After a series of scandals and sudden corporate collapses.
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.
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%.
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.
Contracted to fix the IT-upgrade fiasco at UK lender TSB, now 12 weeks into it, IBM estimates that it would cost $1.25 billion, according to sources. Read… What IBM Said about the IT Chaos at UK Bank TSB and Owner Sabadell
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The bailout was 21 Trillion dollars. Jamie Dimon and Lloyd Blankfein both went from Millionaires to Billionaires after 2008. Hmmm. The Banksters never suffered. The rest of the population did. They “recovered” but we never had a recovery. Now we are set up for the next “recession” and they will own everything.
Recession = the time period during which lenders and creditors socialize their lending losses by foisting them upon the savers in the form of ZERO interest rate paid, all the while getting bailout funds that they in turn use to buy back the lossy assets at firesale prices.
They will own everything until history repeats and the sheeple wake up and put an end to the scheme Never fails because the grifters overdo it They can’t seem to help themselves
JP Morgan Chase made a profit in every single quarter of 2008 and 2009 – no bailout needed.
Well, money makes the world go round…
That said the UK is having a hard time due to Brexit and breaking up the Big Four will need public support to happen.
The standard of auditing has changed from 20 years ago. An example being you would have a team of ten spending 2 weeks on site, now you have a team of 3 expected to exactly the same. All about profits, margins. The quality of auditing has gone down also. The big 4 only have themselves to blame for being greedy.
Make the auditors liable for the debts of corporate failures that occur within 12 months of the signing of the audit report. Cap the amount that can be insured to 10 million.
Advice from accountancy firms, why do businesses outsource the greatest part of running the business – making decisions. Accountants will never be cool in my opinion please send them back to there true cause – writing up the ledger!!!
DQ: you might like this. I was reading Canada’s Globe and Mail paper the other day and in the legals there is a big impressive (expensive) ad taking up about an eighth of the broad sheet page.
It’s announcing a filing under CCRA (bankruptcy protection from creditors while negotiating or like US Chap 13)
There are about ten subsidiary cos of the mother ship.
It’s the Canadian arm ( plus fingers) of Carillion, the huge UK contractor of everything that is bust amidst accounting probs.
I read about it but had no idea the tentacles reached this far.
Thank you, Don Quijones. It seems you see the situation clearly. By now you and Our Illustrious Host are familiar with my own position on these issues, but I will reprise it one last time and wash my hands of it.
A fuller exposition requires looking at the larger picture. As it is, the Big Four audit firms are merely a finger on the mailed fist of the Financial Industrial Complex, and represent only one of many of its corrupt operations. Carroll Quigley accurately summarized the situation over 50 years ago:
The FIC rules. National governments are merely their proxies. Reform of the financial industry would require much more than simply reining in audit operations in one country. The problem is global and has global implications. Reform would require a major uprising among the world’s governments which have been enslaved. I addressed this in another comment a few days ago:
It’s more than just the prospect of widespread economic suffering. As Quigley clearly explained, every major problem in the world for the last hundred years and up to the present can be attributed to the FIC: world wars, political catastrophes, financial predation, and so forth, until now the FIC is leading civilization to its demise in the service of its greed and ambition, and it will not change course. Civilization is ecologically unsustainable as presently constituted and has only a few years left to run at best: the thin film covering this little planet supports all life on it, but it can’t handle this scale of destructive human activities and is clearly breaking down. The situation is so far gone that it is very unlikely that civilization can save itself from its masters, and will not choose to go down fighting.
Yours is an interesting and doubtless somewhat accurate post, but you will pardon my asking how this global financial oligarchy came to the conclusion that environmental suicide (as you describe it) is cost effective.
“Money” has no conscience; Only the”money-handlers” and we all know where that left the global financial system the last time. So, I would proffer that the, “….global financial oligarchy….” had (have) no concern for “Mother Earth”. It’s never part of their equation for “success” and profits.
Right on Walter. It is up to us, the 99% of the worlds population to wake up and change the financial system. Everything is made off of the backs of the 99%. Without us participating there is no Bank, Multi-national corporation or business of any kind. We are the economy. We have not figured it out yet.
