AFM appeals in relation to guidance on duty of care of audit firms

The ruling concerns the appeal EY and PwC had instituted against the fines imposed by the AFM on them in 2016 for failing to comply with the duty of care on the basis of shortcomings in their audits.

Further guidance on this ruling is important, so that it can be established whether the AFM will have adequate enforcement measures available in the future to properly exercise its supervision of the quality of statutory audits of financial statements. This will also establish whether the enforcement framework in the Netherlands in this area corresponds to normal practice internationally.

What is the duty of care?

The duty of care means that the managements of audit firms must ensure that all their affiliated statutory auditors meet the standards that apply to them. The audit firm has to create conditions that ensure that the auditors it employs observe the rules.

In its supervision, the AFM uses the duty of care to link the quality of audits of financial statements by individual auditors to the responsibility of the audit firms to which they are affiliated.

What is the court case about?

The AFM imposed fines on EY, PwC, Deloitte and KPMG on 16 March 2016. The AFM took the view that these audit firms had not complied with their duty of care due to serious shortcomings in multiple statutory audits. EY and PwC appealed against the fine and their appeal was upheld by the administrative court on 20 December 2017.

The central issue in the case was whether a violation of the duty of care could be established if the inspection by the AFM revealed serious shortcomings in multiple statutory audits of financial statements performed by EY and PwC.

The AFM’s primary focus was on the end product (the audit of the financial statements). Based on shortcomings in these audits, the AFM concluded that the quality safeguards at organisational level were inadequate. The audit firms were then fined.

Why has the violation of the duty of care not been adequately demonstrated?

The court stated that shortcomings in the audit procedures of the statutory auditors could indicate inadequate compliance with the duty of care by the audit firm. In the opinion of the court, however, these shortcomings were not in themselves sufficient grounds to fine the audit firm for failing to comply with its duty of care.

According to the court, direct reasons should have been given to show that specific elements in the quality policy of the audit firms had failed.

Why an appeal?

 As a result of this ruling, the AFM can no longer call an audit firm directly to account due to shortcomings in the quality of its statutory audits of financial statements, even though these audits are of great importance to users of the financial statements, such as retail and institutional investors.

The ruling will mean that the AFM’s supervision of the audit sector will be less effective, since the duty of care is the only statutory connecting factor to make the audit firm responsible for the quality of its audits of financial statements. The AFM will then only be able to hold individual auditors responsible for errors under disciplinary law. The AFM sees this as reducing its effectiveness and moreover that it fails to recognise the responsibility of the audit firms.

During the appeal, the AFM will accept the court’s ruling in any current and future enforcement decisions. In addition, the AFM will consult with the Ministry of Finance regarding how this ruling relates to the objectives of the legislature when it introduced the duty of care in 2006 and the consequences of the court ruling. There will also be discussion of whether the law needs to be evaluated on this point.

Broad supervisory approach

The AFM has supervised audit firms since 2006. Its approach to this supervision has developed constantly over the past 10 years. Besides the audit of financial statements, since 2015 the AFM has focused more intensively on influencing culture and behaviour at audit firms. This broad approach will continue to be the guiding principle in the further development of our supervision. The dialogue with investors, audit committees and audited companies regarding quality, structure and culture will be further intensified.

More background information is available in the 10 most important questions and answers on the importance of statutory audits and the supervision thereof.

For further information please contact Daniëlle de Jong, press officer of the AFM, on +31 20-797 2129 or danielle.de.jong@afm.nl.