European Commission holds Big Four to account

Michel Barnier, internal markets commissioner at the EC, has written a draft proposal suggesting that the Big Four – Deloitte, PWC, Ernst & Young and KPMG – should be forced to separate their audit and consulting businesses, and that no firm should be allowed to keep the same auditor for more than nine years at a stretch. Furthermore, firms with balance sheets in excess of 1bn euros would be forced to hire two auditors – one large, one small – in order to conduct a joint audit. Phew! That’s at least as much reform as is likely to be forced on the banks, should Barnier’s proposal ever pass into law. It certainly won’t win him any friends in the industry.
 
Why pick on accountants? They may not be the most exciting people but they are at least pretty ordinary. Unlike those dreadful banker types with their flash cars, wide suits and palpable senses of entitlement, the self-effacing bean-counter makes an unrewarding target for public opprobium. All that’s as maybe. But those of the same mind as Barnier point out that for all their low profile, accountants are one of the guard dogs of financial probity, and that like their oppos, the credit ratings agencies, they entirely failed to bark any kind of warning that things were not as they should have been back in the prelapsarian days of the mid-noughties. These proposed new rules and regulations are supposed to put the profession back in fine voice, before the next crisis comes along.
 
There are two basic accusations which have been thrown at the Big Four accountants. Firstly that the combination of audit (checking the validity and reliability of a company’s accounts) and non-audit (consultancy services) within the same firm and client base leads to conflicts of interest. Not least because high margin consultancy now provides twice as much business as the audit work, although it is the latter which is the accountants’ statutory function.

What happens too often, say the reformers, is that audit is used as a sales tool to get into a firm and secure juicy non-audit work such as tax and risk management consultancy, rather than being seen as an end in itself. And that such is the lucrative nature of the non-audit side of the business that it can make the auditors rather less willing than they should be to pipe up if they find anything amiss.  Very much the same criticism that has been made of the relationships between the analysts and salespeople at investment banks, in fact. It is to address this point that Barnier suggests that accountants should be made to choose between audit and non-audit, rather than being allowed to do both.
 
The other main bone of contention is that there is not enough competition because the Big Four operate what Barnier calls an oligopoly. Hence the joint audit wheeze, to try and get more mid-sized accountancy firms onto the rosters of large multinationals alongside their giant brethren.
 
So, is it justified and will it work? Well, justice often depends on which side of the courtroom you are sitting on, but it’s demonstrably the case that the record of auditors in alerting shareholders, industry and the public in general of potential murky goings-on is very poor. The wider question is whether this is due to conflicts of interest limiting their independence, or to more mundane but fundamental flaws in the audit process itself. On the other side is the delicious irony that the EU itself has not had its own accounts properly signed off for 15 years.
 
Will it work? Perhaps, but if the industry has its way we’ll never find out. If enacted in their entirety the proposals would destroy the business models of the Big Four overnight. And who would do the auditing then?