FRC review and the future of audit: break up or shape up?

This blog gives you the latest topical news plus some informal comments on them from ShareSoc’s directors and other contributors. These are the personal comments of the authors and not necessarily the considered views of ShareSoc. The writers may hold shares in the companies mentioned. You can add your own comments on the blog posts, but note that ShareSoc reserves the right to remove or edit comments where they are inappropriate or defamatory.

Sir John Kingman has been appointed to undertake a thorough review of the FRC. ShareSoc and UKSA will be making a submission to this.

The FT on 16 May had a front page article on this headed Carillion’s demise spurs call for action against Big Four. MPs’ report on collapse asks for possible break-up of ‘cosy’ auditors by Gill Plimmer. The key points were

  • Outsourcer’s fate exposed ‘systemic flaws’ in corporate Britain and its ‘toothless’ and ‘feeble’ regulators, say Commons committees
  • Damning 100-page dossier concludes KPMG, EY, PwC and Deloitte should be referred to competition authority
  • Fall of UK’s second-largest construction company ‘could happen again, and soon’
  • British MPs have demanded the UK’s big four accountancy firms be referred to competition authorities for potential break-up following the collapse of government contractor Carillion, calling them a “cosy club incapable of providing the degree of independent challenge needed”.

My view for quite a long time is that auditors should audit. That’s it. Full stop. Auditors are appointed by company directors on behalf of shareholders to audit the company. If audit firms try to provide other services to management, this conflicts with their fundamental goal.

CSFI (the Centre for the Study of Financial innovation) organised a round-table discussion on “The future of audit: break up or shape up?” with Natasha Landell-Mills (Head of Stewardship at Sarasin & Partners and a member of the Disclosure and Transparency Committee of the International Corporate Governance Network), Jim Peterson (author of Count Down: the Past, Present and Uncertain Future of the Big Four Accounting Firms), Michael Lafferty (Lafferty Group), Mark Babington (Deputy Director of Audit Policy at the FRC) and Paul Boyle (Former head of the FCA) on Monday, April 30, 12.30-2.15pm.

This was a well attended meeting of about 80 present. The key points were:

Every time there is a high-profile corporate failure – and some argue that there have been too many of these – the spotlight falls on the auditor. It has invariably signed off the previous year’s accounts as being within both accounting rules and the law of the land, and providing a ‘true and fair’ view.

Carillion’s collapse has led to a classic round of criticism, including of the auditors, KPMG, and the Financial Reporting Council, which is the UK’s audit regulator. Some believe that the ‘Big Four’, which also includes PwC, Deloitte and EY, offer insufficient competition and choice in the market. Others worry that the place of audit alongside consultancy activities can lead to conflicts of interest.

Defenders of the current model say that the complexity and geographic reach of their multi-national clients require huge investment in a global network that can account for all the parts. They point out that the mid-tier firms have blinked at the prospect of expanding into this demanding space. Some say that talented young people prefer to work for a firm with career options beyond audit.

I learnt how difficult it is to change auditors. A large company may use firm A for their audit, firm B for tax and Firm C for IT implementation and Firm D for remuneration. It is difficult to find a new auditor who is not conflicted.

The concentration of the auditors is built into the dynamics of the business. They need to have global presence and structure and processes in order to deliver the audit service to their clients. It is a natural oligopoly and this is why there are only 4 firms capable of auditing FTSE100 companies and no challengers.

Currently the rules preclude ownership of audit forms other than by accredited auditors. This precludes new entrants and hampers competition. There may be a benefit from different ownership structures which may make this market place operate more effectively.

They are too big to fail. But also the system is too fragile to survive. There is  a non-trivial risk of one failing and the Big 4 becoming the Big 3. Most present agreed there is a problem but there was little agreement of the solution.

I was unconvinced. My solution is to spin off the non audit work into separate firms. Then, when an audit is being tendered, there will be 4 firms competing, which must help both quality and cost. As shareholders, surely we should be pressing for this option? Your feedback is welcome as we prepare our response to the Kingman consultation.

Cliff Weight
Director , ShareSoc.

  1. Stephen Burke says:

    Personally I’d want to know what is the real source of the problem before proposing a solution. Why did the auditors fail in the case of Carillion? Did the company hide information from them? Did they not have the power or ability to look at the details? Was there collusion? Did they not dare to criticise the company, and if so why? Was it too complex for them to analyse? Do they just routinely sign off audits without looking for problems?

  2. Tony Stott says:

    We went through this loop 15 years ago. The auditors were forced to spin off their consulting arms. See accountancy age article below. So its seems simple to force them to do it again, but this time stop them from regrowing new consultancies.

    And to stop the oligopoly we should force rotation of auditors every 5 years, with re-appointment of an auditor banned within a 10 year period. This would encourage new entrants into the market.

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