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