Next Arthur Andersen? No, the “Final Four” audit firms are “too big to replace.”
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
As the rubble from the financial collapse of British infrastructure giant Carillion gradually settles, two powerful parliamentary panels are piling pressure on the world’s biggest audit firms to disclose the full extent of their involvement with the company. The big four auditors — Deloitte, Ernst & Young (EY), KPMG, and PricewaterhouseCoopers (PwC) — have received letters from the Business and Work and Pensions select committees demanding that they reveal all the work they carried out for Carillion since 2008.
The move comes amid growing concern around the world about the power of the so-called Big Four — down from the Big Five after Arthur Andersen imploded in the wake of the Enron scandal — and the potential conflicts of interest that can arise between their myriad roles.
A case in point: when Spanish authorities tried to roll seven failed or failing Spanish saving banks into Bankia in 2011, Deloitte was hired not just as Bankia’s auditor but also the consultant responsible for formulating its accounts, in complete contravention of the basic concept of auditor independence. Deloitte (together with Spain’s market regulators) then confirmed in Bankia’s IPO prospectus that the newly born franken-bank was profitable and in sound financial health. It was a blatant lie. Bankia collapsed within less than a year of its IPO. Shareholders ended up losing billions and were later reimbursed by Spanish taxpayers.
In the case of Carillion, all four of the Big Four provided services of some kind or another to the now defunct company, but it was Dutch-seated KPMG that signed off on its accounts. This it did without fail, even in early 2017 when it was clear that Carillion had wafer-thin profit margins and was dangerously overloaded with debt, including £2.6 billion worth of pension liabilities. Between 2012 and 2016 Carillion ran up debts and sold assets just to continue paying out dividends to shareholders.
Yet in Carillion’s last ever annual report, KPMG approved Carillion’s viability statement, certifying it as strong enough to survive for “at least three more years.” Within less than three months, Carillion’s management was forced to admit it had significantly overestimated revenues, cash and assets, prompting a stunning stock market meltdown from which it would never recover.
A scathing letter to the Financial Times this week called for Carillion’s directors and KPMG to be investigated for the company’s collapse. Martin White, of the UK Shareholders Association, and Natasha Landell-Mills, of Sarasin & Partners, wrote:
“Although fingers are being pointed in all directions, most are missing the real culprit: faulty accounts appear to have allowed Carillion to overstate profits and capital, thereby permitting them to load up on debt while paying out cash dividends and bonuses.”
All of it on KPMG’s watch.
Carillion’s collapse bears a striking resemblance to the dramatic demise of Spanish green energy giant, Abengoa, in 2016. For three years, the auditor, Deloitte again, failed to spot (or at least report) any of the glaring irregularities on Abengoa’s financial statements. By contrast, Pepe Baltá, a 17-year old student in Barcelona who chose Abengoa as the subject of his high school economics project, noticed serious flaws in the company’s accounting — a full year before Deloitte’s auditors finally blew the whistle. “The big surprise was that negative profits were being converted into positives,” Baltá told the Spanish daily El Mundo.
Yet each time a new corporate scandal or collapse exposes the failings, abuses or conflicts of interest of one of the big four accounting firms, a dainty slap on the wrist is the inevitable punishment. When Deloitte was found to have “seriously” infringed Spain’s auditing laws by ignoring at least a dozen glaring errors and irregularities in Bankia’s accounts prior to its IPO, the auditor was fined a paltry €12 million by Spanish authorities.
The problem is that the Big Four are simply too big. Having extended their tentacles into just about every facet of business administration, from accountancy to auditing, to legal and tax consultancy, while wiping out or gobbling up all their smaller rivals, the big four firms have grown horrendously large and conflicted, says British financial journalist Ian Fraser.
In the US, the Big Four audit 497 of the 500 S&P 500 companies. In the UK, the Big Four audit 99 of the FTSE 100 companies. In the vast majority of EU Member States, the combined market share of the Big Four audit firms for listed companies exceeds 90%. In Spain, all IBEX 35 companies are audited by the Big Four. Their global annual revenues have reached $134 billion in 2017.
This perfect oligopoly poses a major problem, not just for companies looking for alternatives but also for governments. “These giant firms are… virtually unassailable and are now called the ‘Final Four’,” says Fraser. “There’s a fear in government that you can’t allow one of these companies to fail because if there’s only three left, there will be even less competition in the sector… and even more of an oligopoly. As such, government is almost being held to ransom around the world by these big four firms.”
