According to the FT this morning:
A UK financial regulator has called for an inquiry into whether the big four accounting firms should be broken up, in a move aimed at ending their dominant position auditing the accounts of Britain's biggest listed companies.
Stephen Haddrill, chief executive of the Financial Reporting Council that regulates accountants, said Britain's Competition and Markets Authority should investigate the case for “audit only” firms in an effort to bolster competition and stamp out conflicts of interest in the sector.
They added:
Mr Haddrill's intervention follows a string of corporate accounting scandals, ranging from Carillion in Britain to Steinhoff in South Africa and Petrobras in Brazil. “There is a loss of confidence in audit and I think that the industry needs to address that urgently,” he said. “In some circles, there is a crisis of confidence.”
The suggestion is one I have little difficulty supporting. It has been apparent for decades that the structure of the Big 4 has created conflicts of interest that have prevented the essential public interest role of acting as auditors from being undertaken either properly more effectively for the benefit of society.
But, the question has to be asked as to why the Financial Reporting Council might be suggesting this now. Might it be because yesterday there was a call from the Local Authority Pension Fund Forum (who I advise, but not on this issue) for the abolition of the FRC. As has been reported:
An influential UK pensions body has called for the country's accounting watchdog to be wound up and replaced with a proper statutory body.
The Local Authority Pension Fund Forum (LAPFF) — which represents 72 of the UK's local government pension schemes — made the demand in its submissionto a consultation on the Financial Reporting Council's (FRC) proposed revisions to the UK Corporate Governance Code.
In its submission, LAPFF said it viewed the positions of the FRC's chair, Sir Win Bischoff, and chief executive Stephen Haddrill untenable and “considers that the FRC should be put into special measures, to be run by commissioners until a new body is set up under primary legislation”.
Let me be clear: I might support the FRC call for reform of the Big 4, but I have even stronger sympathy with this call from LAPFF, which represents more than 60 local authority pension funds with more than £200 billion under management.
If there is a problem with auditing now it must have taken time to develop. And if so it happened on the watch of the FRC, which is an organisation riddled with membership from the Big 4 creating massive conflicts of interest that are at the heart of the crisis of confidence to which the FRC refer.
This is not a time to just reform the Big 4: it is a time to sweep the whole failed structure of UK auditing aside and to start again.
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I have had only one direct experience of the FRC and its twisted logic of interference and would gladly see it replaced with an organisation fit for purpose.
As for the Big 4 my contempt knows no bounds.
I agree
We have quickly become habitualised to the idea that auditors will not hold companies to account for financial rectitude. Whether from sheer incompetence and slipping standards, or outright collusion and coverup, a big 4 audit can not longer be relied upon by investors. Can anyone imagine in November 2017 that KPMG could not see the cash pyramid scheme that Carillion had become?
The bigger flaw that underlies these failings is the woeful lack of understanding in today’s UK political class about what makes the real foundations of good business. One of the reasons that London became a World financial trading centre in the first place was because strong UK institutions and rule of law gave investors confidence that they were not being defrauded. The high quality and standards of our auditing firms played an important role in these systems, but in a fast moving World such reputations can very quickly be ruined. Our politicians seem to act as if this erosion of trust doesn’t matter, but this is part of a wider and even more worrying pattern.
Today one of the UKs truly great corporations, Unilever PLC, announced the move of its headquarters and financial base to Holland, with hardly a comment from the government. Their indifference to the importance of companies which operate to high standards like Unilever is truely staggering :
https://www.ft.com/content/7a85ee0a-286d-11e8-b27e-cc62a39d57a0
And of course the biggest example of all is the madness of Brexit, which will leave many more companies besides Unilever making plans to relocate the base of their operations into the single market in Europe. It seems the Conservatives have strayed about as far from the church of good business as it is possible to go. The cost to the UK economy of this brazen ignorance will be deep and long lasting.
Time after time it has been demonstrated that no one can rely on an audit report, the bigger the audit firm the less you can rely on it. They are just expensive flannel at the moment. The whole system needs rebuilding from the ground up. If HMRC wasn’t subject to regulatory capture you’d expect them to be one of the loudest voices calling for this.
“If HMRC wasn’t subject to regulatory capture”
That’s an interesting suggestion. The problem with the FRC is clearly demonstrable in its membership. Is there something about HMRC we should know about?
Look at the non-executive directors
There is a long history in Britian of regulators being captured by the industries they regulate; it is almost commonplace. I suspect it is a sociological phenomenon; perhaps it is a even a “law’ that applies generally to economic activity. We may wonder why this should be; but then, this is Britain: form over substance is the norm.
