CMA demands change
Big Four accountants face shake-up over audit failures
The failure of Carillion this year brought concerns over audits to a head
Big Four accountancy firms will be forced to split their advisory and audit work in response to failures to spot big company failures.
The Competition and Markets Authority (CMA) also wants to encourage a wider choice of auditors, with audits of the UK’s biggest companies, listed on the FTSE 350, carried out by at least two firms, one of which should be from outside the big four.
The proposals are published as another review calls for the abolition of the accounting industry’s regulator, the Financial Reporting Council (FRC), amid claims that it has been too cosy with firms it is meant to regulate.
The review of the audit business follows high-profile company collapses such as construction firm Carillion, which was audited by KPMG, and Bhs, audited by PwC, but goes back at least 20 years to the failure of Enron and the subsequent collapse of the banks.
In spite of this, partners at these firms have typically earned huge payouts and Bill Michael, the UK chairman of KPMG admitted that they operate an oligopoly – a state of limited competition.
The Big Four, which also includes Deloitte and EY, control 97% of big companies’ audits, but also provide them with a range of management services.
The CMA said companies choose their own auditors and, as a result “we have seen too much evidence of them picking those with whom they have the best ‘cultural fit’ or ‘chemistry’, rather than those who offer the toughest scrutiny.”
The CMA said businesses should be audited by the most challenging firm, rather than the cheapest.
While the recommendations fall short of a full break up the CMA said that if they fall short then it will propose further action.
It also proposed changes aimed at opening up the market to give smaller accounting groups access to the largest clients. The regulator is considering a possible market share cap to ensure that some major audit contracts are only available to firms outside the Big Four.
The CMA’s chairman, Andrew Tyrie, said: “Addressing the deep-seated problems in the audit market is now long overdue. Most people will never read an auditor’s opinion on a company’s accounts. But tens of millions of people depend on robust and high-quality audits. If a company’s books aren’t properly examined, people’s jobs, pensions or savings can be at risk.”
Its three main recommendations are:
- A split between audit and advisory businesses, with separate management and accounts
- More accountability for those appointing auditors, with the aim of strengthening their independence
- A “joint audit” system, with a Big Four and a non-Big Four firm working together on an audit.
FRC under fire
Sir John Kingman, who led the review into the FRC, said the regulator should be serving consumers who rely on financial information rather than the accounting firms themselves.
The review recommends that the FRC is replaced by a new Audit, Reporting and Governance Authority. It would have powers to pursue any company director and not just those who are a member of an accounting professional body like the Institute of Chartered Accountants in England and Wales (ICAEW), heralding the end of industry self-regulation.
Sir John, Legal & General’s chairman, queried why the FRC did not face an overhaul following the 2008 banking crisis, “even though the financial crisis was as much as anything else a crisis of accounting and financial reporting”.
The watchdog cleared KPMG over its audit of HBOS which was said to be in good financial health just months before the bank’s collapse and government bailout.
A third review, led by the outgoing London Stock Exchange Group chairman, Donald Brydon, will question how auditors verify information, identify public expectations and the gap between what audits can and should deliver.