High time for an au­dit of the com­pla­cent top dogs of the ac­coun­tancy busi­ness

The Observer - - Analysis -

It was not only bankers, and cen­tral bankers, who got off lightly in the cri­sis of a decade ago. The group that most suc­cess­fully stayed out of the spot­light was the au­dit­ing pro­fes­sion. Vast fi­nan­cial in­sti­tu­tions fell over in a heap, some­times only months af­ter their books had been signed off as healthy, yet the au­dit­ing in­dus­try was never se­ri­ously held to ac­count. Even when in­quiries hap­pened, their find­ings were mostly ba­nal, and they took years to ar­rive.

The mood now seems to be turn­ing. Sir John King­man, a for­mer Trea­sury of­fi­cial who is now chair­man of Le­gal & Gen­eral, is al­ready con­duct­ing a re­view for govern­ment to de­ter­mine whether the au­dit watch­dog, the Fi­nan­cial Re­port­ing Coun­cil, is fit for the fu­ture. A heav­ier bat­tal­ion ar­rived this week in the form of the Com­pe­ti­tion and Mar­kets Au­thor­ity, which launched a in­quiry into con­cerns that the au­dit mar­ket is not work­ing well for the econ­omy or in­vestors. En­cour­ag­ingly, the CMA says it will move quickly: pro­vi­sional find­ings are promised by Christ­mas.

One trig­ger was the col­lapse of Car­il­lion in Jan­uary this year, which touched a nerve in the way bank fail­ures never did. And a suc­ces­sion of scan­dals with au­dit­ing fail­ures at their heart have played a role. BHS, over which PwC copped a £6.5m fine from the FRC, was a prime ex­am­ple. Fur­ther ques­tions will be raised af­ter the cri­sis that has en­gulfed Patis­serie Va­lerie – au­dited by Grant Thorn­ton – last week.

The CMA is a com­pe­ti­tion watch­dog, and com­pe­ti­tion is def­i­nitely the place to start. Four firms – PwC, Deloitte, EY and KPMG – en­joy a dom­i­nance that would be tol­er­ated in few other sec­tors. They au­dit 99 of the 100 big­gest quoted com­pa­nies and have a com­bined mar­ket share of 98% of FTSE 350 firms – a rea­son­able def­i­ni­tion of a oli­gop­oly.

This con­cen­tra­tion isn’t new, which is why in 2013 the CMA’s pre­de­ces­sor, the Com­pe­ti­tion Com­mis­sion, or­dered com­pa­nies to put their au­dit en­gage­ments out to ten­der ev­ery 10 years. But the re­form has proved use­less in gen­er­at­ing com­pe­ti­tion from new quar­ters. The au­dit­ing merry-go-round turns at greater speed but the big four are still the only play­ers aboard. Grant Thorn­ton, the fifth-big­gest firm, has now given up pitch­ing for au­dit con­tracts from FTSE 350 com­pa­nies be­cause of the ex­pense of com­ing sec­ond.

There is no pain­less way to smash this dom­i­nance, but caps on mar­ket share would be an ob­vi­ous so­lu­tion. The draw­back could be higher prices for au­dit con­tracts, but re­spon­si­ble share­hold­ers might be happy to pay more, since the deep sus­pi­cion is that dom­i­nance has bred com­pla­cency among the big four. Life just seems too com­fort­able for them.

That the qual­ity of au­dit work has fallen is al­most be­yond dis­pute. In June, the FRC said stan­dards had slipped at all four of the ma­jor out­fits. It high­lighted “a fail­ure to chal­lenge man­age­ment and show ap­pro­pri­ate scep­ti­cism”. Car­il­lion’s au­di­tor, KPMG, was put in the reg­u­la­tory equiv­a­lent of spe­cial mea­sures af­ter be­ing sin­gled out as show­ing “an un­ac­cept­able de­te­ri­o­ra­tion” in the qual­ity of its work.

Against such a back­drop, the CMA must be pre­pared to be bold. It should ig­nore the squeals from the big four that sep­a­rat­ing au­dit­ing from non-au­dit­ing work would be too com­plex. If the watch­dog judges that sep­a­ra­tion would raise stan­dards, it should make it hap­pen: dif­fi­cult tasks can be worth­while.

And the CMA should def­i­nitely pur­sue the idea that in­cen­tives are mis­aligned be­cause it’s the boards of com­pa­nies, rather than their in­vestors, that pick the au­di­tor. Hand­ing pow­ers of ap­point­ment to own­ers, to the peo­ple who most want to see scep­ti­cal au­di­tors, would be an in­ter­est­ing in­no­va­tion.

An­drew Tyrie, the CMA’s new chair­man, picked over the bones of the bank­ing catas­tro­phe when he was an MP and chair of the Trea­sury se­lect com­mit­tee. He was com­mend­ably wither­ing about some of the fail­ures he un­cov­ered and un­afraid to chal­lenge vested in­ter­ests. More of that, please.

This year’s col­lapse of Car­il­lion, au­dited by KPMG, touched a nerve. Pho­to­graph by Joe Gid­dens/PA

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