Communication from the Commission to the Council and the European Parliament — Reinforcing the statutory audit in the EU
Date: 2003-10-02
Institutions: European Commission
Subjects: audit, auditing, company law, standardisation

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COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE EUROPEAN
PARLIAMENT

Reinforcing the statutory audit in the EU

(2003/C 236/02)

1. BACKGROUND AND INTRODUCTION

financial

financial

reporting
The collapse of Enron and subsequent
scandals have prompted calls in the European Union for
further examination of
reporting, statutory audit,
corporate governance and securities markets. In the last 12
months investors' confidence in capital markets worldwide
has eroded and public credibility of the audit profession has
been impaired. The aftermath of Enron and the US response to
restore investors' confidence, the Sarbanes-Oxley Act (SOA),
and recent EU financial reporting problems require recon-
sidering EU priorities on statutory audit, as a part of
the
Commission's initiatives on the enhancement of corporate
governance. The Commission will
to this
its Communication
Communication on audit priorities
‘Modernising Company
Enhancing Corporate
Law and
Governance in the European Union’.

issue in parallel

The lack of a harmonised approach to statutory auditing in the
EU was the reason why, in 1996, the Commission organised a
wide-ranging reflection on the scope and need for further
action at EU level on the statutory audit
function. This
reflection was initiated by the Commission's 1996 Green
Paper (1) on ‘The Role, Position and Liability of the Statutory
Auditor in the EU’. Responses to the Green Paper suggested a
need for action at EU level beyond that laid down in Council
Directive 84/253/EEC (2) ‘the 8th Directive’ that broadly deals
with the approval of statutory auditors in the EU. The policy
conclusions which the Commission drew from these reflections
were included in a Commission's 1998 Communication ‘The
Statutory Audit in the European Union, the way forward’ (3).

The 1998 Communication proposed the creation of an EU
Committee on Auditing, which would develop further action
in close cooperation between the accounting profession and
Member States. The overarching objective of this Committee
is to improve the quality of the statutory audit. Key subjects on
its agenda have been external quality assurance, auditing
standards and auditor independence.

Recommendation on ‘Statutory Auditors' Independence in the
EU’ in May 2002 (5). Both these Recommendations are being
implemented by Member States. Preparatory work on the use
of
international standards on auditing (ISAs) has also been
carried out.

further

initiatives

situation requires

Despite these achievements, the Commission believes that the
to reinforce
present
investor confidence in capital markets and to enhance public
trust in the audit function in the EU. Calls have been made to
avoid knee-jerk regulatory reactions but to progress steadily in
line with the overall objective of creating an efficient EU capital
market by 2005,
target. The
Commission is aware of the risk of ‘legislating by accident’
and is intent on delivering a robust, effective but also compre-
hensive, balanced and proportionate response — after a wide
consultation process.

European Council's

the

Whilst audit is a major instrument to ensure proper financial
reporting,
it is not the only factor under scrutiny following
recent financial reporting scandals. Audit is an element of a
larger system of actors and regulators involved in transparent
financial reporting for the EU capital market. The proposed
regulatory initiatives on statutory audit should therefore be
seen in the wider context of
the Commission's Financial
Services Action Plan and the Commission's reaction to the
collapse of Enron (6)
(‘First EU response to Enron related
policy issues’) — which was widely endorsed at the Oviedo
Informal ECOFIN Council in April 2002. It also complements
the Commission's Communication on company law and
corporate governance — its response to the Winter report.
Audit
is an important part of good corporate governance
practice.

On the basis of the work of this Committee, the Commission
issued a Recommendation on ‘Quality Assurance for
the
Statutory Auditor in the EU’ (4)
in November 2000 and a

(1) OJ C 321, 28.10.1996, p. 1.
(2) OJ L 126, 12.5.1984, p. 20.
(3) OJ C 143, 8.5.1998, p. 12.
(4) OJ L 91, 31.3.2001, p. 91.

The EU capital market operates in a global context evidenced
by cross border investors, multi-listed companies and foreign
registrants. From this perspective, the EU capital market should
be attractive to all issuers and investors and ensure a globally
understood, high level of investor protection. The EU pursues

(5) OJ L 191, 19.7.2002, p. 22.
(6) Published online by DG Markt with a press release (IP/02/584).
Website: http://europa.eu.int/comm/internal_market/en/company/
company/news/ecofin_2004_04_enron_en.pdf

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these objectives by promoting and requiring the use of high
quality internationally accepted standards relevant to the func-
tioning of the EU capital market, surrounded by an infra-
structure ensuring the proper application of such standards.

The credibility of financial information provided by auditors is
essential
for a broader scope of entities than merely listed
companies. This is reflected in current Community law that
defines audit requirements for all limited liability companies,
all banks and insurance undertakings (1). Therefore, the starting
point for coherent and consistent EU policy making on audit
continues to cover all (more than a million) statutory audits
conducted within the EU, a number that is significantly higher
than the 7 000 listed EU companies. Where necessary, policies
and measures should be differentiated on the basis of the level
of public interest (‘public interest entities’) specifically taking
into account the needs of Small and Medium Sized Enterprises
(SME's).

