Barnier vows to break the big four

The EC aims to boost competition in the accountancy market. Will it succeed where so many others have failed?

Sean Farrell
Tuesday 27 September 2011 21:13 BST

More than four years after the financial crisis erupted, the big accountancy firms are finally feeling the heat.

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The European Commission is planning a full-on attack on the Big Four firms' business models to increase competition and reinforce independence of the number checkers.

In a leaked proposal, Michel Barnier, the commission's internal markets chief, has called for a ban on Deloitte, PricewaterhouseCoopers (PwC), KPMG and Ernst & Young carrying out lucrative non-audit work for audit clients and for compulsory rotation of auditors and shared auditing.

The proposals are a reaction to the financial crisis and the Big Four's failure to spot, or warn about, the risks building up in the banking sector. Audits are vital to maintaining investors' confidence in public companies and their reported accounts, but concerns about the global giants' dominance of the market predated the crisis.

Until 1998, there were six big auditing firms, whittled down from many more outfits in a series of mergers over the years. Then Price Waterhouse and Coopers & Lybrand merged to form PwC and three years later Arthur Andersen imploded over its cover up of the Enron scandal in the US, leaving only four firms.

A look at the FTSE 100 captures the Big Four's dominance in Britain. Just one of the index's members – Randgold Resources – uses a non-Big Four firm and the average relationship lasts 48 years, a House of Lords report found earlier this year.

The Lords' report accused the banks' auditors of being "disconcertingly complacent" and failing in their duty to scrutinise their clients' books. As a result, the Office of Fair Trading will decide by the end of this year whether to refer the Big Four to the Competition Commission.

Now Europe has stolen a march on the UK. However, the Big Four will be lobbying hard to water down what they argue are crude moves with unintended consequences.

Mr Barnier's opponents argue that preventing the Big Four from combining non-audit services with low-margin audit work could prompt one of the firms to quit auditing, reducing competition further. It would also deny the Big Four's auditors the expertise of non-accountants such as actuaries and property valuers and reduce the pool of potential graduate recruits.

Tony Bromell, head of integrity and markets at the Institute of Chartered Accountants in England and Wales (ICAEW), says: "I used to do audit about 1,000 years ago and I did other things as well and I would have been less enthused about joining a firm where audit is all there is. You get less variety and the nature of audit is you have to specialise."

Mr Bromell adds that mandatory rotation of auditors has drawbacks.

"Independence is a means to an end and you also get a lot of knowledge [with a long-term relationship] and if you keep switching them around you are going to keep having less knowledge," he says.

The ICAEW thinks shared auditing is an idea worth exploring and supports more openness from audit committees about their decisions and more involvement by auditors in judging companies' business models as well as their numbers.

The argument for mandatory rotation and shared auditing is that it will give the next tier of firms – in the UK, BDO and Grant Thornton – a chance to break the Big Four's stranglehold.

The case against, is that globalisation has already happened and that smaller firms would need to make massive investments to emulate the international reach of the Big Four. Many companies in the FTSE 100 such as BP, the miners and financial institutions such as Prudential and Standard Chartered have most or all of their business away from the UK.

Richard Sexton, head of reputation and policy at PwC, says his firm has grown into its current size along with its clients, who are anything but a soft touch.

"Sophisticated clients test all our services very thoroughly. Independent non-executive directors are directly elected by shareholders. They review our audits and this cosy environment is not one I recognise."

However, non-executive directors and shareholders were also found wanting in the financial crisis. The non-execs were attacked for lack of expertise and courage in challenging management and shareholders were effectively divided and ruled by the companies they owned. And powerful business interests can always find reasons to leave them alone, as the banks have done in opposing Sir John Vickers' proposals for reform in the UK.

Gilad Livne, professor of accounting and finance at Cass Business School, says that to argue everything is rosy in the world of auditing is wrong but he doubts whether Mr Barnier's efforts will solve what is a complex problem

"The situation is perhaps not as bad as the regulator would like to argue and not as good as the auditors would like to argue. There is a problem but I'm not sure this remedy will be good enough. In the US they have prohibited providing non-audit services and I'm not sure the audit profession performs better there than in Europe."

In the US, an investigation into Lehman Brothers' collapse accused Ernst & Young of "professional malpractice" over its approval of the bank's accounting manoeuvre to flatter its capital position. Professor Livne also points out that Italy has mandatory rotation of auditors yet this did not prevent the scandal at Parmalat, audited by Deloitte.

"Suppose you are my auditor and you can't provide me with audit services, but I still want you to soften your position. I can pay you more so-called audit fees. If you want, you can always get round the rules."

It remains to be seen whether Mr Barnier's proposals make it through the political process intact but for now they have put him on collision course with the Big Four.

Mr Sexton says: "This isn't about the Big Four versus Brussels. We know from our contacts and discussions with BIS [the Department for Business] and the CBI that they don't support many of these more radical proposals because they don't think they will increase quality or competition... [Mr Barnier] has set out his stall and that is the world of politics."

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