I agree with all of that
Marco Fante says:
“If HMRC wasn’t subject to regulatory capture”
Is there something about HMRC we should know about? ”
If it walks like a duck…..
What is the solution here. Spinning out the audit practices of the big 4 simply won’t work. The audit practice is heavily subsidised by the rest of these firms. You will have people leaving in droves, audit quality will decrease. A statutory audit body could work but presumably would be constrained on civil service type pay so again you aren’t going to get experienced auditors joining
People who work in audit work in audit
They do not spillover after a certain point
There will not be an exodus: audit will be a career of value in its own right, paid for at worth
This is vital
And anyway, audit fee payment should change: it should be from a central body funded by a levy on turnover / staff and asset worth….
Yes, critical point that one.
Given everything that is known about conflict of interest there needs to be a clearly articulated, viable alternative. Has one been devised as yet?
Not that I am aware of a detailed version
I have not done so
I will ask the small coterie of those who comprise the critics
Anth says:
“…… audit quality will decrease. …..”
is that possible and still be even a pretence of audit ?
Don’t believe the press. There must be thousands of perfectly fine audits completed each year, only the big failures make the press. We have a huge number of audit firms in the UK, the industry dosent start and end with the big 4
Anth says:
“Don’t believe the press.”
I don’t . I consider NSN a useful guide to the current style and priorities of establishment deceit.
” industry doesn’t start and end with the big 4 ”
No, but civilization as we know it might 🙂
I don’t doubt there are a lot of people in audit, as in all walks of life, who are intent on doing a good job to the best of their sometimes prodigious, sometimes limited, ability and with little recognition.
Anth says:
“What is the solution here. ”
The surprising thing to me is that the market ‘players’ aren’t leading the charge. How are investors to assess the prospects of their investment decisions when the audit process is spinning them a line ?
Presumably the ‘big boys’ do their own research through insider network contacts (?)
If it mattered to them surely they would be getting a grip of the situation and the salary levels of auditors is a non issue. They must currently be paying through the nose, for information which is reliable , or suffering the financial losses of betting blind. (?)
I don’t get it.
No one really wants to work in audit. The juniors crank the handle on the audits to get qualified and then move to more interesting bits of the firm. Trust me, the staff turnover at the point of qualification in the audit practice is huge and a massive issue, hence the investment in ai
I am not sure I entirely agree
I accept many train and move on
Bout some actually do want to audit
And why not? Done well it has a real social value
You may not agree but it’s a reality and a real issue for the big 4. I can’t honestly see how a spun out audit practice will attract sufficient numbers of trainees to do the audits unless the requirement of an audit changes significantly, although checking physical stock etc would seem reasonably fundamental to any new style audit.
How about paying more?
It’s an old trick but it often works
Richard Murphy says:
“How about paying more?
It’s an old trick but it often works”
….but it also often works to attract the very people who end up running the Big 4 (and a raft of other dubious enterprises) because if making more money is the objective it is open ended, and knows no bounds.
Yes pay more but in a statutory audit body you will presumably be linked to civil service type salary bands. There’s an outcry whenever anyone earns more than the pm for some reason. A bog standard brand new audit manager (so just post aca qualified) is looking at 50-55k in london, you will need to pay more than that in a statutory body so the whole model starts to struggle
Unless a statutory body is ‘grown up’ on this issue it will fail
Anth
“no-one really wants to work in audit”.
I’m sure you’re right. Isn’t that a truly horrible statement of all that is wrong in our country? They would far rather work in tax planning which is better paid & considered “sexier”.
Now, I loathe, above anything, the BLiar stuff about “Britain Plc”but, if you think about what the country needs it is surely obvious that we need auditors much more than tax advisers.
We’re going to have to sort this out & if the ‘Big 4’ or ‘Big 20’ Accounting firms won’t, or can’t, give an adequate audit service then it will have to be nationalised. As you say, that would require paying Civil Service rates but, more importantly for the city & anyone in investment, it will mean abiding by their deadlines. Eg a leading A PLC may want to buy B PLC but not until its accounts are audited. “I’m sorry, you are in a queue, we hope to audit B PLC’s 31/12/17 accounts no later than Easter 2019”. That’ll go down well, won’t it?
So I think we are all in agreement there is no easy answer here. A “grown up” public body would certainly be a first RM!!!
Agreed
I take issue with your comment “Audit is heavily subsidized “ by other sections. It is the suffering shareholders who are subsidizing the betrayal and fleecing of their assets and it is shareholders who suffer billions of losses because auditors served the finance directors wishes rather than the shareholders who appointed them to check the Directors books.