The Commission therefore proposes a modernisation of the
8th Directive to provide a comprehensive legal basis for all
statutory audits conducted within the EU. To the extent appro-
priate, these principles should be applicable to non-EU audit
firms performing audit work in relation to companies listed on
the EU capital markets. The 8th Directive which was adopted
in 1984, and never amended since, deals mainly with the
approval of (natural and legal) persons that are allowed to
perform statutory audits. It also contains numerous provisions
on transposition that have all become outdated since the
beginning of
the 90's. The present 8th Directive lacks a
comprehensive set of elements for ensuring an appropriate
audit infrastructure (for example public oversight, disciplinary
systems and systems of quality assurance) and it does not refer
independence requirements
to the use of auditing standards,
and ethical codes.
In the light of recent developments the
time has come to modernise the 8th Directive into a shorter,
more
comprehensive piece of European legislation with
sufficiently clear principles that will underpin all statutory
audits conducted within the EU.

Following the EU's first response to the Commission's Enron
paper,
the Commission services have consulted with the
Members of the EU Committee on Auditing on priorities for
the future.

Chapter 2 of this Communication sets out the Commission's
vision for a modern regulatory framework for statutory audit
in the EU and chapters 3 and 4 describe the envisaged
initiatives on statutory audit. Commission proposals on the
outlined initiatives will be prepared in close cooperation with
the EU Committee on Auditing and will be subject to proper
and transparent due process.

2. A MODERN REGULATORY FRAMEWORK

2.1. A modernised and principles-based 8th Directive

The 1998 Communication on statutory audit
led to the
adoption of Commission Recommendations on External
Quality Assurance in 2000 and Auditor
Independence in
2002. Member States are already implementing the Recom-
mendations and the degree of harmonisation achieved will be
assessed by the Commission three years after adoption of these
Recommendations. However, non-binding instruments should
not be solely relied upon to deliver the necessary degree of
rigorous application required by the present post Enron
situation.

(1) 4th (78/660/EEC) and 7th (83/349/EEC) Company Law Directive,
Directives on banks
accounting
(91/674/EEC) include audit requirements. In accordance with the
4th and 7th Directive, Member States may exempt small companies
for the audit requirement.

(86/635/EEC) and insurance

clarification,

The European approach to audit
(and financial reporting)
policy making is fundamentally a principles-based approach
this approach. However,
and future actions should reflect
proper and consistent application of principles may require
additional
detailed
through,
guidance, best practice recommendations, etc. This approach
has been followed in the Recommendation on Auditor Inde-
pendence. Sufficiently clear principles in EU legislation flanked
with implementing measures is an approach that is also in line
with the Lamfalussy approach to securities markets regulation,
now being considered also for the banking and insurance
sector.

example,

for

Since the European capital market operates in a global context,
the application of these principles also to non-EU audit firms
performing audit work in relation to the EU capital market,
shall allow for the recognition of equivalent solutions in other
regulatory systems.

2.2. Creation of an Audit Regulatory Committee

The approach to EU statutory audit policy making laid down in
the 1998 Communication is essentially ‘monitored self-regu-
lation’. The EU audit profession is challenged to live up to
its commitment to deal with audit matters on the basis of
self-regulation. In line with this approach, the EU Committee
on Auditing includes representatives from the audit profession.
So far, this arrangement has proven fruitful. Representatives
from the profession have contributed significantly to the

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work of the EU Committee on Auditing and a direct exchange
of views with Member States' regulators improves mutual
understanding on the key policy issues.

in the present situation, a shift

However,
in the balance
between representatives of the public interest and those of
the audit profession must take place in order to sufficiently
ensure the independence of EU policy making. This shift in
balance does not
imply that EU policy making would no
longer involve and draw upon the profession's knowledge
and resources. Rather, it will ensure that, both in fact and in
perception, the public interest is and remains the overriding
principle for EU audit policy making. This balance could be
an Audit Regulatory
achieved by the
establishment of
that
Committee. The present EU Committee on Auditing,
should be renamed to be the Audit Advisory Committee, will
keep its function as a preparatory discussion forum between
regulators and the audit profession. The new Audit Regulatory
Committee will be a separate regulatory Committee of Member
State representatives only chaired by the Commission. The
Commission will adopt appropriate implementing measures
in accordance with comitology procedures. The new audit
regulatory committee would be established by an amendment
to the 8th Directive, and operate in accordance with existing
inter-institutional arrangements on comitology. Accordingly,
initiatives on statutory auditing will no longer be processed
via the Contact Committee on the Accounting Directives
which will continue to deal with accounting.

Summary of actions on the Creation of a Modern Regu-
latory Framework

1. Commission: Propose to modernise the 8th Company
law Directive giving a comprehensive principles-based
Directive applicable to all statutory audits conducted in
the EU in the first quarter of 2004. The modernised
the
Directive will clarify the role and position of
auditor and define requirements for the audit
infra-
include
structure to ensure high quality audits. It will
provisions on: education (see 3.7), public oversight (see
3.2), quality assurance (see 3.6), disciplinary sanctions
(see 3.8), auditing standards (see 3.1), ethics and inde-
pendence (see 3.4 and 3.5).

2. Commission:

Include the establishment of an Audit
Regulatory Committee in the modernised 8th Directive.

