The Scribbler

Good business stories are like buses, nothing for ages and then two come along at once.  Friday was just such a day.  In the morning we had the Competition Commission laying into the Big 4 accountancy firms and by the evening we had lost our AAA credit rating.

I’ll start with the Competition Commission though, before moving onto the downgrade tomorrow.

Certainly the Commission’s report should make for uncomfortable reading on the partner floors of the big firms.  You would think that phrases like “high prices, low quality”, “insufficiently independent” and “cosy relationship between auditors and senior management” would ring alarm bells.

We are talking about the Big Four here though, who promptly declared that there was no conflict of interest in management teams appointing auditors (PWC) and that the market is competitive (Ernst & Young).

In fact, PWC went as far to say that the Commission had grossly under-estimated the role of the Audit Committee in protecting shareholders’ interests.  Perhaps, but the problem is that there is much money to be made from selling other services alongside an audit to the executive management teams.  The danger is that those services, such as tax advice, become so lucrative that auditors potentially become constrained in their criticism which fatally undermines the audit process.

This is not a new concern.  Robert Bruce, who wrote the Audit column in The Times for many years, used to say that an audit should be no more comfortable for a management team than the pulling of teeth.  I know from my own experience that there used to be a client services manager within one of the Big Four here in Birmingham whose job it was to ring up clients post-audit and ask “how was it for you?”

Where do we go from here?  If I was advising the Big Four I would urge them to go along with the Commission’s proposals which seem reasonable.  The Commission is arguing for mandatory tendering and rotation of audit firms.  You could certainly argue it should go much further and insist on no reappointment for at least six years which would allow some of the second tier firms to get a piece of the FTSE 350 action.

The Commission is also recommending the prohibition of ‘Big 4 only’ clauses in loan documentation.  Again, this is not unreasonable and should help introduce further competition.

Personally, I would also introduce a rule that no former auditor should be eligible for appointment to a company’s board for at least five years following his departure from an accountancy practice.  This should ensure that the gravy train comes to a crashing halt.

My advice to the accountancy profession would be to accept that change is required, that major mistakes have been made, such as Ernst & Young declaring Lehman Brothers to be solvent, and that the market is uncompetitive.

The danger for the Big Four if they continue their belligerent approach is that the Commission’s ultimate proposals will be far more draconian.  What’s more it will play into the hands of the European Union which already has them in its sights!