SJ Berwin comments on the regulation of accountants in Europe

20 March 2004

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A recent release from SJ Berwin has focused on the regulation of accountants in Europe, noting that the continent has recently witnessed its own corporate scandals. According to the law firm, the European authorities are responding with draft new rules of their own. The difference, say the rule-makers, is that the European proposals are not a reactive response, but the result of careful scrutiny over many years. Some of the proposals bear a striking similarity to those pushed through in the US in 2002 and a number of them have implications for the European private equity community and their (privately held) portfolio companies.

The draft rules, issued by the European Commission in March, would underpin the independence of auditors and regulate their fee structures to ensure that they are not dependent on other services provided by the same firm. Companies would also have to disclose any other services provided - although the proposals stop short of banning firms from taking on other engagements for their audit clients. There are measures to strengthen the oversight of accountants (ending self-regulation) and for registration of firms from countries outside the European Union to ensure consistently high standards of regulation. For listed companies, banks and insurance companies, audit partners would have to change at least every five years, or the firm would have to change every seven. There would also be a legal requirement for those companies to establish an audit committee, which must include at least one member competent in accounting or auditing, to select the auditors.

European accounting firms have praised some of the proposals, but all are strongly opposed to auditor rotation, arguing that it damages audit quality. Presumably, it would also increase costs. Businesses have reacted against a rules-based approach, saying that, for example, the requirement for audit committees should come from codes of conduct and not from legislation.

Whatever the outcome, the Commission's draft rules have fuelled the debate within Europe. They are some way from finalisation, let alone from becoming law. But it is certain that something will emerge which moves further towards the US approach; indeed, in some countries, changes are proceeding ahead of European-wide reforms. In the UK, for instance, a bill is currently going through parliament that will strengthen the oversight of auditors and improve their powers of investigation.

Whether US legal changes provided an impetus or not, there is no doubt that stricter regulation is coming. With stricter regulation will come increased compliance costs, and small- and medium-sized companies will have to watch carefully how much of that will flow through to them. Some of the proposed changes will mainly affect companies with publicly traded shares, and, therefore, a wider base of investors in need of protection. There is clearly a case for protecting creditors too, and all companies have those, whether public or private. But the burden must be in proportion to the benefit. All companies (except the very smallest) have to pay auditors, and have to comply with accounting rules. Very few (relatively speaking) go out of business in ways that could be avoided by increased regulation.