3. REINFORCING THE AUDIT FUNCTION

After the collapse of Enron, the Commission issued a paper
entitled ‘A first EU response to Enron-related policy issues’ that
gives a comprehensive overview of the policy actions in five
key areas including the statutory audit. EU Finance Ministers
conclusions
to
signalled
the
agreement
Commission's Enron paper
informal meeting in
at
Oviedo in April 2002. A majority of the proposed initiatives
(3.1 to 3.7 below) flow directly from those conclusions. They
were also discussed with the members of the EU Committee on
Auditing.

the
the

their

of

3.1. The use of International Standards on Auditing (ISAs)

for all EU statutory audits from 2005

A key element to support a uniformly high level of audit
quality throughout the EU is the use of common auditing
standards. The EU Committee on Auditing has, since 1999,
undertaken preparatory work on the use of ISAs in the EU
by conducting a benchmarking exercise of
ISAs against
Member States' audit requirements. This exercise has shown
that there is already a high degree of convergence with ISAs.
However, this exercise identified also the need to improve the
set of ISAs on particular issues, such as the development of a
standard on international group audit, updating the ISAs audit
risk model and the development of audit guidance related to
International Accounting Standards (IAS). The International
Auditing and Assurance Standards Board (IAASB) is currently
actively working on improving present ISAs. The Commission
encourages the IAASB to continue along those lines in order to
develop the highest quality standards on auditing.

the development of
for the assessment of

The Commission envisages the use of ISAs as a requirement for
all EU statutory audits from 2005 onwards. However, a
successful implementation of a binding requirement to apply
ISAs in the EU from 2005, requires the completion of a
number of preliminary actions: the update and completion of
the analysis of differences between ISAs and national audit
set of principles
requirements;
(‘framework’)
ISAs; the evaluation of
possible endorsement systems; the development of a common
audit report; and the availability of high quality translations
the
into all Community languages. As to audit reporting,
ISA
Commission plans to use the forthcoming revision of
700 (audit
analysing
a
differences between national audit reports by EU professional
bodies, facilitated by the European Federation of Accountants
(FEE).

starting-point

reporting)

for

as

a

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that

standard-setting activities

The IAASB is one of the standing technical committees of
the International Federation of Accountants.
IFAC,
In this
post-Enron era,
separating
the Commission believes
IAASB's
from IFAC should be
seriously considered. Currently, IAASB audit standard setting
activities are fundamentally conducted by and for the audit
profession. Although improvements have been made recently
to the transparency of the due process and to better represent
the public interest by the inclusion of a limited number of
non-practitioners in the IAASB, the over-arching governance
structure of
international
accounting profession. A standard-setting body independent
of IFAC, operating primarily from a public interest perspective,
under a governance structure with a majority of (non-practi-
tioners) international stakeholders would be more credible from
a public interest perspective and could be more easily
recognised by the EU.

control by the

IFAC implies

existing structures of supervision of the audit profession and
the importance of sector specific regulatory monitoring of
audit quality. Securities regulators or sector specific regulators
may be a proxy for representation of the public interest. But
any initiative concerning public oversight should take into
account also the potential role of other stakeholders. No
stakeholder has a sufficiently broad
single supervisor or
scope to adequately reflect
in the
these diverse interests
oversight of auditors that perform more than one million
statutory audits in the EU.

To support harmonisation of public oversight, there is first of
all a need to analyse differences and commonalties of
the
present Member States systems of public oversight. The EU
Committee on Auditing has already started analysing existing
public
discussing minimum
requirements (principles) of national systems for consistent
public oversight throughout the EU. The following issues in
relation to public oversight should be addressed:

oversight

systems

and

Summary of actions on ISAs

1. Commission: Announcement, via this Communication,
of EU's objective to use ISAs from 2005 onwards for all
EU statutory audits;

— the scope of oversight (e.g. education, licensing, standard

setting, quality assurance, disciplinary systems);

implementation of

2. Commission/Audit Advisory Committee: Preliminary
actions ensuring a successful
ISAs
from 2005. These will include: an analysis of EU and
Member State audit requirements not covered by ISAs; a
report and high quality translations;
common audit
to IFAC/IAASB
improvements
initiation of
audit
standard setting process, notably by ensuring
proper public interest;

further

3. Assuming satisfactory results of the preliminary analysis,
a binding

the Commission intends
instrument requiring the use of ISAs from 2005.

to propose

3.2. Public oversight of the audit profession

Public oversight is a major element in the maintenance of
confidence in the audit
function. The present erosion of
confidence is partly based on a public perception that any
self-regulating profession runs a risk of conflicts of interests
in dealing with its shortcomings.

At EU level, public oversight has so far been dealt with only in
the Commission Recommendation on Quality Assurance.
Additional initiatives should build on what has already been
agreed, such as the requirement for such an oversight body to
comprise a majority of non-practitioners.

actual organisation of public oversight

The
for quality
assurance differs between Member States depending on

— the competences of oversight (e.g. investigative and disci-

plinary powers);

— the composition of oversight boards (e.g. majority of

non-practitioners, proper nomination procedures);

— the transparency of oversight (e.g. publication of annual

work programmes and activity reports);

— the funding (e.g. not solely by the audit profession).

systems

into a cohesive,

In the light of the emerging EU capital market there is a need
for an EU coordination mechanism to bring together the
national
efficient pan-European
network. It is important that those people who are in charge
of public oversight at national level have the possibility to meet
regularly to discuss their concerns, to exchange experiences
and to develop best practices. Respecting the principle of subsi-
diarity, the Commission believes that the practical implemen-
tation of oversight should remain the responsibility of Member
States. The Commission sees
encouraging
convergence of principles and practice in the committee
which it will chair. An effectively coordinated EU mechanism
would then assess the need for registration and oversight
requirements of non-EU audit firms that perform audit work
for companies whose securities are traded on the EU regulated
capital markets. Whatever initiative on the important issue of

role

its

as

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public oversight will be considered as most appropriate, it will
need to be anchored in the modernised 8th Directive.

committees help to ensure high quality financial reporting and
statutory audit as well as well functioning, effective internal
control including internal audit practices.

