International Journal of Government Auditing – January 2015

Regaining public trust: the future of the audit profession in the Netherlands

There have been a number of major incidents in recent years involving poor quality of work and inappropriate behavior in the audit profession in the Netherlands. Time and time again, it was proven that the quality of the work performed by auditors was not in order.

The Dutch audit profession has come under increasing pressure in recent months to take action. This prompted the Dutch Institute of Chartered Accountants (NBA) to set up a committee to come up with proposals for the future of the audit profession. The committee published its report on September 25, 2014.

The Netherlands Authority for the Financial Markets (AFM) also published a report on the same day. Under the Audit Firms Supervision Act, the AFM is required to supervise audit entities that issue audit reports that are relevant to the Dutch capital market. Since October 2006, audit firms wishing to perform ‘statutory audits’ in the Netherlands have been required to hold a licence from the AFM.

The AFM report concluded that the quality of the statutory audits performed by the ‘Big Four’ audit firms was not up to standard.

In the summer of 2014, we discussed these developments with a number of high-level stakeholders. Regaining public trust was the central issue in these discussions.

Inevitably, the public is losing trust in the audit profession, which it used to hold in high esteem. Regaining public trust is especially relevant for the public sector, which depends on a strong and quality-oriented accountancy sector.

In a letter to Parliament in November 2014, we stressed the key issues affecting the public sector in the debate.

The problems in the audit profession also affect the public sector. Schools, housing associations, local authorities and government agencies all use audit reports drawn up by private audit firms. Government is by the people, for the people. This means that people need to rest assured that their government acts with integrity, spends its money carefully, is clear about its intentions and capabilities, and delivers on its promises.

This should be reflected by the quality of the audits performed by private audit firms working for the public sector. Only then can the public be confident that the government spends taxpayers’ money carefully.

The recent report by the AFM, combined with the many incidents in the recent past, make clear that, sadly, confidence in the audit profession is no longer a matter of course. The reputation of the audit profession in general, and chartered accountants in particular, has taken a battering. Public trust needs to be regained.

It goes without saying that the interest taken by the Netherlands Court of Audit in the Dutch audit profession is not new, and stems from our statutory duty to audit the ministries’ annual reports. The local authorities and provincial councils in the Netherlands receive specific-purpose grants from the government for performing a variety of tasks, such as disaster relief and mitigating educational disadvantage. In 2013, the central government distributed €12.7 billion worth of specific-purpose grants. These are audited in accordance with the “single-information, single-audit” (SISA) principle, which means that local authorities provide assuranceabout the spending of specific-purpose grants in an annex to their annual report, which is audited by private audit firms. In 2011, we uncovered a serious shortcoming in the SISA system. Our review showed that the quality of the audit work did not provide an adequate basis for deciding whether the specific-purpose grants had been spent in a lawful, or regular, manner.

portrait: Ellen van Schoten

"The reputation of the audit profession in general, and chartered accountants in particular, has taken a battering. Public trust needs to be regained."

— Ellen van Schoten

Fortunately, that situation has now improved: the Minister of the Interior took steps in 2013 to improve the SISA system and informed Parliament accordingly. However, this does not detract from the importance of our original observation. The government is now planning further transfers of tasks, responsibilities, and budgets in relation to youth care and social services to the local authorities (representing an annual budget over €8 billion). Private audit firms will audit this spending. The public must be confident that this public money is well spent, which means that the quality of their audit work must be beyond reproach.

The AFM stated in its report of 25 September that 60% percent of the audit work performed for public and semi-public corporations was of inadequate quality. Although the proportion of audit work at public-interest entities (PIE) classified as inadequate was also high, the percentage was considerably lower, at 31 percent.

Under the Audit Firms Supervision Act, a “public-interest entity” is defined as a publicly listed company, among various other types of organizations. However, the organizations in which the public interest is most apparent, i.e., public-sector organizations, do not fall under the definition of a PIE. Since public-sector organizations such as schools, hospitals, and housing corporations are of vital public importance, this does not make sense.

The NBA and the AFM are now proposing to change this. We endorse the recommendations made by the AFM and the NBA to extend the definition of PIEs to the public sector.

However, great care needs to be taken both in terms of the speed with which the definition of PIEs is extended to the public sector and the manner in which this is done. Not only are many different organizations involved, the number of PIE permit-holders is limited.

In addition, the PIE framework is tailored to private organizations governed in a manner that is different from organizations funded fully or partly with public money. Local authority governance is totally different from the way in which private companies are governed.

For this reason, we advised Parliament to explore how the role of auditors at local authorities could be improved before extending the PIE framework to local authorities. This is especially important as local authorities feel that the current system of statutory audits is based too much on the system used for auditing private businesses, and is therefore ineffective and not efficient.

In 2013, we informed Parliament that the share of public spending authorized by Parliament in the form of budgetary laws is falling – gradually but steadily. Countervailing this trend, an increasing share of public expenditure (i.e., spending by the local authorities, and spending on care and social security) takes place beyond Parliament’s field of vision and influence. Parliament and local authorities rely onprivate audit firms to ensure that this money is spent in accordance with laws and regulations.

We also informed Parliament that an increasing amount of public money falls outside the direct responsibility of the relevant minister. This applies, for example, to the Municipalities Fund (the budget for which will rise by more than €10 billion as of 1 January 2015, in the wake of the decentralization operation), the National Police, and schools. Parliament depends on private audit firms to provide assurance about the regularity of this spending.

All the more reason, therefore, for us to be involved in the debate about extending the definition of PIEs to public- sector organizations and, in more general terms, in the action taken by the audit profession to improve the quality of their work.

There are two other issues which we feel are particularly important. First, the governance of the audit profession itself is not mentioned either in the report issued by the NBA or in the AFM report.

A crisis such as that now facing the audit profession requires decisive action and firm leadership, especially in those areas in which public trust must be restored as a matter of priority, such as in relation to the public sector.

We believe that it would be worth examining whether extending the definition of PIEs to public-sector organizations would affect the governance of the NBA.

This could also help solve certain problems related to specific laws and regulations. At the moment, problems arising from the complexity of specific laws and regulations are solved in negotiations between the relevant ministry and the NBA. It might be wiser to discuss problems in a broader context, so that lessons can be drawn for the public sector as a whole that will enable similar solutions to be found for similar problems.

Second, the committee proposes setting up an independent institute to investigate the causes of poor quality control and the effects of national and international action in relation to the audit profession.

We welcome the audit profession’s desire to boost its learning capacity and investigate shortcomings and incidents. We would recommend taking account of the specific characteristics of the public sector, which require a tailored approach using specific expertise. We have offered to get together with other stakeholders, such as the Minister of Finance, the AFM, and the NBA, in order to discuss how this might be achieved.

As I have sought to make clear in this article, the recent developments affecting the audit profession in the Netherlands have not come to an end. In fact, the process of change has only just begun.

Audit firms now have to start adopting the 40 different measures proposed by the NBA committee. These include changes in their governance, business models, and remuneration structures, as well as the introduction of claw-back regulations and so forth.

The Netherlands Court of Audit is planning to closely monitor the measures taken to improve the quality of audit work in the public sector. As I have already said, extending the definition of PIEs to public-sector organizations plays an important role in this.

I would be very interested in hearing from colleagues from other SAIs whether they have encountered the same issues in the audit profession in their own countries, and whether they have any suggestions or lessons that could be useful for us in the Netherlands.

Please feel free to contact me at e.vanschoten@rekenkamer.nl