The Big 4 firms of accountants must be cock-a-hoop at the government’s audit reform proposals

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The government has published its audit reform proposals this morning in a new White Paper. In this they say:

[T]he audit regulator has in recent years found up to a third of audits carried out by the seven largest audit firms to be in need of improvement or significant improvement.

The entire focus of this review should have, in that case, been on the inability of these firms to do the task that they claim to undertake on behalf of society, and which lets them earn exceptional profits.

There have also, of course, been many concerns expressed over the conflicts of interests within Big 4 firms. Their whole structure is set up top be opaque, as I have shown in my research with Saila Stausholm. As we suggested the only possible explanation for that is their own desire to avoid regulation. What such structures also permit is the cross-selling of c0nsulting services to audit clients, creating significant conflicts of interest. I know they say that this is no longer happens but what is undoubtedly still true is that they remain the backbone of offshore, as the same research showed.

The government is aware of this. What they say is this:

It is not healthy for audit quality that the UK audit market is so concentrated, with 97% of FTSE 350 audits undertaken by just four audit firms. This concentration is not helped by the fact that those firms also compete to provide a wide range of other business services to the largest companies.

But then they say:

The core of the Government’s proposal is a managed shared audit requirement for UK-registered FTSE 350 companies. This form of shared audit would see an audit firm appointed to lead the group audit, for which it bears the overall liability. When tendering the statutory audits of entities within the group, companies would be required to appoint a Challenger audit firm to conduct a meaningful proportion of the statutory audits. The requirement would apply across the FTSE 350, giving the audit firms the opportunity to gain exposure to the statutory audit engagements and audit committees of the largest and most complex companies, and giving those companies greater choice of auditor.

In other words, they leave the status quo intact. But what they do is evolve responsibility for the drudgery that they do not really want to do anyway to a smaller firm, and when everything fails you can imagine what the defence from the Big 4 will be: the claim will always be that it was the 'challenger' firm that got is work wrong, and not them. The excuse is quite literally lined up to use, off the peg.

It should be added that the government also says this:

[T]he Government also proposes a reserve power for the Secretary of State to allow the regulator to introduce a market share cap. This would be operated following a joint review by BEIS and the regulator, if mandatory shared audits do not bring about the desired change to the FTSE 350 audit market within a reasonable period of time.

That however is utterly meaningless. If there are no firms able to take on the role of the Big 4 then imposing a cap on them does not increase audit quality, but likely reduces it.

Finally, it should be noted that the government does suggest that there should be some reorganisation within audit firms. They say:

The Government proposes to require:

- the strengthening of governance within audit practices through the creation of independent Audit Boards within firms;

- Audit Boards to have oversight of audit partner remuneration and ensure it is linked to audit quality;

- the publication of a separate profit and loss account for the audit practice, accounting for cross subsidies between the audit practice and the rest of the firm through arm’s-length transfer pricing; and

- regulatory oversight of the remuneration of audit partners, with a view to supporting policies and practices that reward high-quality audits.

Let me be candid: no one is going to be quaking as a result of those suggestions. A little light reorganisation and the publication of a little extra data is a tiny price to pay for keeping the status quo intact, where Big 4 partners regularly earn well in excess of £500,000 a year.

The simple fact is that if these reforms were meant to deliver fundamental change it is very apparent already that they do not. Maybe the dependence of the government on these firms for Covid advice might have had something to do with that. We will never know.