Summary of actions on Public Oversight

1. Commission/Audit Advisory Committee: Analysis of

existing systems of public oversight;

2. Commission: Definition of minimum requirements
(principles) for public oversight to be laid down in the
8th Directive;

3. Commission: Define coordination mechanism at EU
level to link up national systems of public oversight
into an efficient EU network.

3.3. Corporate governance in relation to statutory audit;

Audit committees and internal control

Regarding the role of the statutory auditor in the context of a
company's corporate governance, one of the main objectives is
that statutory auditors should maintain an appropriate degree
of independence from executive directors. It is clear that the
auditor should not become too familiar with or too dependent
on executive directors which prepare financial statements that
he is supposed to assess objectively and critically in the best
interest of shareholders and other stakeholders. Therefore, the
Commission will consider the development of principles in a
modernised 8th Directive on the appointment, dismissal and
remuneration of statutory auditors that would guarantee funda-
mental ‘sovereignty’ from executive directors. Equally important
issues are the communication of the statutory auditor with the
governance body (1) and principles on the independence and
the governance body and
competence of
effective working procedures.

the members of

All members of the EU Committee on Auditing underlined the
need for clarification of the role of the statutory auditor and
audit committees and their interaction with the company's
for, and
corporate governance system. But the requirement
corporate
composition of,
governance
are
parallel Commission Communication
in
addressed
‘Modernising Company
Enhancing Corporate
Law and
Governance in the European Union’.

issue. Accordingly,

committees

committees

is
audit

also a

audit

the

audit

internal

function. Several

Another important corporate governance issue is the responsi-
bility for and quality of a company's internal control system
corporate
including the
governance codes used in the EU and some Member State
laws require the statutory auditor to specifically report on
the internal control system. The Commission proposes to
examine the present situation in the EU on the statutory
in the assessment and reporting on
auditor's involvement
internal control
to possibly come forward with
proposals on this issue.

systems,

Summary of actions on corporate governance/audit
committees

1. Commission: Define principles in a modernised 8th
Directive on:
the appointment, dismissal and remun-
eration of statutory auditors; as well as the communi-
cation with the statutory auditor.

2. Commission: Propose to examine the present situation
in the EU on the statutory auditor's involvement in the
assessment and reporting on internal control systems.

In particular, audit committees can play an important role in
the governance of a company by assisting the statutory
auditors to stay at arm's length from management. Audit

(1) Governance Body: A body or a group of persons which is
embedded in a company's corporate governance structure to
exercise oversight over management as a fiduciary for investors
and,
law, for other stakeholders such as
employees, and which consists of or, at least, includes individuals
other than management, such as a supervisory board, an audit
committee, or a group of non-executive directors or external
board members.

if required by national

3.4. Code of ethics

inappropriate

The recent financial reporting scandals have led to a public
perception of
ethical behaviour by some
auditors. This has highlighted the importance of ethical
guidelines for auditors (and the need to follow these in
practice). As a starting point, the Commission proposes to
analyse together with the Audit Advisory Committee existing
national codes of ethics and the international IFAC Code of
Ethics. This analysis could be used also to consider whether
there is a need for a harmonised EU code of ethics. General
principles could be set out in the 8th Directive, which already

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contains some ethical principles such as the principle of
professional integrity.

Summary of actions on auditor independence

1. Commission:

Include principles on auditor

inde-
pendence in a modernised 8th Directive that will
further the independence of the auditor in accordance
with the existing Commission Recommendation on
auditor independence.

Summary of actions on a code of ethics

Commission/Audit Advisory
Committee: Analyse
existing national codes and the IFAC code of ethics to
consider where further action may be necessary.

2. Commission: Study on the impact of a more restrictive
approach on additional services provided to the audit
client.

3.5. Auditor independence

approach that provides

The Commission Recommendation on auditor independence
was adopted on 16 May 2002 (2002/590/EEC). It follows an
innovative principles-based
the
statutory auditor a sound framework against which he has to
assess
the EU
independence risks. The key objective of
the statutory auditor should not carry
approach is simple:
if
out a statutory audit
there are any financial, business,
employment or other
relationships between him and his
client (including the provision of non audit services) that a
reasonable and informed third party would conclude compro-
mising the statutory auditor's independence. This approach of
principles with sufficient guidance to demonstrate how those
is probably one of the most
principles should be applied,
robust safeguards to auditor independence in the world as it
allows auditors to deal with any situation where independence
risks might occur.