In other words, the Big Four, the self-anointed guardians of fiduciary responsibility and probity at the world’s biggest companies and banks, are not just woefully compromised and conflicted; they have grown too big to replace. And doling out petty fines for bad behavior each time they’re caught out is not going to change that. By Don Quijones.
At “the company that runs Britain,” profits were privatized, costs will be socialized. Read… Collapse of Construction Giant with 43,000 Employees Globally Sparks Fear and Mayhem
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There’s an alternative to the Arthur Anderson solution for this problem. Senior management has no skin in the game for these auditing failures. Change that with perhaps some jail time for the top dogs overseeing these egregious failures. Underlings might be a little more diligent with their work. As it is now underlings don’t want to be responsible for loss of business so they roll over and play dead when they see a problem like those discussed.
Great piece! Thank you!
The real risk underlying all the above is that these FOUR and their unaccountability puts the entire world’s economy in jeopardy. What IF most large corporations are really in no better shape than Carillion?
How close are we to a total devastating collapse?
What’s that high school kid doing now? Maybe we need him to lead a team to diagnose all the major corporations and tell the public what kind of condition we are really in..
First things First.. First you must know the true facts before a problem can be analyzed.. Then solutions can be discussed. Seems to me we don’t even know the facts.
What else could one expect when the “democracy” you were taught to believe in as a child turns out to be nothing but a totalitarian oligarchy?
All the ratings agencies are nothing but “ladies of the night” for the War Party Of The Rich. One party in America, folks. That’s the truth.
To think we lost budding financial genius M.Balta to medicine of all fields.
Think of the short seller he might have become!
no evidence he was/is a financial genius just like the old tale … a child saying “look mommy, the emperor has no clothes.”
So he moves on with his life and seeks M.Diety status instead of an economist … who could blame him?
What seems to me to be M.Balta’s unique characteristic is his possession of integrity, at least until he is licensed to practice medicine
Auditors are payed to look the other way. ’twas always so.
Debit, expense or asset, expense or asset????
Holy Toledo ,this is unnerving.I had no idea of the scale of this.
Thanks very much for this article.
I think KPMG is also taking heat for the sudden $6B insurance write-off at GE.
The big problem is that companies can switch audit firms at will. They use this as leverage against the auditors. Plus, some companies put caps on audit fees, which unreasonably shrinks the audit procedures.
I don’t feel sorry for them though. The partners of accounting firms are overly greedy and think short term. They always seek to do the bare minimum to fund their outrageous pay checks. I hear partner rates are now $1000 to $1500 per hour. Ridiculous. A trip to the bathroom will cost you $500. Small talk before a meeting will cost you $1,000 to $5,000.
But firm can’t really switch too often. If they switch one firm out and then two years later changer auditors again, it will look bad for the firm, rather than the auditors. And even if they do switch, it will wind up with one of three other firms.
Is it true that most of the accounting practices at Enron are now commonplace in finance
No, not even remotely.
When a dispatcher moves his lips he is telling you BS right? BTilles is a dispatcher.
Fraud has become endemic in our neoliberal crony capitalist wonderlands, with accounting firms just as crooked as our captured regulators and enforcers. It makes you wonder at the magnitude of the fraud and fictitious valuations still waiting to come to light.
No, not even remotely.
In this context, it might help to think of accounting firms like lawyers for the mob. Occasionally they get “way too close” and cross the line. Unfortunately for investors we have to figure that out long before the lawsuits and indictments begin.
So >>>>> Fraud, Smoke and Mirrors, Level 3 and a few Opioids thrown in with a whole lot of exuberance from the speculating elitists. Not only is there no valid price discovery, there is no way to value anything anymore.
Yeah, things will work out.
By contrast, Pepe Baltá, a 17-year old student in Barcelona who chose Abengoa as the subject of his high school economics project, noticed serious flaws in the company’s accounting — a full year before Deloitte’s auditors finally blew the whistle.
A modern-day take on “The Emperor’s New Clothes.” Maybe young Baltá, whose generation has no future under the Oligopoly, could be pressed into service as an auditor when post-collapse tribunals finally bring these fraudsters and their enablers to justice.
