Break up the big-four auditors?

The SA Institute of Chartered Accountants (Saica) has decided not to comment on European moves to curb the dominance of the big-four auditing firms but standards boss Ewald Muller says EU commissioner Michel Barnier is “smoking his socks”. Spokesperson Bontle Sikwe said Saica has nothing to say. The accounting institute is in the invidious position of having the Big Four and thousands of smaller members. The Big Four pay by far the biggest subscriptions and contribute the lion’s share of Saica’s vital Thuthuka educational project. But while Saica won’t comment Ewald Müller, senior executive, standards, told me Barnier was on “a one-man crusade” and “over the top”.

Having said that, Müller conceded that the profession needs to reform. The Big Four must address their market dominance, which among listed companies in SA, is 90%. "The JSE aggravates the matter by insisting that any firm auditing a listed company prove its competence." Barnier recommended in a green paper that the Big Four - Pricewaterhousecoopers, Ernst & Young, Deloitte & Touche and KPMG - be forced to separate their auditing and advisory businesses. The European Commission also sought to limit the length of time any individual firm audits the financials of any company to six years. At one stage the commission considered requiring the Big Four to undertake joint audits with smaller firms but that idea has been shelved.

The Big Four command 85% of business in Europe and probably a similar proportion of business in the UK. The UK Competition Commission is separately investigating the major audit firms, which make twice as much money as smaller rivals. In Europe, according to the Daily Telegraph, the heads of medium-sized audit firms, BDO International, RSM International and Grant Thornton, have asked the European Commission not to mitigate its proposals. Müller said that if the EU accepts the proposals, the SA authorities are likely to follow suit. The Big Four have defended their position. They say auditing and advising deepen knowledge of the client and defend long term client relationships on the grounds that it takes six years and more to develop an in-depth understanding.

Ernst & Young SA put out a statement on Thursday. "We believe that several of the key proposals… would damage audit quality and provide little or no added value while increasing the cost of audit at a time of economic uncertainty. "Furthermore, these proposed measures would have minimal impact in addressing… the role of the audit profession in helping to prevent past or future financial crises. "We share the concerns of others that more choice is needed in our profession and have said on many occasions that having only four global networks is not ideal. Therefore, we support those commission proposals that would increase choice and enhance audit quality, including the proposal for an EU passport and the adoption of International Auditing Standards, which we believe will create a stronger European audit market. We also support the proposed elimination of ownership restrictions and artificial barriers to choice which would be good for investors and overall audit quality.

"The European Parliament and Member States now have an opportunity to turn the debate into a constructive discussion that considers the quality and relevance of audits and the important role of independent audit committees. It is our view that a multi-disciplinary service model, particularly when combined with an engaged and effective audit committee, improves audit quality, helps the profession attract the best talent and fosters the provision of high quality services to companies around the world.

Geoff Pinnock, head of audit: Deloitte Southern Africa, said: "The Bill seeks to strengthen the independence of auditors by separating out and effectively prohibiting the provision of non-audit services to the same audit client. It also seeks to enforce the rotation of audit firms every six years in an attempt to minimise the perceived familiarity threat, and consequently increase audit firm choice in capital markets. "Effectively it is trying to broaden the access to audit services by encouraging companies to set up joint auditor arrangements which will then extend the large firm appointment term to nine years. This is a challenging position as gaining comprehensive understanding of the business and risks of a major financial institution in six years will in practice prove difficult. This again increases the risk of an audit failure rather than enhancing it.

"My view is that the bill, if passed in its current form, will weaken rather than strengthen audit quality and audit effectiveness. In modern large complex global corporations, especially in financial industry sector companies like banks and insurance companies, it is not possible to perform an effective audit without the use of numerous specialist skills which are not part of the normal audit base for example actuaries, financial instrument and corporate finance valuation experts, credit modelling expertise (usually performed by actuaries and math quants), taxations specialists, to name but a few. "The Bill effectively is requiring audit firms in the European Union to separate their audit business from these "non audit" / consulting businesses. As a quality audit cannot be performed without these skills, auditors will have to 'contract' in these specialist skills onto the team. Apart from the increased cost of an audit, this will create numerous issues in assessing and controlling the independence of these specialists if they are not part of the audit firm in question, which again increases audit risk.

"Another issue is that of the heightened risk of audit failure through loss of knowledge when forced audit firm rotation is enacted. There is to my knowledge, no geographies globally where mandatory firm rotation has proved to improve audit effectiveness and decrease the risk of corporate failures. The "forced" use of smaller firms through encouraging joint audit arrangements seems to me to reduce market choice for large companies rather than increase such choice. "While the Bill if enacted will not directly affect the larger firms in South Africa, there will be an impact on global corporations that are domiciled or owned in the European Union with subsidiary operations in South Africa. I envisage that in order for the holding company auditors to prove compliance with the Act, the South African subsidiary company auditors will have to ensure that no use is made of 'own firm' non audit services such as tax, actuaries, etc. This will lead to increased costs for local companies and will increase rather than lessen the chance of audit failure occurring.

"In conclusion I believe that all the large firms have strict independence rules which are in most instances more onerous than those best practice rules required by IFAC, and significant quality processes and procedures to ensure high quality audits are performed. However, all the rules in the world will not prevent corporate failures from occurring in the future."

This article was written by David Carte and published on Moneyweb.

Category: guest articles