The Recommendation constitutes a major step forward in the
harmonisation of an issue that is controversial and difficult to
regulate. Most Member States are already in the process of
implementing the Recommendation and the Commission will,
via the Audit Advisory Committee, closely monitor these
exercises. Recent financial reporting scandals have emphasised
that a (perceived) lack of auditor independence is one of the
main issues impairing investor's confidence. The Commission
proposes to incorporate the basic principles of the Recommen-
dation in the modernised 8th Directive so as to provide a
stronger,
legal underpinning for auditor independence in the
EU. Some are calling for even more stringent restrictions on
auditors in the light of recent scandals. Indeed, the substance of
the Commission's approach may be challenged by calls for
more
In
response, the Commission proposes to launch a study on the
impact of a more restrictive approach, with a view to avoiding
potential conflicts of interests, to the provision of additional
services on auditor independence and the audit profession.

stringent measures

scandals

appear.

further

if

3.6. Quality assurance

In November 2000, the Commission issued a Recommendation
on ‘Quality Assurance for the Statutory Auditor in the EU’. By
virtue of this Recommendation all EU statutory auditors will be
subject to a proper system of external quality assurance with
public oversight by 2003. The Commission will review the
results of its implementation in 2003.

All Member States have indicated to conform with the
requirements of the Recommendation by the end of 2003.
The Commission will use a monitored self assessment on the
to verify proper
basis of
implementation of
in all
assurance
Member States.

standardised questionnaire
systems of quality

a

In addition, a requirement for quality assurance systems along
the lines of the Recommendation will be included in the 8th
Directive.

Summary of actions on quality assurance

1. Commission: Review in 2003 of the implementation
and effectiveness of the Quality assurance Recommen-
dation by Member States;

2. Commission: Include requirement for quality assurance

systems in the modernised 8th Directive.

3.7. Education and training

To meet
the required breadth and depth of competence,
auditors must acquire a wide range of knowledge, and
develop skills and understanding of professional values.
Proper education and training are indispensable. Accordingly,

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and to ensure harmonisation,
subjects which must be covered in an auditor's curriculum.

the 8th Directive lists the

the

the contents of

continued relevance of

educational
the
To ensure
requirements,
the curriculum should be
assessed against relevant developments in business practice
and financial
taking
account of international research and developments. Such an
assessment
education
guidelines such as IFAC's International Education Standards
for Professional Accountants.

the IAS Regulation),

reporting (e.g.

draw upon

international

should

The revised requirements should be incorporated into prin-
ciples wherever possible, so as to introduce the flexibility
needed to track best practice more closely. Such an approach
should not reduce the harmonisation of the present curriculum
which has been particularly useful
in the context of the EU
enlargement process.

The 8th Directive should also specifically include the principle
of continuous education.

Summary of actions on education and training

1. Commission/Audit Advisory Committee: Examine
the relevance of the current EU curriculum requirements
in the context of new developments.

2. Commission: Consider the inclusion of a principle on
continuous education into the modernised 8th Directive.

3.8. Systems of disciplinary sanctioning

Systems of disciplinary sanctions are an important instrument
to correct and prevent inadequate audit quality. At the same
time they are also a means for the audit profession to demon-
strate its public credibility. The enforcement of appropriate
already
sanctions
the 8th Directive.
required under
is
the Commission Recommendation on quality
Furthermore,
assurance
link between negative
systematic
outcomes of quality reviews and sanctions under the disci-
plinary system.

requires

a

it may be difficult

Whilst
to harmonise sanctions due to
differences in judicial and legal systems, the Commission will
consider further steps towards the convergence of disciplinary
procedures, notably with regard to transparency and publicity.
An obligation to cooperate in cross border cases will be

In particular,
included, as in the Market Abuse Directive.
to
subject
systems of disciplinary sanctions
(See Section 3.3.). The existing
external public oversight
requirement
for appropriate sanctions in the 8th Directive
will be reinforced by requiring that all Member States will
have an appropriate and effective system of sanctions.

should be

Summary of actions on disciplinary sanctions

1. Commission/Audit Advisory Committee:

assess
national systems of disciplinary sanctions to determine
common approaches and to introduce an obligation to
cooperate in cross border cases.

2. Commission: Define the principle for appropriate and
effective systems of sanctions in the modernised 8th
Directive.

3.9. Transparency of audit firms and their networks

There is concern that a significant discrepancy exists between
the image of networks of audit firms as global practices and
the level of control exercised over individual member firms of
International networks are often
the international network.
based upon rather loose agreements between separate and
independent
entities which do not allow decisive
control over (and responsibility for): individual member firm's
audit
audit
client
recent
procedures, partners
implosion of one international network of audit
firms has
made apparent the loose character of network arrangements.

and retention procedures,

decision making,

acceptance

etc. The

legal

the world.

As a result there is a risk of an expectation gap that one brand
name also implies an equally high level of audit quality
throughout
In order to clarify this situation, a
minimum level of transparency of audit firms, their networks
and their relationship to the network is necessary. Special
emphasis should be placed on information pertinent to the
internal quality assurance systems of such networks that are
designed to ensure an equivalent audit quality across the
member firms. The Commission will elaborate the circum-
stances under which disclosure is necessary and what
the
minimum disclosure requirements should be. The Commission
views transparency as a natural requirement for audit firms
which fundamentally operate
transparent
financial reporting by companies.

to ensure

the

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The Commission will also closely follow the work of the inter-
national Forum of Firms (1).

be a need to examine the broader economic impact of present
liability regimes.

