Setting an Appropriate Level of Regulation

As an industry, audit practice is subject to at least two levels of scrutiny and regulation by parties external to the audit firm itself. In addition there will also be an internal quality assurance mechanism in anything but the smallest practices. This scrutiny and attention to compliance is justified to a large extent by the many scandals that have seen some form of audit failure, however there must always be a balance between the level (and therefore cost) of regulation and the level of risk that is mitigated that is achieved by what appear to be ever increasing levels of scrutiny and regulation.

But if some Regulation is Good isn’t More Regulation Even Better?

The logic in a statement such as this is quite seductive – especially where the effects of the of the regulation have yet to be fully worked out, and where the wider community is in the grip of a news frenzy following the discovery of another scandal. And this is very understandable, the losses to many people in, for example, the collapse of Enron were very real. Peoples pension funds were destroyed, investors lost plenty, and confidence in the capital markets was severely undermined.

For years we in the auditing profession have countered this with an argument that there is a danger of over-regulation, and that over-regulation could result in a range of consequences from large increases in compliance costs to flight from markets that are considered over-regulated to less regulated, but this was largely speculation. There is evidence coming through however that this is now coming to pass in some jurisdictions.

Sarbanes Oxley

Following the collapse of Enron, the Houses of Congress in the United States implemented the Sarbanes Oxley Act (sometimes known as “SOX”). Understandably the act sought to prevent such a collapse in the future by implementing a significant regulation and compliance regimen on all companies quoted on the Stock Markets of the US. Many companies have found the implementation of SOX an arduous task. This has led to a number of unintended consequences, including US Companies moving off-shore, Companies which trade on both US and International markets withdrawing their US listing, companies choosing not to list on US exchanges, and as recently reported by the Wall Street Journal, increases in the requirement for Financial Controllers and Compliance Officers, as well as the Chief Financial Officer having to take on more responsibility than ever before.

Better Regulation not More Regulation

My own view is that regulation and oversight needs to be balanced against th risks the regulation is designed to counter. Not all companies are potential Enrons and should not treated as such. Over regulation will stifle innovation and take management time away from the activities which create value for their company. A soft-touch approach is not necessarly a bad thing.