It is up to us, the 99% of the worlds population to wake up and change the financial system.
Good luck with that. As long as most of the sheeple don’t have an idea in their head that wasn’t put there by their TeeVee, they’ll keep mindlessly voting for the Oligopoly status quo, then wonder why nothing changes except for the worse.
Great article if only to see how little “auditing” audit firms do. Accounting is the nexus of financial engineering. I do think PwC solution (opening access for new firms) makes sense, and by analogy instead of tariffs the president should have offered incentives to American manufacturing. The point of course is that if you have (four?) truly independent audit firms each providing different audits, which don’t agree, does that make the system more or less stable?
How can any Big Four firm make any prognostication with a straight face? They can’t even accurately report on things happening now or in the past.
Their defense in criminal and civil trials is that they A) only provide reasonable assurance a company’s financial statements are true and B) do not guarantee results of audits.
See Brooke Masters “A clubby oligopoly that is overdue for reform” from 2016-08-19.
https://www.ft.com/content/b7b97e82-6540-11e6-a08a-c7ac04ef00aa
Who audits the big four auditors?
Deloitte’s warning that heightened scrutiny might harm Britain’s standing holds about as much water as the Wicked Witch of the West’s warning Dorothy against having a bucket of water thrown on her.
I worked for Price Waterhouse some decades ago, when auditing was the soul of the business, the moral and ethical soul. That is no more, of course. The problem, as I see it, is almost without solution. How do you recruit, train and employ competent auditors? And provide them with a career and an income to make the profession attractive, in a way that white shoe law firms are able to attract and retain talent?
The current model, where the corporation selects and compensates the audit firm, and the audit is frequently a low-bid affair, is obviously flawed. Recently, KPMG was found guilty of trying to bribe it’s standard setters, the PCAOB. So much for who audits the auditors. . .
There is simply not enough money available to make this work. No company wants to pay audit fees.
A possible solution is to create a new agency, part of the SEC, perhaps, to perform audits, with a cadre of long-term, well compensated staff to perform all audits. But then you might end up with regulatory capture and a stifling bureaucracy, with even less competent people.
The suggestion by PWC to get more competition for audit work is worth a look at, to be sure. But it doesn’t solve the problem of attracting high quality professionals, and providing them a career and, most importantly, INDEPENDENCE.
Perhaps, we should just end “clean opinions” altogether, and make all of them qualified opinions. How so? Approx 80% or higher of most balance sheets can be verified by simply confirming the balances with third parties. e.g. a bank will send a letter to the auditor confirming the the cash balance is so-and-so. Same for receivable and payables. As for the dicey assets and liabilities, the auditors would be better off simply stating that the numbers are Management’s and incapable of assessment given the time and financial constraints of an audit. Let Management convince skeptical analysts and other financial watchdogs that the numbers are “fairly stated”.
My Two Cents, and more . . .
Hi Bruce, I agree with your sentiment but we already do have bank letters confirming year end balances and debtor-creditor circularisation letters. Fixed assets have to be reviewed year for impairment, stocks are valued at net realisable value. The only iffy asset I’ve encountered is goodwill which is highly subjective but again should have an asset life.
Another informative post, thx, DQ. You write well.
There was awareness following the crash of +- 2008, that the auditing and rating businesses had played a significant part in blowing the pre-crash bubble. I remember well, AIG’s AAA rating which was intact until the eve of the crash. (A post on the relationship of auditing:rating would be of interest. An incestuous relationship ?) Something was going to have to be done……
Nick kelly, you provide an interesting sidebar (re Carillion’s Canadian subsidiary apparently going into the bankruptcy process, with auditing now evident as part of the problems). My vague recollection is that some historians have tied the crash of 1929 to economic troubles beginning in Europe. Turned out to be contagious. One always has to wonder, could this be the straw that breaks the camel’s back ?
In the meanwhile, I caught just a bit of Fed Chairman Powell’s testimony before Congress this morning (CNBC), and he several times made the point that wages are going up, and anyone who wants a job can get one.
Take to the hills, we’re all doomed. But of course you can’t, as they are owned by and have mansions on them for the wealthy banksters.