Summary of actions on transparency of audit firms and
their networks

Commission: develop disclosure requirements of audit
firms and their networks which could be included into
the 8th Directive.

Summary of actions on auditor liability

Commission: Analysis of economic impact of auditor
liability regimes.

3.10. Auditor liability

In its 1998 Communication on Statutory Audit,
the
Commission noted that a majority of the respondents to its
Green paper
expressed the view that harmonisation of
professional liability is impossible and unnecessary but that it
received strong representation from the audit profession to
initiate action in this area.

the conclusions of

Responding to this the Commission launched a study into the
liability which was completed in January
systems of civil
2001 (2). One of
the study was that
auditor's liability is part of a broader concept of national
liability systems and that differences in auditors' civil
civil
liability are derived from the basic features of national
legal
regimes. Harmonisation of professional
liability is therefore
very difficult.

should be held responsible

the study within the EU Committee on
The discussion of
statutory
Auditing showed that
failures.
auditors
However,
the
concept of joint and several liability which means that plaintiffs
can claim their total damage from one party, regardless of
proportionality.

there is agreement
for

audit profession is

concerned about

that
their

the

The Commission considers auditor liability primarily as a driver
for audit quality and does not believe that harmonisation or
capping of auditor liability is necessary. There may, however,

international

firms that perform audits of

(1) Launched in January 2001, the Forum of Firms (FOF) is an organ-
ization of
financial
statements that are or may be used across national borders.
the
Members of
certain
Forum voluntarily agree
requirements,
independent quality
including undergoing a global
review.
Website http://www.ifac.org/Forum_of_Firms/

to meet

(2) ‘A study on systems of civil

liability of statutory auditors in the
context of a Single Market for auditing services in the European
Union’
http://europa.eu.int/comm/internal_market/en/company/audit/docs/
auditliability.pdf

3.11. International aspects of the Commission's strategy;
the Sarbanes Oxley Act and mutual recognition

This Communication reinforces the existing EU policy on
statutory audit and the proposed actions and their conse-
quences should be considered also in the broader international
context of a global capital market. In this regard, the adoption
of
implementing
measures by the SEC (Securities and Exchange Commission)
and the PCAOB (Public Company Accounting Oversight
Board) in the US are of particular interest and importance.

the Sarbanes-Oxley Act and subsequent

Since the final legislative phase of the adoption of the SOA in
mid-July 2002, the Commission has expressed serious concerns
over the measures put forward. In particular, of major concern
the SOA for EU
are the unnecessary outreach effects of
companies and EU auditors. Whilst the Commission shares
its
the objectives of
measures,
legal
the
environments require mutual acceptance by the US of equally
effective European solutions. A transatlantic (and global) capital
market cannot be achieved unless the EU and the US mutually
recognise the equivalence of high quality regulatory systems.

the SOA and supports many of

differences

cultural

EU's

and

in

The Commission has in coordination with Member States
determined 7 main areas of concerns broadly divided into
corporate governance and audit issues. They are: certification
financial statements and internal control systems, regis-
of
tration of EU audit firms in the US, direct US access to EU
loans to bank
audit working papers, auditor independence,
this
management and audit committees. On the basis of
analysis the Commission has had regulatory discussions,
in
particular with the SEC but also with decision makers in US
roundtables on
Congress and participated in international
auditor independence and the registration of
foreign audit
firms with the PCAOB. The key objective of these discussions
has been to achieve recognition that EU regulatory approaches
investors and other stakeholders are
to the protection of
equivalent to US rules.

The result of these activities is mixed. The SEC and the PCAOB
have not recognised the concept of equivalence as a basis for
general EU wide exemptions in their rulemaking. The comfort
given by the US in the rules adopted so far aim notably at
resolving some legal conflicts.

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The Commission is particularly concerned about the required
registration of EU audit firms with the US PCAOB by April
2004. The Commission continues to oppose the idea of regis-
tration of EU audit firms because:

The following actions of this Communication are relevant from
an international perspective:

— equivalent systems of registration and oversight are already
in place in Member States (and have been since the late
1980's);

— the actions proposed in this Communication show that EU
policy is confirming the broad regulatory equivalence;

— the PCAOB oversight system is currently being developed
and it is not clear what the implications of registration on
foreign firms are either now or in the future;

— there are major conflicts of law both with European and
national laws on data protection and professional secrecy.

For all those reasons, the Commission maintains its proposal
for a moratorium to discuss and resolve registration issues
aiming at an effective oversight of EU audit firms based on
home country control and mutual recognition, a position that
was supported by the EU finance Ministers at the informal
ECOFIN meeting on 5 April. Given the regrettable decision
the Commission urges the SEC which still
of the PCAOB,
needs to approve the PCAOB rule (expected mid June)
to
firms from registration, on the basis of
exempt EU audit
section 106 c of
issue could be further
the SOA. This
discussed in the context of the EU-US regulatory dialogue on
financial markets or in a broader international context.

