David Prosser: A decade after Enron, auditing needs a shake-up

Ten years ago tomorrow, Enron, which was then the US's seventh largest company, filed for bankruptcy following a shocking accounting scandal that seemed to have completely passed its auditor by. The auditor in question, Arthur Andersen, subsequently disbanded.

One might think the lesson from Enron is that any auditor which fails to spot a problem large enough to sink a company can expect big trouble of its own. Yet no audit firm has paid the price for the failure to warn about the potential black holes in the accounts of the banks prior to the credit crunch, or the extent to which so many of them were using off-balance sheet special purpose vehicles. Rather, the dominance of the big four firms remains absolute, with Deloitte, Ernst & Young, KPMG and PriceWaterhouseCoopers even enjoying a boost from the post-Enron disappearance of Arthur Andersen.

It is in this context that Michel Barnier, the European Union's internal market commissioner, yesterday published new rules for auditors that had the biggest firms spitting tacks. Firms will have to split their audit and consultancy operations, while companies will be required to change their auditors regularly – maybe as often as every six years.

The big four may be angry, but the case for reform is compelling. Between them, Deloitte, Ernst & Young, KPMG and PWC hold the audit contracts for 85 per cent of blue-chip EU companies. They enjoy profit margins that are 50 per cent higher than the next four largest auditors, Mr Barnier claims.

Improved competition and higher standards go hand-in-hand. The requirement to prevent auditors selling consultancy to companies they audit is important because of the conflicts of interest that arise when providing both services. But in a more diverse market, such conflicts would be less likely even without such a ban. Similarly, it might also be that had a bank's auditor, say, previously been prevented from spending decades with the account, it might not have got so cosy that it failed to see the financial crisis coming.

There is an inherent conflict of interest in the auditing sector – auditors are paid by the very people they are supposed to be keeping an eye on. Still, mandatory rotation of audit accounts should give firms less reason not to assert their independence.

The argument against Mr Barnier's reforms seems simply to be that companies' audit costs may rise as a result of them. Well, that doesn't seem logical – more competition should surely lead to lower fees, especially if Mr Barnier is right about those margins. But even if costs do rise, isn't that a price worth paying if we end up with more robust auditors that do a better job of holding their clients to account?