EDINBURGH — The Big Four auditing and consultancy firms are in a cushy position. They are perceived to be too big to fail by the authorities. They have used this position to their advantage by raking in juicy fees for audits as well as consulting work, all the while turning a blind eye to irregularities they are supposed to call out. Although companies like KPMG have played a key role in corruption and failed to do their bit to prevent major corporate collapses, they keep on printing money for their shareholders. The Financial Times of London explains the big flaws in the world’s auditing sector and provides some suggestions for fixing some of the shortcomings in the system. – Jackie Cameron
By Thulasizwe Sithole
Auditing is in crisis and ripe for reform, as the Financial Times series The Big Flaw has shown. It has highlighted the following problems:
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- Changes to accounting standards have reduced auditors to box-tickers;
- Conflicts of interest are rife, between firms and their clients and between firms and their regulators;
- Auditors are subject to weak oversight and feeble enforcement;
- Deloitte, KPMG, PwC and EY are close to an untouchable oligopoly, too big to fail and increasingly too big to regulate effectively.
“These problems have contributed to a dangerous decline of public trust in the system, exacerbated by repeated scandals,” says the FT. “They have in turn added to overall mistrust in business.”
The newspaper also points out that there is a significant overarching problem in the latitude given by “fair value” accounting to the use of models, estimates and projections. “This has diluted the underlying requirement for accounts to show a ‘true and fair’ picture of a company’s position,” it argues.
“A return to that framework of prudence is an essential prerequisite for an improvement in audit choice and quality,” it says.
Nevertheles, the structure of the market for audit must also be addressed. “Since Andersen’s disintegration, the Big Four have regularly warned about the danger of losing another firm. As the head of the Institute of Chartered Accountants in England and Wales has pointed out: ‘Four is just one step away from there being no choice at all’.”
This has a number of malign effects, points out the FT, including:
- Reducing competition. “Ninety-seven per cent of the FTSE 350 UK companies are audited by one of the Big Four firms, and 99 per cent of the S&P 500 in the US.”
- Increases the risk of conflict. “The Big Four provide consulting services to the same group of companies and their alumni populate the audit committees of client-companies, and the higher echelons of the world’s accounting regulators.”
- Lack of choice ties the hands of watchdogs who shy away from forceful action for fear of reducing the Big Four to just three. “Merely tinkering is ineffective or, worse, counter-productive.”
“After the EU insisted on auditor rotation, some mandates passed from second-tier firms to the Big Four, increasing their dominance. Conflicts of interest have sometimes cut the line-up of potential replacements to one or two firms,” comments the FT.
The UK is a good laboratory for a more radical change, argue its editors. This is because the UK is “a hub for the largest firms, the debate is already well advanced, and the existence of global networks of firms and regulators means successful change will spread to other jurisdictions, notably the US”.
A two-track approach is now required, recommends the FT. “The UK’s Financial Reporting Council has failed to act with sufficient speed or force against lax auditors. Rather than being disbanded, though, its mandate needs to be reinforced.
“It needs to have access to sharper weapons to back up its verdicts and it needs to loosen ties with the Big Four. The regulator can then ensure an effective cap is put on the biggest auditors’ market share.
“The firms themselves have discussed temporarily limiting the Big Four to 80 per cent of the FTSE 350. This is a good start but does not go far enough.”
A cap of, say, 60 per cent would catalyse real change, says the FT. This should be combined with a requirement for the biggest firms to share audits of the largest companies and give smaller rivals access to their technology platforms.
In addition, there should be a mechanism to offset audit committees’ conservatism by ensuring some prize mandates go to challenger firms.
“Over time, this should ensure that a Barclays or a GlaxoSmithKline can as easily appoint an auditor from outside the Big Four as they currently do from within. PwC, Deloitte, KPMG and EY self-interestedly oppose the most sweeping remedy for concentration: break-up. They argue it would be unduly disruptive.”
They have a point, says the FT. “Such a move would be complicated and time-consuming. But so was dismantling Standard Oil or AT&T. Those cases showed, though, that as a last resort radical restructuring can reinforce the free market in areas hit by the blight of complacency.”
Politicians and regulators should hold the threat of a split in reserve in case progress towards a market-share cap is too slow, continues the FT. If the Big Four wish to avoid such an outcome, they need to demonstrate a clear and urgent determination to reform themselves, in the public interest and their own, it adds.
