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Parmalat Scandal

The scandal surrounding the Italian dairy giant Parmalat may have been huge, but it’s over the next 12 months that the real repercussions will be seen by companies across the EU as the Eighth Directive gets underway.

Jonathan Farrow of MGI Midgley Snelling looks at the issue.

One of the key financial issues over the next months for companies across the EU is the 8th directive - Formally titled The EU Parliament and Council Directive 2006/43/EC of 17th May 2006 on statutory audits of annual accounts and consolidated accounts ("the new 8th Directive").

This is essentially the EU’s version of Sarbanes Oxley and covers the rules regarding how companies can be audited.  The European Commission proposed the new Directive to ensure that investors and other interested parties can rely fully on the accuracy of audited accounts and to enhance the EU's protection against the type of scandals that recently occurred in companies such as Parmalat.  This involves rules being introduced to ensure complete objectivity from auditors, therefore the rules regarding what other financial work the auditor can get involved with are becoming stricter.

Parmalat, an Italian company specialising in long-life milk nearly disappeared following accusations of financial wrongdoing against founder Calisto Tanzi who was accused of perpetrating a massive fraud. Billions of euros went missing from its books in a scandal that has drawn parallels with the collapse of Enron, the US energy giant, the scandal which resulted in the introduction of Sarbanes Oxley.

The Directive will clarify the duties of statutory auditors and set out certain ethical principles to ensure their objectivity and independence, for example where audit firms are also providing their clients with other services.   This aims to identify alleged fraud much earlier.  A Directive is a piece of EU legislation which provides the general aim to be achieved. The actual implementation measures are left up to each individual state but the individual states may not impose measures which fall short of achieving all the aims of the Directive.  It’s therefore important that companies are fully aware of the rules concerning their particular country and how this is implemented, particularly if they are a subsidiary of a company based in another country.

The Directive came into effect on the 29th June 2006 but the UK and the other member states do not need to actually have the necessary national implementing measures in place until 29th June 2008.  As we therefore reach the half way mark, now is the time to seek advice and make plans if your company has not already done so.
  
Essentially the aim of the Directive is to ensure that auditors remain independent of their audit clients.  This also goes one step further to ensure that members of an accounting network are independent of the audit clients of other members of the network.

Requirements to prove objectivity include the publication by auditors of an annual transparency report.  Audit partners should also be rotated at least every five years and quality assurance reporting is essential for audit committees and management.

The aim of the Directive and the measures outlined above makes sense for large multi-national auditing companies like the Big Four however a problem does arise when you consider that many companies employ the services of firms which belong to smaller loose knit associations of firms, such as MGI.  There is no way that one MGI firm could influence the audit opinion of another member.

More importantly, there is no way that an MGI member could ensure that no other MGI member has any connection with a new audit client.  This area of the Directive remains in discussion.

When comparing the Directive to Sarbanes Oxley, we see that it is more far-reaching in terms of the topics that it touches. Sarbanes Oxley is for the most part focused on internal controls, but when you look at the corroboration of laws in the United States and then here in Europe - the eighth Directive and other laws - both geographies are touching upon the same issues.

What’s very important not only in Europe, but also globally is to get a common answer around the world because the capital market systems are becoming global, and we have to have convergence of accounting standards, regulatory standards and financial reporting. This doesn’t mean that we need to copy another country as there is no such thing as the right way - but what’s important is to have consistency and relevance in our approach.

One of the main considerations for any company will be if the Directive has a financial impact upon them.  Audit costs have risen anyway over the past few years due to increased legislation and the rise in the audit threshold, which saw a drop in audit business and therefore some firms increased prices to make up for the short fall.  The directive could also have personal indemnity insurance cost implications for accountants so there is speculation costs could rise for clients.

The main point is that companies should be consulting with their accountants now in order to ensure they are ready for the 2008 deadline.