The solution is quite easy really – getting it done is the difficult bit and I doubt it will ever happen ( too much self interest). Audit firms should do only statutory audit work , nothing else. The audit firm should be owned by its partners and be properly regulated by an independent body ( not the Institutes ). They must be properly remunerated and that will mean audit fees going up a lot. The drive down of fees over the years has only being achieved by doing less audit work. It’ll never happen though.
All of that is a good start
I believe fees should be based on a levyL probably turnover but also employees / assets / capital based to deliver fairness
Gavin says:
” It is the suffering shareholders who are subsidizing the betrayal and fleecing of their assets and it is shareholders who suffer billions of losses because auditors served the finance directors wishes rather than the shareholders who appointed them to check the Directors books.”
Excellent, Gavin. As I was saying earlier. Lot of people being badly served by dodgy audit. The ones with a keen vested interest will eventually be motivated to do something about perhaps.
Do I detect a wedge appearing between the one-percent and the ten-percent ?
The point-one-percent are out on their own and don’t give toss. The rest of the population either naively trusts that their savings and investments are being expertly managed or they haven’t got any to worry about.
Compared to the 95% loss on RB S PLC add on Carillion you could pay for proper audits on all the PLCs in the ft100 all over again.
As for would the big 4 want to do audit – of course it’s the only Guarenteed way for large amounts of time selling to the finance director other products or conspiring to charge shareholders higher Directors pay and higher audit fees which cost the audit partner less money to undertake.
A SNAC shareholder nomination to the Agm would sort this out as the majority shareholders on the committee would demand to direct the areas and scope of the audit. Perhaps refocused attention on Directors manipulation and bonus ltip etc schemes rather than petty theft each year.
It generally comes down to accountants regulating accountants and accountants working to rules created by accountants.
How to break this circuity?
I would certainly argue that in certain circumstances, for instance those that revolve around moral hazard or substantive public funding, auditors should report to the public as well as to the Directors of a company.
Is there any place for morality in business? Lots of people would argue not; indeed it would spell the end of aggressive tax avoidance and gaming of tax law.
Can you have an amoral regulator?
If morality and social responsibility are ruled out then we are back to statute and its ongoing amendment.
Gordon Brown made the mistake of saying that “businesses want to act responsibly” and that regulation should be of a light touch and limited.
He was wrong.
Revision needs to be root and branch but too many people are living well of the existing system.
We need accountants with a social conscience, unfortunately the vast majority hide behind standards and statute.
KeithP says:
“Can you have an amoral regulator?”
Assuming you mean by ‘amoral’ an objective regulator, the only hope is for higher levels of Artificial Intelligence. Even then it is difficult to imagine an AI machinery being set up and programmed without ‘political or moral’ underpinning.
Traditionally we have assigned this role to ‘God’ as the governor of moral conscience in human affairs with very mixed results.
So I think the answer has to be a ‘no’. And that means we have to control the moral parameters of the process. Something we are not doing, or doing very badly at present. This presents an abject failure of governance.
Andy
Arguably you could have for audit. The audit function doesn’t differ whether the company was set up to supply water functionality in the Sudan or to supply arms to Saudi Arabia. The only issue is whether the accounts actually reflect the activity of the company.
Now, I know Richard would say, probably rightly, that the accounts of a Company that engages in immoral enterprises, or that, having carried out enterprises moral or otherwise, chooses to avoid tax on its profits,should be qualified.
The 1st point, however, is that the accounts must reflect the activity of the company & in the case of Carillion that just didn’t happen. The accounts were showing “fair seas ahead” even as everyone who knew was scrabbling for the exit.
I also don’t understand Anths comment that
“Don’t believe the press. There must be thousands of perfectly fine audits completed each year, only the big failures make the press. ”
Would it not be more true to say that the vast majority of firms are honest & law abiding? A tick & cross exercise does no harm if they’re abiding by the rules anyway. You’re meant to catch the small number that don’t abide by the rules & seem to utterly fail to do so.
My recollection, please correct me if I’m wrong, is that Carillion weren’t doing anything that clever. They were both inflating & anticipating income streams, often from customer discounts . Sorry, but that’s bog standard. We’re not talking Professor Moriarty here.
At a ShareSoc individual shareholders meeting it was suggested that until the big fours checked audits are above 85% then the lowest of the four should directly pay several millions to add a further 40 staff for the next three years for every yearly failure. With a further 40million penalty to go to the Serious Fraud Office who have to investigate such failures.
40m fine? I suppose that’s one way to get the big 4 to stop doing audits lol
The 20 million figure is the amount Arthur Anderson were paid off for the audit failure at Enron and seems a standard bribe to look the other way.