‘Growing concern’ about the big four..?
Private Eye magazine has been covering the accounting cartel and its complicity in corporate malfeasance since way before the 2008 crash.
Also there are ‘non exec’ directors who are PAID – handsomely – by the stockholders of the company to sit on the board and exercise oversight – once again it appears they have been about as effective as a chocolate teapot.
It seems the ‘non exec’ thing is just a cosy CFP (Club For Pals) – a way for friends of the directors to pick up a nice easy payday – and do nothing apart from be a ‘yes (wo)man’.
Strangely, Carillion appears to have appointed two new ones just before Xmas.
This whole thing stinks like a rotting fish TBH.
Neoliberalism – cutting up your country and turning it over to ‘club members’ for 40 years.
What a bankrupt ideology.
Some random observations:
#1 Governments are shirking their responsibilities to provide meaningful oversight/control of their largest corporations, and are outsourcing this to private organizations, the auditing companies, with no enforcement powers. Indeed, if any “bad news” is discovered and disclosed to the public, legal action for libal and slander may follow, and at the very least the client will be lost, costing the auditing company for doing their job.
#2 It is possible the long-term “frauds” which bankupted the client companies could have been so well concealed that these were not detected by the normal audit procedures. That is the numbers added up but were meaningless or misleading.
#3 Another possibility is that the bankrupt company was indeed a “going concern” at the time of the audit, but was “stripped” starting the day after the audit. A version of this is to “swap” good assets among companies so that a company appears solvent at the time of the audit, in effect counting the same good asset multiple times.
#4 While I am reluctant to suggest an expansion of government, it appears necessary to establish a “Bureau of Audit Verification” to select at random selected [mega] company operations which have just been audited, and conduct an in-depth forensic audit from the board room/ledger all the way down to physical verification of the asset by on site inspection. In effect statistical quality control of the audit process. Some version of MilSpec 105D will be needed to establish the level at which a full forensic audit, including the IRS and SEC, of the entire company would be triggered. When such a governmental “super” audit is triggered, long prison sentences and forfeiture of assets by the accountable people should be expected.
#5 The auditing “rules” appear to be in fact auditing “suggestions,” and need to be overtly defined to allow comparison across companies. An examination of the corporate bankrptcy filings over the last 50 years or so should establish the maximum safe debt levels v free cash flow, and other critical metrics, which the auditors mst apply, and notify the public/government when these limits have been reached, even though the company is still technically still solvent. Indeed, it may be helpful to require the companies themselves to notify the “Bureau of Audit Verification” when the critical operating metric limits are exceeded.
How have you succeeded in remaining so idealistic? There does come a time when optimism impedes good judgement. But good ideas Sir.
The canadian arm of Carrillion has also imploded. So why would the canadian government simply assume none of our bug pension funds are perhaps somewhat splashed by this? Aside from surely this is a systemic risk that needs to be vetted but has not been.
Blaming the CPA firm is a calculation. It provides a deflection from the joint and several liability from others while also providing a scapegoat for investors and lenders who should have known better.
CPA opinions are legally hedged. Complain all you want. Only a sympathetic court/jury and a bad defense lawyer can offset that and the appeal will even the odds. Unless there’s a shredding machine or worse involved, CPA opinions are highly defendable. The best offense is skilled whining.
The annual audit is not a guarantee of any kind except that the review was performed according to appropriate standards, appropriate tests were made, management and controls said/did the right things except as noted, and things look reasonably OK. Publicly traded companies follow a much higher standard than not publicly traded companies, but overall there’s not a lot of difference.
The going concern exception is the only out investors have here and that’s their burden of proof, assuming the opinion stated no issues there and problems were more obvious than a 1 inch pimple on someone’s nose and should have been discoverable if GAAP was correctly applied.
What do you expect from KPMG? It’s short for Klepto and Plutocrats Management Group.
I thought it was well known that Carillion was in bad financial straits. Funny since Carillion was mainly a government contractor. What I find interesting is that the same government finds it untenable that they could have low bid Carillion into the grave and now they need to blame the book keeper. At the end of the day… as a society we just can’t handle the truth.
Petedivine, You make an assumption not born out by facts.. You assume the cause was low bid. More likely that it was greed by those who could rather than the government making a contractor who held so much leverage over that government even bidding.. without back door funding.. Not likely in this world. Still my assumptions.. all we really know is that it went under and some are blaming the auditors because they should have known it far in advance.
