationship with the Recognised Bodies is led by the Professional Oversight Team, but it would seem unreasonable to assume that the same Team would establish the size of a financial penalty for example.

In our opinion, there is too much emphasis, throughout the consultation document and the Guidelines themselves, on the deterrent effect of enforcement measures. Any deterrent effect should primarily be in respect of the continuation of the current non-compliance. This is the only way in which financial penalties can be seen to relate to enforcement. We acknowledge that transparent enforcement policies and processes send a message to all Recognised Bodies that will act as a deterrent. However, a financial penalty that is enhanced in order to achieve such a deterrent (for example, by being set with reference to a Recognised Body’s total income) would be, by its nature, disproportionate and unfair to the Recognised Body on which it was levied (and its membership and the wider public).

In conclusion, we believe that the Guidelines are fundamentally flawed. Furthermore, as currently structured and drafted, they are open to judgement and subjective implementation. A perception that some Recognised Bodies may be exposed to significant penalties – within a framework that does not provide complete transparency around the maximum exposure – may, ultimately, persuade a Recognised Body to withdraw from audit regulation, which would, of course, be detrimental to the audit market.

Question 2: Do the proposed guidelines include the factors that you would expect the Board should take into account when deciding which enforcement measure to impose?

The consultation document makes clear that the Guidance aims to uphold the five principles of good regulation, as well as ‘the overarching principles of fairness and natural justice’.[1] We also note the assertion, on page 3 of the consultation document, that the FRC’s policy objectives are ‘consistent with the Regulators Code’. However, the same paragraph states that the aim of the Guidelines is to help to determine ‘… proportionate and appropriate Enforcement Measures that will provide a credible deterrent …’. The objective of enforcement measures serving as a deterrent is not mentioned in the Regulators’ Code.

ACCA believes that undue focus on a deterrent effect risks undermining the regulatory principle of proportionality and the principle of fairness. Proportionality is very important in terms of both fairness to the Recognised Bodies and the reputation of the accountancy profession. Disproportionate measures will reflect adversely and unnecessarily on auditors generally.

The factors set out in paragraph 16 appear arbitrary. We believe that factors should be quantifiable, for example the number of people who may be affected, the period for which the non-compliance has remained unaddressed, the likelihood of continuing or repeated non-compliance, etc. These are factors that measure the urgency of enforcement (including the potential harm from continued non-compliance), which should be the focus of these Guidelines. As drafted, some of the proposed factors are so subjective that the FRC’s explanation of its approach (specifically required by paragraph 18) would be difficult to achieve.

Question 3: What is your view of the starting point proposed (a percentage of the Recognised Body’s total UK fee income) for calculating the amount of a financial penalty?

First, we must make clear our opposition to enforcement measures that rely heavily on financial penalties, as this would be contrary to good regulatory practice and principles. The proposed Guidelines appear to have been predicated on the financial services regulatory regime, which is fundamentally different in that it governs entities, such as banks, that are profit-making. Professional accountancy bodies are non-profit-making, and all their income is used to better support (and regulate) their students and members. If Recognised Bodies are to incur severe penalties, this would be counter-productive to the FRC’s aims of higher standards of regulation through timely compliance.

It appears, from the draft Guidelines, that a financial penalty would not be ‘the starting point’ in determining an appropriate enforcement action. Indeed, the draft Guidelines refer to directions and compliance orders first. (We comment further on these possible measures under question 5 below.) Nevertheless, paragraph 12 makes clear that the FCR may impose a financial penalty at any stage – even if the Recognised Body has already complied with the relevant requirement – without any explanation of why that might be appropriate. The Guidelines are not, therefore, sufficiently transparent.

It would clearly be inappropriate to seek to impose a financial penalty before more nuanced enforcement measures had been fully considered. Furthermore, the Guidelines should make clear that, if an application for a compliance order is unsuccessful, there should be no option for the FRC to seek a financial penalty or to make a direction.

Section 1225D (2) of the Companies Act 2006 (‘the Act’) states: ‘In deciding what amount is appropriate the Secretary of State … must have regard to the nature of the requirement which is not satisfied or the obligation which has not been complied with’. Before imposing the penalty, the FRC (with delegated authority by the Secretary of State) must give the Recognised Body a ‘notice of proposed penalty’ which, among other things, must state why it appears to the FRC that the requirement is not satisfied or the obligation has not been complied with. The Recognised Body is then given a period (at least 21 days) in which it may make written representations.

Where, following this procedure, the FRC decides to impose a penalty, it must publish a ‘penalty decision notice’. It is assumed that any process that reached this stage would be one that is being robustly defended by the Recognised Body concerned, and so it is assumed that written representations would have been submitted, and that these would also have been published.

