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Advisory contracts with audit clients threaten auditor independence

Report

Report The Netherlands Authority for the Financial Markets (AFM) is concerned about a series of contracts for advisory services that the four largest audit firms entered into shortly before the end of 2012 with companies for which they also conduct the statutory audit of the financial statements.

Contrary to new rules, it seems that auditors want to take large risks to their independence with these contracts, and thus do not put the quality of the audit foremost in the performance of their duties. The four largest audit firms have been asked to examine, together with the audit client and the supervisory boards of these companies, the extent to which the contracts have been entered into according to the rules.

The AFM is pleased that audit firms have meanwhile stated that the contracts that are obviously at odds with the transitional provision have now been withdrawn or will not be implemented. Concerning the findings on which no consensus exists, the AFM will conduct a constructive dialogue with firms and audit committees to prevent future problems in advance.

Separation of audit and advisory services

Since the start of 2013, a statutory separation applies between audit and advisory services that no longer allows advisory services to be provided to the public interest entities (PIEs) which are audited by the same firm.

However, a transitional provision has been agreed for existing contracts, which is intended to allow some time for transferring current cases to other consultants or advisers. This could include, for example, tax advisory work up to and including 2012 that was performed in addition to the audit by the same audit firm. The AFM can easily imagine that this type of work could run on a little after the year-end. The AFM also understands the continuation of tax advice in the specific prospect of termination of the audit engagement.

Inspection by the AFM of contracts entered into in November and December 2012 shows that each of the four firms had entered into contracts for non-audit services that, in the opinion of the AFM, should not actually fall under the transition provision. The AFM concludes that all four of the Big 4 firms have initially interpreted the transitional provision such that each contract for non-audit services to PIE audit clients that was entered into before 1 January 2013 falls under the transitional provision.

Social responsibility

It is clear to the AFM that in doing this the firms have not acted in the spirit of the law. This is all the more disappointing because audit firms should be expected to take their social responsibility seriously. The AFM concludes therefore that the firms have insufficiently safeguarded compliance with the new legislation.

The audit clients who have entered into these contracts have also paid insufficient attention to the importance of the independence of their auditor. Supervisory boards, and audit committees in particular, have an important role in ensuring the independence of the external auditor. The AFM has the strong impression that only a very limited number of contracts are assessed and approved in advance by the supervisory board or the audit committee of the audit client.

Confidence

The users of financial statements, including investors, must be able to have confidence in the knowledge that the auditor has been objective and critical in his audit, has performed sufficient work, and that his procedures and opinion have not been affected by considerations other than those of professional practice. The auditor should not only be genuinely independent, but should also avoid the appearance that he is not independent.

The AFM is committed to promoting fair and transparent financial markets.

As an independent market conduct authority, we contribute to a sustainable financial system and prosperity in the Netherlands.

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