Auditing standards (see 3.1)

Mandatory use of high quality ISAs in the EU would not only
contribute to the creation of an Internal Market
in audit
services but would also provide a sound basis for international
mutual recognition of audits performed in third countries by
third country auditors. The Financial Stability Forum (FSF) (1)
has identified ISAs as one of the 12 key standards for sound
financial systems. In this context, the Commission noted with
regret that the US approach to auditing standards as laid down
in the SOA, and the recent PCAOB decision on audit standard
setting in the US, does not pursue a similar international
direction of mutual acceptance of a comprehensive set of inter-
nationally accepted high quality auditing standards. Finally, a
convincing EU strategy on the mandatory use of ISAs for all
from 2005 onwards could have an
EU statutory audits
important knock-on effect on other countries. This could
initiate global convergence similar to that catalysed by the
adoption of
IAS,
the EU Regulation on the adoption of
which has been followed by Australia and New Zealand.

Public oversight (see 3.2)

A coordinating mechanism of national systems of public
oversight at EU level could also be an important platform for
a regulatory dialogue on audit policy issues with regulators
from third countries including with the PCAOB and/or SEC.

Auditor independence (see 3.5)

that would fail,

If
the EU will have to consider parallel
solutions e.g. requiring the registration of US audit firms in
the EU, a measure that will not contribute to creating an
is not
cost effective, global capital market.
efficient,
acceptable for the EU to have its audit firms regulated by the
United States. The EU should now try to open negotiations
with the US to find a satisfactory solution well in advance of
April 2004, the final date for registration of
foreign audit
firms.

It

Since the European capital market operates in a global context,
the application of the principles that will be included in EU
legislation to also non-EU audit firms performing audit work in
relation to the EU capital market, should allow to work
towards the mutual recognition of equivalent solutions in
other regulatory systems.

The Sarbanes-Oxley Act and the subsequent SEC implementing
rule on auditor independence,
introduced in the US a more
restrictive
and rule-based approach. This US rule-based
approach is neither in line with the EU's principles-based, risks-
safeguards approach, nor in line with the IFAC Code of ethics
that
is broadly similar to the EU approach (and which is
recommended by IOSCO (International Organisation for
Securities Commissions)). Although the SEC's final rulemaking
on 22 January 2003 has accommodated several concerns, the
Commission regrets that the SEC has not taken into account
the Commission's proposal
exemption. The
Commission will continue the regulatory dialogue with the
SEC and the PCAOB on auditor independence and other

full

for

a

(1) On the initiative of the G7 finance ministers and central bank
representatives of
institutions,

governors
national
regulatory and supervisory groupings and central banks.

the FSF brings
financial authorities,

international

financial

together

senior

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audit issues with a view to achieve proper solutions that will
effectively and efficiently protect the interests of investors and
other stakeholders.

Quality assurance (see 3.6)

The SOA changed drastically the quality assurance system
regarding US audit firms (and potentially foreign audit firms)
by granting the responsibility for inspections to the PCAOB. In
substance,
the Commission Recommendation on Quality
Assurance goes beyond the approach on quality assurance
under the SOA. The Commission will therefore closely follow
US developments also to ensure the equivalence of (future) US
quality assurance on US audit firms that perform audit work in
relation to the EU capital market.

4. DEEPENING THE INTERNAL MARKET FOR AUDIT

SERVICES

4.1. The establishment of audit firms in the EU

to remove

all unnecessary
The Commission proposes
restrictions that could frustrate intra EU management and
firms. Current provisions of
ownership of audit
the 8th
Directive and their
transposition into Member States law
have not resulted in a level playing field and could effectively
hinder the establishment of fully integrated EU audit firms.
Moreover, ownership and management requirements should
be reconsidered in the light of
the modifications to the
Treaty and case law enacted since the adoption of the 8th
Directive in 1984. Finally, the Commission would favour the
possibility of using any legal
firms. The
Commission is of the view that market access for audit firms
should be facilitated by minimising ownership requirements
within the limits of safeguarding auditor's independence.

form for audit

4.2. The cross border provision of audit services

for

audit

foundation for a better

to further harmonise specific issues

EU efforts
such as
education, auditing standards and auditor independence lay
integrated internal
an important
market
services. Although the 8th Directive
specifically mentions in its preamble that it is not a mutual
recognition Directive, some of its provisions are clearly relevant
for mutual recognition. These provisions will be re-considered
in line with the recently proposed Directive on the recognition
of professional qualifications (1), which would allow the
provision of services using domestic qualifications.

(1) Brussels, 7.3.2002 COM(2002) 119 final 2002/0061(COD).

security, etc. Until

At this point the Commission does not consider the home
State regulation approach appropriate in the case of statutory
auditors. Statutory audits require a fundamental knowledge of
the host State laws on financial reporting, taxation, company
these laws are sufficiently
social
law,
analogous,
it is necessary to maintain specific safeguards of
mutual recognition for statutory auditors. In this respect, all
members of the EU Committee on Auditing are in favour of
maintaining the current discretion of Member States to choose
the most appropriate method of verifying that the migrant has
the necessary knowledge. This approach can be justified by
reference
requirements
interest
to the particular general
protected at EU level by the relevant Directive.

