“Big Four” Audit Oligopoly Strikes Back at Plans to Break it Up

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After a series of sudden corporate collapses, audit firms face a crisis in the UK.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

Deloitte, one of the so-called “Big Four” accountancy firms that have effectively cornered the global audit industry, has warned the UK government and regulators that any attempt to break up their oligopoly could backfire. Forcing the Big Four — which also include KPMG, PwC and EY — to split could harm Britain’s standing as a global financial center just at a time when the City is straining under Brexit pressures, the accountancy firm told a parliamentary inquiry.

“The Committees, and other commentators, have suggested that the break up of the largest professional services firms should be examined as a means of increasing competition and ensuring audit quality,” Deloitte said. “We do not believe that this is a viable solution to either matter and would be concerned that it would damage both audit quality and the UK’s position as an attractive capital market.”

In April, following a string of corporate scandals and collapses, the UK’s top accounting regulator, the Financial Reporting Council (FRC), called for an inquiry to explore the possibility of breaking the audit arms of the Big Four accounting firms — KPMG, Deloitte, Ernst & Young, and Price WaterhouseCoopers — into separate pieces. Serious doubts remain as to how genuine the regulator’s stated intentions are, since the FRC faces its own government inquiry following accusations of being too soft on big accountancy firms.

The influence of the Big Four is virtually unparalleled across the industries in which they operate. Their alumni control the international and national standard-setters of the accounting industry, ensuring that the rules of the game suit the major accountancy firms and their clients. Their reach also extends deep into the heart of government. “There’s no major policy change without the big four involved,” says Richard Brooks, award-winning journalist and author of Bean Counters: The Triumph of the Accountants and How They Broke Capitalism.

On Wednesday Sam Woods, the chief executive of the UK’s top banking and insurance supervisor, the Prudential Regulation Authority, told the Treasury select committee, in a masterclass of understatement, that it was “a bit of a worry” that the FRC had flagged up the four firms for a fall in quality, particularly in banking audits.

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That the auditors are still not auditing banks properly despite the crippling costs of the last banking crisis is cause for a lot more than a bit of worry. Unlike most companies, banks play a vital systemic role within the broader economy, and the collapse of large bank can have a domino effect on others. When a large bank fails, shareholders, taxpayers, and occasionally junior bondholders end up holding the tab, while the bank’s management keep their compensation and the auditors/consultants keep their fees.

The ties between the accounting profession and the banking industry in the lead-up to the global financial crisis offer a striking example of the sorts of conflicts of interest that arise between the Big Four’s auditing roles and their much more profitable consulting services.

During the bumper years before the crisis, the Big Four “dramatically” increased their earnings from financial services and helped design some of the financial products that would end up corrupting bank balance sheets, says Brooks. “They [the Big Four] really didn’t have any interest in saying to Lehmann Brothers or RBS … ‘Look, your balance sheets are really looking not that great’ because they were full of products that they had helped create.”

Having extended their tentacles into just about every facet of business administration, from accountancy and auditing to legal and tax consultancy, while wiping out or gobbling up all their smaller rivals, the Big Four firms have grown too large and conflicted for anyone’s good but their own. In the vast majority of EU Member States, the combined market share of the Big Four audit firms for companies listed on benchmark exchanges exceeds 90%. In the UK and the US it’s 99%.

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The Big Four’s combined global annual revenues reached $134 billion in 2017. Only around a third of that came from auditing, but it’s the auditing that helps pry open doors to the more lucrative contracts for their consulting and tax services. As such, it’s a racket the Big Four will do anything to protect, including issuing doom-laden warnings to elected representatives.

PwC recently wrote to the UK parliamentary committees bemoaning that a break-up of the large firms would impact audit quality. This is from a firm that was just fined $625.3 million by a U.S. federal judge for failing to uncover a $2.3 billion fraud scheme that contributed to the collapse, in 2009, of Colonial Bank. In India its local subsidiary faces a two-year ban for failing to report fudged invoices worth more than $1 billion at IT services firm Satyam Computer Services Ltd.

For the first time in a long time, the Big Four are on the back foot in a number of key markets. “They are bracing themselves for change — they recognize something has to happen but they want the agenda to suit them,” says Brooks.

PwC argues that instead of breaking up the big firms, UK authorities should break down barriers to entry to the “complex market” to encourage competition. “These barriers include increased auditor liability, greater regulatory scrutiny and the need for significant investment,” it said. In other words, PwC’s proposed solution would make audit firms even less accountable than they are today. By Don Quijones.

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