The last decade has seen a number of high-profile collapses of publicly traded companies in circumstances involving allegations of fraud in relation to their financial statements. (See, for instance, our blog on regulatory enforcement action against Carillion).

Fraud in this context is typically found in mis-statements in company accounts. Although mistakes can and do happen, mis-statements in a company's financial statements can be the result of a fraud within the company, whether for personal gain or to falsely improve the trading picture for investors. These fraudulent mis-statements broadly fall into two categories:

  • Mis-statements resulting from fraudulent financial reporting; and
  • Mis-statements resulting from the misappropriation of company funds and assets.

Evidence of this kind of fraud can be difficult to identify. The recent incidence of corporate collapses amidst allegations of fraud has triggered a demand for the implementation of updated standards to provide clarity as to what is expected of auditors in in the conduct of company audits.

The Financial Reporting Council, the professional regulator for accountants and auditors, published new standards on 27 May 2021 on auditors' responsibilities for identifying fraud in the conduct of company audits. These followed a consultation on the subject launched in October 2020 (see our blog here for more information).

Renewing existing – and introducing enhanced – duties on auditors, these new standards will be effective for audits of financial statements for periods commencing on or after 15 December 2021.

The new standards emphasise the importance of the auditor's application of professional skepticism. An auditor must be alert at all times for conditions suggesting potential fraud and probe matters giving rise to concern. The standards provide that there is no excuse for missing a fraudulent misstatement on the basis of the auditor's past experience of working with the company's management, and stress the importance of auditors preserving an appropriate degree of professional independence from the businesses they audit.

In the event a fraud is identified, the new standards set out a number of duties to be discharged by the auditor including (among others):

  • an obligation to discontinue their engagement in the audit where it would be inappropriate or unlawful to do so;
  • a duty to communicate to those charged with governance of the company or public entity matters relevant to their responsibility for the purpose of prevention; and
  • a duty to report to the relevant authorities responsible for carrying out investigations into these issues where law, regulations or ethical responsibilities require.

Where an auditor reports a suspicion of fraud to a relevant authority, and it transpires that the suspicion was mistaken, the auditor will not be held in breach of duty provided the decision to report was both reasonable and made in good faith. Nevertheless, it would be prudent for any auditor considering whether these duties apply in a particular case to take independent legal advice in advance of making any report to the authorities and/or the company's management.

As will be apparent, these new standards reinforce the importance (both for auditors and for those charged with corporate governance) of ensuring vigilance and transparency in relation to corporate reporting and financial management. They send a strong signal that failures by auditors to comply with the standards are liable to result in enforcement action by the FRC. Recent sanctions imposed by the FRC have included a requirement to complete additional training, personal fines of up to £500,000 and disqualification from the profession. Beyond this, there is also the risk that a failure to report in circumstances in which a report should be made could amount to a statutory offence and result in criminal sanctions.

If you would like to discuss any of the issues raised in this blog, please do not hesitate to contact Paul Marshall, James Millward or Lisa Kinroy.


Martha Speed

Trainee Solicitor