” all we really know is that it went under and some are blaming the auditors because they should have known it far in advance.”
What is it that you think auditors do? I suspect it bears no relationship to what they actually do. What specific fraud did they cover up? Were the footnotes to the financial statement wrong? Were the accounts misstated materially? What is the purpose of the financial statements and GAAP, or the euro version of it?
Also, management created the financial statements, not the auditors. Always. Every public company.
Agreed, management first.
It seems clear mgmt is at fault. I can’t tell about the auditors though it doesn’t look good . . . how do auditors evaluate “intangibles” for a company which does business with a gov’t and doesn’t have a consumer-facing brand?
You have a point, that the Private contract Auditors, only inspect what is presented to them.
A bit like the Eu Reviewing the greek application to join the Euro.
Some if not all of the EU officials must have known what was written on the paper before them. Bore very little relationship to what was under the rug in Athens.
However said papers had been signed off, by Auditors.
In a better world. Publicly listed companies would have to pass an audit, by the exchanges they list with. Which would make the exchanges, culpable for the audits. Which would immediately make the audits, much more INTRUSIVE.
This company borrowed money and sold assets in order to pay its dividend from 2012 to 2016.
This should have been illegal (U.K. law) except they booked profits they hadn’t made which made it appear they were paying the dividends from reserves. This is accounting fraud like Enron. The finance people in the company must have known the game they were playing.
Exactly I know one government contract Carillion pulled out of in October. The warning signs were there then and had been for at least a year.
It’s no surprise that a 17 year old bested them. In 2006, I prediced the ban;krutcy of general motors. The hard part is timing. Within the next three years, UPS will belly up. None of the big four is predicting that.
“It’s no surprise that a 17 year old bested them. In 2006, I prediced the ban;krutcy of general motors. The hard part is timing”
AS Meredith Whitney showed us over Munis.
George McDuffie suggests maybe we should have a government organization overlook the auditors,,,
If that organization was created the first thing they should look at is government pension funds..
Calpers has one percent cash on hand.
If regulators targeted the individual auditors etc who were responsible for the failure, having no doubt accepted various forms of “hospitality” from their clients in the process, rather than the firms themselves. Giving big fines to the individuals and striking them off professional registers things would change very rapidly.
We must also remember that auditors, who are supposed to work for shareholders, are checking the work of directors. Sam Antar is very clear on how easy it is to fool an auditor. The directors need to be subject to the same individual sanctions as the auditors. Fining firms whether it is the firm being audited or the auditors just punishes the shareholders of those firms, if there are no effective individual sanctions.
Both the audit committee and the remuneration committee of all public firms should be chaired and run but appointed shareholders, who have no connection to the board. Directors should just be providing evidence and secretarial service to those committees.
Do these thing and things will change rapidly across the piece for the good of everyone.
The real issue is that these companies are paid by the same firms that they audit.
We need to abolish the legal requirement to be externally audited a it’s useless.
KPMG have also been implicated in possible collusion with Zuma and the Gupta family in South Africa. Taxpayers’ money seems to have been systematically siphoned off over years and no-one seems to know where the Guptas have slithered off to.
One of the problems is that these large corporations no longer have any moral compass or any basic ethical practices.
KPMG was wholeheartedly responsible for the entire 08 crash, and they used Iceland to do it. Without the overarching imprimatur of KPMGs auditors, accountants, and managers, Iceland would never have been set up as the patsy for the central banking implosions that manifested all over the entire world. KPMG knew exactly what they were doing when they coerced all the central bankers in Iceland to join their ruse.
See Inside Job
P.S. Let KPMG fall next to Arthur Anderson’s Chapter 11 gravesite, and then tell everyone on ZH so they will urinate on it for posterity sake.
Here’s a nice article explaining how both financial markets and British Gov rules coincided to help keep stuff off balance. Worth a read (pinch and zoom please)
I guarantee you if I took one look at either company’s balance sheet, it would not take an auditor to be alarmed at what thin ice the company is on. Stop blaming the auditor – when you see debt to capital ratios exceeding .3, and as an investor you don’t run away, you are complicit in your own gambling. Stop buying leveraged companies – they are gambling with debt to juice returns to lure you in. Solid companies only use debt sparingly.