Michel Barnier has shocked the Big Four accounting firms. The European Union internal market commissioner wants to ban them from operating as consultants as well as auditors, force them to work jointly with others, and set time limits on how long they can audit each company.
It could be the biggest shake-up of accounting since the collapse of Enron laid low Arthur Andersen and led to the 2002 Sarbanes-Oxley Act. Yet it will not amount to much unless the industry’s looming disaster – the failure of another audit firm and contraction to a Big Three – can be avoided.
Making accountants perform better and ending the conflict of interest of auditors also acting as consultants and tax advisers are laudable aims. But if no way is found to break the Big Four oligopoly and return to a Big Five (preferably a medium-sized six or seven), then Mr Barnier’s proposals will be little more than crowd-pleasing gestures.
The hard reality is that large companies and financial institutions – the kind of banks that suddenly found their assets had collapsed in value between 2007 and 2009 despite their books being given a clean bill of health by auditors – have precious little choice. They often employ two or three of the Big Four in various roles, so rotating auditors is like shuffling a tiny pack of cards.
The figures speak for themselves. The Big Four perform 99 per cent of audits on FTSE 100 companies and 95 per cent of those on FTSE 250 companies. Some 85 per cent of the UK industry’s fee income goes to the Big Four, leaving their nearest rivals BDO International and Grant Thornton trailing.
Large companies cannot replace a Big Four auditor with a second-tier firm because they lack the expertise and resources to compete. Without a significant shift in the terms of competition – or an enforced break-up by anti-trust authorities – there is little chance of this improving.
Indeed, there is every prospect of it getting worse. “The shift to concentration in this industry is an irreversible, one-way, ratchet,” says one senior accountant. Since the failure of Arthur Andersen, governments and regulators are wary of provoking another collapse. KPMG paid $456m to the US tax authorities in 2005 over illegal tax shelters but escaped criminal prosecution.
If another Big Four firm went down, there would not be enough capable of auditing multinationals to go around. The hopes of regulators and shareholders of curbing their conflicts of interest and imposing higher standards of scrutiny would become moot. Their importance to the global economy has made them too big to fail, or to control.
The Barnier proposals that have captured the headlines and provoked outrage in the industry do little to address this, instead focussing on improving the existing firms’ standards of conduct. They are the latest in a series of such regulatory and legal shifts, both in the US and Europe, since Enron.
The core proposal to end conflicts of interest between the firms’ accounting and consulting operations, by barring them from consulting to audit clients, is a good idea. That was the focus of Sarbanes-Oxley and led to three of the Big Four selling their consulting divisions, before quietly building them up again.
The industry is already going this way in Europe. In the UK, the Auditing Practices Board restricts the overlap in its code of conduct – for example, barring accounting firms from offering more aggressive types of tax advice to audit clients, or from consulting on some kinds of information technology.
The Big Four’s consulting arms mostly sell services to non-audit clients – those audited by other firms. Deloitte, for example, gained consulting and tax fees of £1.4bn in 2009 from non-audit clients, compared with £200m from audit clients. Among the Big Four as a whole, the gap has been widening and they could easily and usefully end the remaining overlap.
I see no need for the Big Four to spin off their consulting operations altogether, as Mr Barnier, for ill-defined reasons, prescribes for the largest firms. It would stop the Big Four from being able to draw on inhouse expertise and attract young recruits who train as auditors and then switch to more exciting work, without clear benefits.
A structural change is needed but this is the wrong one. It would be better to let the Big Four retain their consulting arms (once the conflicts of interest over audit clients have been ended) and instead encourage the emergence of new competitors to the biggest firms through ownership and anti-trust measures.
Mr Barnier’s best proposal in this regard has attracted little attention – an amendment to the EU audit directive to end the requirement for accounting firms to be majority owned and controlled by accountants (the same rule is written into state law in the US). That has hitherto protected the Big Four by barring outsiders from challenging them, in a way that is akin to insisting that all airlines are owned by pilots.
The next step should be to unleash the competition authorities. This is already under way in the UK, where a House of Lords committee declared in June that the auditing of large companies “is dominated by an oligopoly with all the dangers that go with that”. The Office of Fair Trading has now threatened the Big Four with being referred to the Competition Commission.
If the European Union wants to restructure the accounting industry it ought to call Joaquín Almunia, its competition commissioner. With due respect to Mr Barnier, he is the wrong man for the job.
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