The proposals come in the wake of recent European corporate scandals such as Parmalat and Ahold, and form part of a larger package of measures overhauling EU company law and corporate governance, announced in May last year.
The intention is to create a comprehensive set of EU rules on how audits should be conducted and on the audit infrastructure needed to safeguard audit quality.
"No-one is naive enough to think any Directive will stop accounting fraud at a stroke," said Internal Market Commissioner Frits Bolkestein. "But what we are proposing would inject more rigour and a stronger dose of ethics into the audit process, bolstering that defence on which all market economies rely."
Bolkestein said it will also remove some unnecessary restrictions on ownership and management of EU audit firms and lay the foundations for agreements to limit red tape for European audit firms working outside the EU.
However, the proposals have already faced industry criticism. The UK's Confederation of British Industry (CBI) has sent a letter to Bolkestein, arguing, "a Directive on audit committees would introduce an inflexible legal framework that overlooks the progress made under the current system of voluntary best practice."
The letter has been endorsed by the trade associations of France, Germany, Holland, Austria, Finland and Greece. The CBI now plans to lobby the UK government and MEPs on the issue.
John Cridland, CBI Deputy Director-General, said: "The CBI supports the principle of the new audits Directive, in order to combat fraud. But it goes one big step too far. Companies and investors are best placed to drive corporate governance, not regulators."
The proposal will now be sent to the EU's Council of Ministers and the European Parliament for approval.
The main proposals:
1. Helping auditors to resist inappropriate pressure from managers
Some of the provisions in the proposed Directive would help auditors to resist inappropriate pressure from managers of the company they are auditing. For example, audited companies would have to set up an audit committee, with independent members, which would oversee the audit process, communicating directly with the auditor without going through management.
That committee would also select the auditor and propose the appointment to shareholders. In addition, if a company dismissed an auditor it would need to explain the reasons to the relevant authority in the Member State concerned.
2. A clear chain of responsibilities
The proposed Directive would also set out a clear chain of responsibilities in situations where groups of companies are audited by several different firms in a large number of locations worldwide (as was the case with Parmalat). The proposed Directive would specifically require that the group auditor of the consolidated accounts of a group of companies take full responsibility for the audit of those consolidated accounts. In doing this, the group auditor would be obliged to review and document the work of other auditors.
3. Raising the quality and transparency of auditing
The introduction of international auditing standards as required by the proposal would enhance and harmonise audit quality throughout the EU. Those standards would have to be endorsed, after appropriate consultation, by the Commission in cooperation with Member States. Compulsory continuing education of audit staff would help ensure good knowledge of such standards. Furthermore, all auditors and audit firms would be obliged to undergo quality assurance reviews.
Audit firms which audit listed companies, banks or insurance companies would have to publish annual transparency reports allowing an insight into the audit firm, its international network and other non-audit services provided by it. This report would cover among other things a governance statement, a description of the internal quality control system and a confirmation of its effectiveness by the management of the audit firm.
4. Strengthening the regulatory framework and its enforcement
Further elements of the proposal would reinforce oversight of auditors. The proposed Directive would set out common criteria for public oversight systems, in particular that they should predominantly be led and staffed by non-practitioners, but including sufficient number with experience and/or expertise in audit.
At EU level the proposed Directive would create an audit regulatory committee of Member State representatives, so that detailed measures implementing the Directive could be rapidly taken or modified and to allow for continuous monitoring of and responses to new developments.
The proposal lays out a concept for a model for cooperation between the relevant authorities of Member States, on the basis of "home country control" – in other words regulators in the country where an audit firm is established would take full responsibility for supervising it, and on that basis it could work throughout the EU. However, individual audit staff would need to prove their aptitude and knowledge of the relevant country's legislation before they could undertake statutory audits in another Member State.
The proposed Directive would also establish procedures for the exchange of information between oversight bodies of Member States in investigations. In order to lay the foundations for better cooperation with foreign oversight bodies such as the US Public Company Accounting Oversight Board (PCAOB), the proposed Directive would allow reciprocal co-operation with third countries, also based on the "home country control" principle.
5. New opportunities for audit firms
Finally, as well as cracking down hard on malpractice and negligence, the proposal would provide new opportunities for the vast majority of honest, conscientious and competent auditors. It would, for example, allow auditors from any Member States to own and manage audit firms in all the others. This would facilitate further integration of European audit firms and help open up the market.