Therefore, we believe that the circumstances of a financial penalty would be exceptional. The need for a financial penalty would imply grossly inappropriate behaviour by a Recognised Body, and the refusal of the Recognised Body to cooperate with the compliance process prior to the issue of a notice of proposed penalty. (Although this is the implication, the Guidelines fail to state it.) For this reason, ACCA believes that the proposal to introduce financial penalties should be pursued only with caution, and feels strongly that paragraph 10 (which states that a financial penalty may be imposed if the Recognised Body ‘breaches any Requirement’) is unreasonably vague.

The primary purpose of these Guidelines is to enforce proper behaviour. The deterrent effect is brought about by the visibility of the enforcement process, which must operate effectively, in accordance with transparent Guidelines that uphold the principle of proportionality. It is inappropriate to draft the Guidelines with the objective of deterring future improper behaviour of Recognised Bodies generally. It is unreasonable and unfair to consider a financial penalty in order to deter future non-compliance by a Recognised Body other than the one on which a fine might be imposed. In particular, in paragraph 11b, the word ‘or’ should be replaced by ‘and’.

Despite our objections set out above, we are happy to address the specific point raised of whether the starting point for a financial penalty should be a percentage of the Recognised Body’s total UK fee income. We strongly oppose this proposal, as the inclusion of income from activities other than audit would be seen as both punitive and unfair.

Finally, we question whether the financial penalty proposition seems appropriate in the context of the shared audit regulation model that exists in the UK. The FRC itself regulates audit firms that conduct audits of public interest entities. There have been cases of high profile audit firm failures – firms regulated by the FRC. As currently proposed, there would be no mechanism to enforce improvements in quality of the FRC’s work. Particularly when it comes to imposing a financial penalty, the FRC might be perceived as being conflicted.

Question 4: Do you consider there is anything missing from the proposed guidelines that would improve their effectiveness?

The Guidelines set out three types of formal enforcement action, but say nothing about the option of taking no formal action. We believe it would be appropriate to provide guidance concerning where the boundary lies between taking no enforcement action and issuing a direction (which should usually be the first stage in the formal enforcement process). There comes a point at which the potential publicity surrounding the issuing of a direction is sufficient to bring about the necessary corrective action. While the primary objective of publicity is to provide transparency, and not to influence the behaviour of Recognised Bodies, we believe that the transparency of formal enforcement action should serve to encourage compliance by Recognised Bodies. Of course, this is only the case if undue publicity is avoided in the stages prior to imposing a direction.

It is important to differentiate between the refusal of a Recognised Body to cooperate with the FRC and disagreement regarding the appropriate way to address a particular issue, where the Recognised Body is constructively engaged with the regulatory process. Determining the appropriate enforcement action (or whether any enforcement action is necessary) must focus on the desired outcome – effective regulation – and not on the process. With this is mind, an additional means by which more nuanced measures may be taken would be to facilitate an independent arbitration process in the situation where less formal discussions between the FRC and a Recognised Body have failed to achieve agreement. This would be likely to avoid unnecessary costs; it would be more efficient; and it would provide an independent opinion as part of the process of issuing a direction.

Boundaries also need to be defined at the extreme of the enforcement process. For both ethical and practical reasons, the Guidelines must state a cap on the level of financial penalty that the FRC may impose.

There is no clarity offered within the draft Guidelines with regard to costs. It might be reasonable to assume that the costs of a Recognised Body that successfully defends a compliance order, or successfully appeals a financial penalty, should be borne by the FRC. This should be clearly stated, in order to inform a decision of the FRC whether to pursue an order or penalty, or a decision of a Recognised Body whether to defend one.

Generally, the proposed Guidelines, as drafted, would have a disproportionate impact on the risk registers of the Recognised Bodies. A perception that the risk of a compliance order or financial penalty is unreasonably high would be likely to inhibit constructive conversations between the various bodies (including the FRC) that participate in the UK’s audit regulation framework. The Recognised Bodies all take their public interest responsibilities very seriously, and so a move in that direction would not advance the public interest.

Question 5: Do you have any other comments about the proposed enforcement measures?


Paragraph 7 of the draft Guidelines requires more clarity concerning the timeframe within which a Recognised Body would be expected to rectify a non-compliance prior to a direction being imposed by the FRC. More clarity is also required concerning the nature of non-compliance for which a direction would be appropriate. This should be explained early in the Guidelines, as it would help to focus the Guidelines throughout.

There is an expectation that Recognised Bodies and the FRC will act in the public interest. Therefore, the second and third bullet points of paragraph 7 are unclear. In particular, the second bullet point appears to confuse the implementation of systems to reduce the risk of future failings (the failure of which might be an example of non-compliance) with those possible future failings (which may be impossible to completely and confidently eradicate).

The publication provisions are vague and aimed largely at ‘persons likely to be affected’. The transparency that these Guidelines claim to provide is not evident in respect of these publicity provisions.