4.3. Market structure and access to the EU audit market

The financial reporting scandals in the US have led to the loss
of one of the ‘big 5’
international networks of accounting
firms. As a consequence, only four big international networks
of audit firms remain. This could potentially raise competition
concerns in certain segments of the market for audit services
such as that of listed companies. A high degree of concen-
tration could make market access for audit firms in the EU
increasingly difficult. The impact on the audit market of the
loss of one of the large networks is being examined by the
responsible department in the Commission on a country by
country basis. Questions were also raised in the European
Parliament on the concentration of the audit market in the
EU. In the US, the SOA orders the Comptroller General of
the US to conduct a study into the consolidation of accounting
firms
limited
since 1989 and possible consequences of
competition. The Commission proposes to carry out a study
into the present structure of the audit market(s) in the EU.

Summary of actions on deepening the internal market
for audit services

1. Commission: Facilitate establishment of audit firms by
removing restrictions on ownership and management
requirements laid down in Article 2 of the 8th Directive;

2. Commission: Exempt provision of audit services from
the proposal on the recognition of professional qualifi-
cations by amending the 8th Directive to require an
aptitude test as a condition for mutual recognition;

3. Commission: Conduct a study on the audit market

structure and market access in the EU.

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10 POINT ACTION PLAN ON STATUTORY AUDIT

Short term priorities 2003-2004

Action

Description

Modernising the 8th Direc-
tive

The Commission will put forward a proposal to modernise the 1984 8th Company law
Directive to ensure a comprehensive, principles-based Directive applicable to all statutory
audits conducted in the EU. The modernised 8th Directive will include sufficiently clear
principles on: public oversight, external quality assurance, auditor independence, code of
ethics, auditing standards, disciplinary sanctions and the appointment and dismissal of
statutory auditors

Reinforcing EU regulatory
infrastructure

The proposals for a modernised 8th Directive will also include the creation of an audit
regulatory committee. The Commission will
(via comitology procedures) decide on
implementing measures necessary to underpin the principles set out in the modernised
8th Directive. The present EU Committee on Auditing, renamed the Audit Advisory
Committee, composed of Member States and the profession, will continue its work as an
advisory committee

Strengthening
EU
Public oversight on the
audit profession

of

The Commission, together with the Audit Advisory Committee, will analyse existing
systems of public oversight. The Commission will develop minimum requirements (prin-
ciples) for public oversight for inclusion in the 8th directive. The Commission will define
a coordination mechanism at EU level to link up national systems of public oversight
into an efficient EU network

Requiring
national
Auditing)
statutory
2005

ISAs
Standards
all

for
audits

(Inter-
on
EU
from

requirements not covered by ISAs;

The Commission and the Audit Advisory Committee will work on actions to ensure
successful implementation of ISAs from 2005. These will include: an analysis of EU and
Member State audit
the development of an
endorsement procedure; a common audit report and high quality translations. The
Commission will work towards
to the IFAC/IAASB audit
standard setting process, notably by ensuring that public interest is taken fully into
account. The principle of compliance with ISA will be included in the 8th directive.
Assuming satisfactory results of the preliminary analysis, the Commission will propose a
binding instrument requiring the use of ISAs from 2005

improvements

further

Mid term priorities 2004-2006

Action

Description

Improving
systems
disciplinary sanctions

of

The Commission and the Audit Advisory Committee will assess national systems of
disciplinary sanctions to determine common approaches and will introduce an obligation
to cooperate in cross border cases. The Commission will
reinforce the existing
requirements by introducing a principle for appropriate and effective systems of
sanctions in the modernised 8th Directive

Making audit
their
parent

networks

firms and
trans-

The Commission will develop disclosure requirements for audit firms covering, inter alia,
their relationships with international networks

Corporate
governance;
strengthening Audit com-
mittees and internal con-
trol

The Commission and the Audit Advisory Committee will work on the: appointment,
dismissal and remuneration of statutory auditors, as well as the communication with the
statutory auditor. The Commission and the Audit Advisory Committee will examine the
present situation in the EU on the statutory auditor's involvement in the assessment and
reporting on internal control systems to identify the need for further initiatives

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Action

Description

Reinforcing Auditor inde-
pendence
and code of
ethics

The Commission will carry out a study on the impact of a more restrictive approach on
additional services provided to the audit client. The Commission will continue the EU-US
regulatory dialogue on auditor independence with the SEC and/or PCAOB aimed at
recognition of equivalence of
the EU approach. The Commission and the Audit
Advisory Committee will analyse existing national codes of ethics and the IFAC code
of ethics to consider further appropriate actions

Deepening
internal
market for audit services

the

The Commission will work on facilitating the establishment of audit firms by proposing
to remove restrictions in the present 8th Directive on ownership and management. The
Commission will exempt the provision of audit services from its proposal on the
recognition of professional qualifications by amending the 8th Directive to include a
principle for mutual recognition. The Commission will carry out a study on the EU audit
market structure and access to the EU audit market

Examining Auditor liability The Commission will carry out a study analysing the economic impact of auditor

liability regimes

List of Abbreviations

FEE:

European Federation of Accountants

FSF:

Financial Stability Forum

IAASB:

International Auditing and Assurance Standards Board

IAS:

International Accounting Standards

IFAC:

International Federation of Accountants

IOSCO:

International Organisation for Securities Commission

ISA:

International Standards on Auditing

PCAOB: Public Company Accounting Oversight Board

SEC:

Securities and Exchange Commission

SME:

Small and Medium Sized Enterprises

SOA:

Sarbanes-Oxley Act