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Home > Blogs > Ian Fraser > 'Big Four' auditors on back foot after UK parliamentary report exposes failures

'Big Four' auditors on back foot after UK parliamentary report exposes failures

Auditing profession | 'Big Four' auditors on back foot after having failures exposed by UK parliamentary report Ian Fraser

The report into the auditing profession published by the House of Lords economic affairs committee last week signals a major turning point for accountancy. In a previous blog, I wrote that accountancy firms had become "so big, so conflicted, so self-interested, so obsessed with growing revenues and profits ... that they had become a danger to capitalism itself." Earlier, Berkshire Hathaway vice-chairman Charlie Munger said "accountancy has become a sewer". It seems the committee agrees.

Following an eight-month inquiry, the Lords committee has produced the hardest-hitting report into the reasons for the banking and financial crisis so far. The report, entitled Auditors: Market concentration and their role, slams the 'Big Four' audit firms for failing to raise the alarm ahead of the banking and financial crisis, and recommends an independent investigation into the lack of competition in their industry.

The report slammed the 'Big Four' - Deloitte, Ernst & Young, KPMG, and PwC - for being:

“Culpably unaware of the mounting dangers or, if they were aware of them, they equally culpably failed to alert the supervisory authority of their concerns.”

PwC was singled out for special criticism over its audit of the failed mortgage bank Northern Rock. The report said:

“We are astonished that PwC appeared not to recognise an amber light that flashed so brightly.”

The Lords said the accountancy firms' “complacency” and “dereliction of duty” contributed to crisis.

“We do not accept the defense that bank auditors did all that was required of them. In the light of what we now know, that defence appears disconcertingly complacent. It may be that the Big Four carried out their duties properly in the strictly legal sense, but we have to conclude that, in the wider sense, they did not do so.”

The Lords were also astonished that bank auditors had failed to have regular meetings with the UK regulator, the Financial Services Authority, to discuss their concerns about the state of the UK’s banking sector in the run up to the crisis, saying, "We regard the recent paucity of meetings between bank auditors and regulators, particularly in a period of looming financial crisis as a dereliction of duty by both auditors and regulators.”

In an attempt to boost competition in the sector, the committee recommended that FTSE 350 companies should be forced to tender their audit contracts every five years and to explain the reasons behind their choices. The lack of competition in the audit market was illustrated by how rarely large companies change their auditors. The report said FTSE companies changed their auditor, on average, every 48 years, while Barclays has had PwC as it auditors since 1896.

Having seen some of the evidence-gathering hearings, it was fairly self-evident that the Lords did not intend to pull their punches. In one session in January a group of investment managers I respect said UK accounting standards, based since 2005 on IFRS, had legitimized Alice-in-Wonderland-style financial reporting that produced phantom profits and permitted remuneration committees to award bonuses that could, in reality, be ill-afforded. After watching this session, it was fairly clear to me that the Lords had decided radical action was required.

At a committee hearing last November the bosses of the “Big Four” said they saw absolutely nothing wrong with helping banks deceive investors about their solvency ahead of the crisis!

So is the game up for the Big Four? It remains to be seen, but they are arguably now drinking in the last chance saloon.

It seems likely that, following the likely UK competition probe, they will either be broken up or lose their extraordinary grip of the market for auditing the largest companies. The European Commissioner for internal markets, Michel Barnier, is also breathing down their necks. In a recent interview he said he wants to stop them from selling any consultancy services to their audit clients. He told the magazine WirtschaftsWoche that an audit firm “should have no commercial interest in the company whose books it reviews.”

Why does this matter? Because if audit firms are as cozy with their clients as they have been over the past 15 to 20 years, they are a waste of space. As I said in the opener, they may also have become a danger to capitalism itself.

Further reading on reforming the audit profession:

Tags: accountancy , audit , auditing , auditors , EU , fair-value accounting , Financial Services Authority (FSA)
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  1. Anonymous Comment says:
    Wed Jun 20 14:47:08 BST 2012

    Thanks for sharing. Always good to find a real expert.
  2. fortfield says:
    Mon Apr 04 17:06:43 BST 2011

    Excellent article and "absolutely on the money"

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