The drafting of Appendix 1 appears incomplete in respect of directions. This section largely reproduces a number of requirements of section 1225B of the Act, but does not set out a procedure (which the appendix is said to provide). There also appears to be an omission between paragraphs 1.2 and 1.3, as there is no mention of the FRC being persuaded by the written representations that a direction is, in fact, inappropriate. (Similar comments apply in respect of financial penalties.)

Paragraph 1.3 of Appendix 1 states that the direction decision notice shall contain ‘[t]he period during which any limitation on the Recognised Body’s ability to undertake particular engagements shall remain in effect’. We find this reference to a Recognised Body’s ‘engagements’ bemusing, as it is difficult to imagine to what this might refer.

Compliance orders

Despite the factors listed in paragraph 9, it remains unclear under what conditions the FRC may apply to the Court for a compliance order without first issuing a direction. (It is difficult to imagine how it could be consistent with the principles of fairness or proportionality to apply for a compliance order before giving the Recognised Body concerned the opportunity to comply with a direction.) It is important to make this clear, as it would not be in the public interest to apply for an order unless it was highly likely to succeed, in which case, issuing a direction would appear to be the proportionate course of action. The key here is to ensure that a direction is accompanied by appropriate publicity. Conversely, inappropriate disclosure of an FRC requirement of a Recognised Body prior to (or instead of) a direction being issued would serve to diminish the effectiveness of directions generally.

Paragraph 1.4 of Appendix 1 states that the notice of proposed direction may be expressed as a pre-action letter for the purpose of a future application to the Court for a compliance order. This again implies that there would be no reason to apply for a compliance order without first making a direction, as the latter need not significantly delay the former.

The consultation document does not explain why it may be deemed appropriate to allow a Recognised Body only 14 days to respond to a protocol letter when the procedure (and the Act) allows 21 days to make written representations following the issue by the FRC of a notice of proposed penalty. It appears that the proposed Guidelines have simply lifted the minimum timelines from the Act, without regard for the necessary good governance procedures with which a Recognised Body would be required to comply. This offends both proportionality and fairness.

Financial penalties

Paragraph 1.15 of Appendix 1 refers to ‘para 3.1a-c above’. It is unclear to which paragraph this refers. There appears to be a similar error in paragraph 1.17, relating to a failure to comply with the financial penalty procedure.

Appendix 2 is not focussed on enforcing compliance, but on fining Recognised Bodies for past non-compliance. This is illustrated in paragraph 3a in which the starting point for a single (past) event is the fee income for a specific 12-month period, and for a ‘repeated non-compliance’, a longer period. These bases are completely arbitrary. A repeated non-compliance might be as few as two instances of non-compliance, perhaps with a year or more in-between. This raises a number of significant questions.

The same paragraph goes on to talk about ‘interest’ being added for continuing non-compliance. Interest should not be confused with the financial penalty itself, but should be reserved for non-payment of amounts due. In fact, the most relevant situation in which an enforcement measure would be appropriate would be a continuing non-compliance, where there has been no attempt by the Recognised Body to make the necessary changes. The Guidelines should establish the basic penalty to be applied to this situation.

Paragraph 3b goes on to apply a percentage based on the seriousness of the non-compliance. This is not a principles-based approach, as it simply looks to past non-compliance, and applies a tariff. Paragraph 3d is perhaps the most important, as it focuses on the impact of the non-compliance. There must be a clear, defensible reason for the imposition of a financial penalty, and this must be in the public interest, bearing in mind that any such penalty will be suffered by the members of the Recognised Body and, ultimately, by consumers.

The proposed guidance on adjustments for aggravating or mitigating factors appears rather complicated, but omits to suggest by how much the basic penalty should be increased or reduced. We do not believe that step 3 is necessary or appropriate. Furthermore, steps 2 and 3 both include factors that are already (and more appropriately) considered as part of step 1. This serves to further impede transparency.

A regulator should not benefit financially from fines. Therefore, the guidelines should specifically state that any money received from financial penalties would go to the Secretary of State or be directed elsewhere. In any event, it would be inappropriate for the FRC to benefit from any financial penalties collected. This would distort the FRC’s funding mechanism, and impede the judgement of what is ‘reasonable’ when making the numerous decisions necessary (according to the draft Guidelines) in the enforcement process.

In our opinion, the case for the proposed Guidelines, in their current form, has not been made out. In order to do so, the Guidelines on Enforcement Measures would have to demonstrate a clear enhancement to FRC’s regulatory oversight procedures, but with strong regard for the five principles of good regulation, as well as principles of fairness and natural justice. It is not clear, from the consultation document or the draft Guidelines, what types of non-compliance the FRC is trying to address. We believe that a clear view of this would greatly assist in the drafting of proportionate Guidelines in the future.