Efforts to fix the market in auditing rumble on
AUDITORS ARE supposed to provide an independent view of company accounts. But regulators fear that the relationship between auditors and those they audit can become too cosy—which is why the European Union has decided that, from 2020, companies will have to switch auditor at least once every 20 years. Last week the Financial Reporting Council (FRC), a British regulator, sent a letter to audit firms warning them away from “rotation in form but not in substance”.
That was aimed at subsidiaries of American banks. The FRC wants to deter Goldman Sachs and PwC, the auditor it has used since 1926, from seeking to satisfy the new rules by hiring a smaller auditor for the Wall Street firm’s British subsidiary while retaining PwC for the global business.
The spat is a consequence of flaws in the audit market. It is dominated by four global networks: PwC, Deloitte, KPMG and EY, which also have consultancy arms and between them audit 98% of companies in the S&P 500 and FTSE 350. Most big multinationals receive consultancy services from those of the Big Four that they do not use as auditor. Rotating auditors therefore means either severing a consulting relationship or turning to a smaller audit firm. But none outside the Big Four is likely to have the expertise to audit a global company.
Recent high-profile corporate failures, notably that of Carillion, a construction firm, have put Britain at the centre of discussions about how to fix the audit market. The Competition and Markets Authority (CMA), the national antitrust watchdog, has been considering possible reforms since last autumn. In a paper published in December it suggested several, including operational division of audit and consulting within firms (it shied away from proposing forced break-ups). A consultation on its ideas closed on January 21st.
Another of its proposals was for mandatory joint audit, in which two firms would share the work. Both would retain full responsibility, unlike Goldman’s plans to split its audit work geographically. Companies could not retain either for longer than 20 years. The thinking is that joint audits might be higher-quality and, if one of the auditors was a minnow, it would be given the chance to gain experience and grow.
On the same day as the CMA published its paper, another review came out looking at the FRC. Commissioned by the British government from Sir John Kingman, the chairman of Legal & General, a life insurer, it was scathing. It likened the FRC to a “ramshackle house” built on weak foundations, and recommended its replacement by a new regulator with more powers. Despite the harsh words the FRC welcomed the report, which it said had “set a course for a stronger, new regulator to emerge”.
The government said it would act on the recommendations. Meanwhile, the outgoing chairman of the London Stock Exchange, Donald Brydon, has been asked to lead yet another review on audit quality, building on the previous work. Companies up against a tight deadline to switch auditor can expect the rules to change more.
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