UK accounting watchdog looks to tighten audit independence rules

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The UK accounting regulator has moved to tighten its rules on auditor independence by closing a potential loophole in the profession’s ethical principles that was thrown into the spotlight during scrutiny of the business empire of metals magnate Sanjeev Gupta. 

The Financial Reporting Council launched a consultation on Tuesday on planned changes to its ethical standard, a critical rulebook for the accounting profession, that it said would “enhance and clarify the principles of integrity, objectivity and independence” that govern the sector. 

Under the current standards, accounting firms are prohibited from regularly generating more than 15 per cent of total fee income from a single client, or 10 per cent if the client is a “public interest entity”. 

The rules are designed to preserve auditors’ independence from the clients whose accounts they scrutinise. However, they do not explicitly state whether companies that are under common ownership or control must be treated as a single entity when calculating the fee cap if they are not formally part of a single corporate group. 

The planned changes would close the potential loophole by specifying that the fee caps apply not only to the aggregate fees received from a company and its subsidiaries but to “a collection of entities with the same beneficial owner or controlling party”. 

The issue was highlighted when a Financial Times investigation in 2021 revealed that King & King, a small audit firm, had signed off the accounts of about 60 entities in Gupta’s business empire with combined revenues of nearly £2.5bn. 

The Gupta Family Group comprises hundreds of separately audited companies, some owned by Gupta and others by his father Parduman, but does not produce a consolidated set of accounts. 

Milan Patel, partner at King & King, told the House of Commons business committee two years ago that his firm complied with the requirement that a firm’s fee income from a single audit client does not exceed 15 per cent of its total. 

However, Patel added that the firm considered each GFG company individually and he did not directly answer whether GFG companies in aggregate accounted for more than 15 per cent of audit fees received by King & King.

Darren Jones, Labour MP and business committee chair, said on Tuesday: “We welcome the regulator looking at this issue. As we saw during our inquiry into Sanjeev Gupta’s use of King & King, a small or medium sized auditor relying on a dominant client for fee income can result in unacceptable conflicts of interest and questionable independence.”

King & King did not respond to a request for comment.

The regulator said on Tuesday that the changes were partly “to respond to issues identified through audit inspection and enforcement cases”. It did not name any specific inquiry that led to the proposals. 

It has yet to announce the outcome of an investigation it launched last year into King & King’s audits of companies in the Gupta Family Group. 

“High standards of ethical behaviour go to the heart of high-quality audit and are designed to ensure auditors act with independence, objectivity and integrity at all times,” said Mark Babington, the FRC’s executive director of regulatory standards.

“While many of these proposed changes reflect developments at the international level, additional enhancements have also been introduced to ensure the ethical requirements are clearly understood and abided by so that there can be no uncertainty of the standards expected,” he said. 

The overhaul is also intended to bring the UK standards in line with updates to the equivalent international code, the FRC said.