WRITTEN QUESTION E-3049/02

by Wolfgang Ilgenfritz (NI) to the Commission

(24 October 2002)

Subject: Effectiveness of the peer review procedure

The European Commission recommends that all persons who draw up annual accounts on behalf of firms should be covered by a quality control system designed to guarantee a uniformly high standard in the preparation of statutory end-of-year accounts. Two arrangements are regarded as appropriate to this purpose: either monitoring by the relevant authorities, or the peer review procedure, under which the quality checks are carried out practising auditors, the peers. The Commission has given the Member States three years in which to introduce systems of this kind and regards a ten-year interval between checks as acceptable for small auditing firms.

At present, quality checks of this kind are mandatory in only a very few European countries. In Austria, auditors who draw up annual accounts for firms quoted on the stock market, credit institutions or insurance companies have been subject since 2002 to a peer review procedure carried out at four-year intervals. As from 2003, this arrangement will apply to auditors who draw up annual accounts for major corporations. It is not yet clear whether the original proposal to extend peer review procedures to cover all other auditors as from 2004 will be implemented.

The professional association representing Austrian auditors has quite rightly criticised the fact that the mandatory introduction of overly strict quality control systems generates disproportionately high costs for small auditing firms, placing them at a serious disadvantage vis-à-vis their larger competitors. Many smaller firms may be forced to close, thereby automatically increasing the market share enjoyed by the bigger companies. The smaller firms would merely be forced to take on extra administrative staff and the additional costs they incur in connection with each auditing exercise would increase enormously, whereas the peers would enjoy a steadily increasing turnover.

The peer review procedure does not eliminate the real causes of errors or shortcomings in the auditing of firms' accounts, i.e. the lack of independence enjoyed by auditors vis-à-vis the firm whose books they are checking, since the auditors are frequently also tax advisers or management consultants, and the poor qualifications of the low-cost staff often used to carry out the relevant audits. The peer review procedure will thus merely serve to force highly reputable small and medium-sized auditing firms from the market, without establishing guarantees of quality.

This argument is now gaining ground in the light of developments in the USA, where peer review has been employed for decades. The auditing firms caught up in the recent scandals in the USA involving balance sheet manipulations, the so-called Big Five (now reduced to the Big Four), have been subject to peer review procedures for many years. The Steuer und Wirtschaftskanzlei (Tax and Business Journal), one of the oldest and most respected specialist publications in Austria, has reported that the USA is responding by implementing fundamental reforms: in late July the peer review procedure was abolished, on the grounds of its blatant ineffectiveness, and replaced by strict governmental supervision of auditing firms.

1. What conclusions will the Commission draw from the abolition of the peer review procedure in the USA?

2. Does this development also mark the beginning of the end for peer review in the EU?

Answer given by Mr Bolkestein on behalf of the Commission

(5 December 2002)

Quality assurance is the audit profession's principal means of reassuring the public and regulators that auditors and audit firms are performing at a level that meets the established auditing standards and ethical rules. Quality assurance also allows the profession to encourage quality improvements.

The Commission Recommendation of 15 November 2000(1) recognises both basic forms of quality assurance systems, the Monitoring and the Peer Review, to be in general equivalent.

The Sarbanes-Oxley Act which came into force at the end of July 2002 resulted in the end of self-regulation in the American audit profession. This included an end to what used to be the usual practice of peer reviews. Instead the Sarbanes-Oxley Act foresees for the auditors of listed companies the introduction of an inspection program by the newly created board, the PCAOB. This is close to the idea of monitoring. Sarbanes-Oxley only contains framework provisions. The members of the PCAOB appointed on 28 October 2002 will have to fill in the details of the Sarbanes-Oxley Act by making concrete rules on inspection mechanisms.

This clearly represents developments in the United States that do not have a prejudicial effect on the Union. The Commission Recommendation includes all auditors i.e. listed and non-listed companies , whereas the Sarbanes-Oxley Act affects only auditors providing services for listed companies. The Recommendation does not impose such far reaching requirements on statutory auditors not auditing public interest companies.

The implementation of the Recommendation on quality assurance will be reviewed after a three year period. This review will take place in 2003. Preparations for this will be discussed in the Community Committee on Auditing. The further applicability of the peer review methodology in the Community will be subject to a closer examination during this review.

According to the Recommendation, possible concerns over the missing independence of the peer reviewer shall be prevented by sufficient public oversight on the administration, execution and presentation of the results of peer reviews. The actual application of such measures will play an important role in the assessment of peer review methodology which will take place in 2003.

The Commission is also planning to bring forward a wider communication on the statutory audit function in the near future.

(1) OJ L 91, 31.3.2001.