UK: EY sanctioned for breaching non-audit services cap fee
August 7, 2024
The Financial Reporting Council (FRC) has imposed sanctions on Ernst & Young LLP (EY UK) for breaching ethical standards related to non-audit services during its 2021 audit of Evraz plc, a FTSE 100 mining company. The sanctions, announced on August 7, 2024, come after an investigation under the FRC’s Audit Enforcement Procedure.
The breach centers on EY UK exceeding the 70% fee cap on non-audit services set by the FRC’s Revised Ethical Standard 2019. This cap limits the total fees for non-audit services provided by an audit firm to no more than 70% of the average audit fees paid over the previous three consecutive financial years.
According to the Final Settlement Decision Notice, EY UK “breached paragraph 4.15(b) of the Ethical Standard by providing non-audit services to Evraz in FY2021, in circumstances where the total fees for such services were not limited to no more than 70% of the average of the fees paid to EY UK in the last three consecutive financial years for the audit of Evraz, its controlled undertakings and the consolidated financial statements of its group.”
The breach occurred in connection with a project known as “Project Gemini,” which involved non-audit work related to Evraz’s proposed demerger of its coal business. EY’s services included reporting on working capital, assisting with Financial Conduct Authority correspondence, and providing a comfort letter for a circular supporting the demerger.
The FRC’s investigation revealed that EY UK failed to properly test compliance with the fee cap at the UK firm level, instead only checking at the network level, which includes fees paid to EY’s Russian member firm.
The average of the fees paid to EY UK for its audits of Evraz in the three consecutive financial years prior to Project Gemini was $400,462, making the 70% cap $280,323. However, the total fees for EY UK’s non-audit services on Project Gemini subject to the cap amounted to $535,000, significantly exceeding the limit.
“The Ethical Standard sets clear limits on the value of non-audit services an auditor can provide. Its aim is to uphold high standards of auditor independence and ensure public confidence in audit. In this instance, EY’s systems and controls failed to ensure compliance with the Ethical Standard which led to the fee-cap being breached,” said Claudia Mortimore, Deputy Executive Counsel of the FRC.
The sanctions imposed on EY UK include:
A financial sanction totalling £251,305, comprising £121,305 in disgorgement of profits earned on fees in excess of the fee cap, and an additional £130,000 (discounted from £200,000 for admissions and early settlement).
A published statement in the form of a reprimand.
Non-financial sanctions requiring EY to prepare a root cause analysis report and implement further remedial actions as proposed by the FRC.
The root cause analysis report, due within three months of the Final Settlement Decision Notice, must identify why the breach occurred, why the firm’s processes and controls did not prevent it, and whether current processes would lead to a different outcome. It must also address actions taken in response to wider issues around EY’s handling of non-audit services approval and assessment, as identified in the FRC’s 2023 Audit Quality Inspection and Supervision Report.
The Final Settlement Decision Notice provides insight into how the breach occurred. In February 2021, EY carried out engagement acceptance checks for Project Gemini but failed to test compliance with the 70% fee cap at the UK level.
In April 2021, a new audit team took over but did not perform its own tests, relying instead on the February 2021 results. A July 2021 interim review memo omitted fees relating to Project Gemini, thus failing to identify the breach. EY UK only discovered the breach in August 2021 when considering another non-audit services project.
Who is Evraz?
Evraz, the company at the center of this case, is a multinational mining group headquartered in Moscow but incorporated in London. It was listed as a FTSE 100 company until March 2022, when its shares were suspended from trading on the London Stock Exchange following the UK Government placing Evraz’s largest investor on the UK Sanctions List.
EY UK had been Evraz’s auditor since it listed in London in 2011, resigning in November 2022 following new UK Government sanctions against Russia in response to the invasion of Ukraine.
The FRC emphasized that this breach does not question the truth or fairness of Evraz’s FY2021 financial statements. Furthermore, there is no suggestion that EY has failed to comply with its obligations under applicable sanctions laws.
In addition to the sanctions, EY UK has agreed to pay the costs of Executive Counsel’s investigation, amounting to £45,000.
Mortimore concluded, “In addition to the financial sanctions announced, EY is required to report to the FRC on the reasons for the breach and to provide assurance that appropriate measures are in place to avoid any future recurrence.”
As the audit industry continues to face scrutiny over issues of independence and the balance between audit and non-audit services, this sanction serves as a reminder of the need for vigilance and strict adherence to ethical standards.
The outcome of EY’s root cause analysis and any further remedial actions proposed by the FRC will be closely watched by the industry as potential indicators of future best practices in managing the complex relationship between audit and non-audit services.
[Accountancy Age]
