Not Quite a Breakup: Big Four Auditors Avoid ‘Drastic’ Steps

(Bloomberg) -- The Big Four accounting firms may have to split their operations into separate U.K. business units as part of a sweeping overhaul of the industry proposed by regulators that stopped short of the measures sought by some critics.

The Competition and Markets Authority said audit work should be split from the much larger consulting business at an operational level, but held off on recommending a full structural breakup or a cap on auditor’s market share. A further report said the U.K. needed a tough new watchdog to prevent the failings of the past.

The reports "represent a meaningful effort to address long-standing weaknesses in the audit market by addressing insidious conflicts of interest," said Natasha Landell-Mills, head of corporate governance at asset manager Sarasin & Partners. "There is now an urgent need to make clear what exactly the audit is for."

Stung by a string of scandals at prominent British firms including Carillion Plc, the government demanded regulators set out reforms to roll back the dominance of the largest accounting firms, which are generally known as the "Big Four." The industry has had a turbulent year, with record fines and reprimands.

“These intractable problems may take some years to sort out," CMA Chairman Andrew Tyrie said in a statement. "If it turns out that the proposals are not far-reaching enough, the CMA will persist until the problems are addressed."

Separately the U.K. government said it agreed with a new report that the heavily-criticized Financial Reporting Council should be abolished and replaced with a new accounting regulator. The new watchdog, the Audit, Reporting and Governance Authority, will have powers to investigate companies, their accounts and governance.

The FRC was accused of being to be too close to the firms it oversaw, especially Deloitte, KPMG, EY and PricewaterhouseCoopers. "I have sympathy with the view that the FRC has tended overall to take too consensual an approach to its work," said John Kingman, who led a review of the regulator.

KPMG said the reports contained “constructive suggestions” while David Sproul, chief executive of Deloitte’s U.K. business, acknowledged that many had lost faith in auditors.

"It’s clear that trust and confidence in the role of the profession is not where it should be and we are supportive of change that enhances audit quality," he said.

PwC and EY also issued statements pledging support for measures that boost public trust in the audit sector.

The operational split envisaged by the CMA would allow for separate profit pools within the firms -- ensuring that auditors are only paid for the audit work they do. Under the current structures, profits are drawn from the entire company.

The Big Four avoided a full break up of accounting and consulting into separate companies as the CMA said such proposals would be "protracted and complex" because of the reach of the firms’ large international networks. The regulator said “drastic but harder to implement remedies” would need to be revisited.

Industry groups largely praised both reports.

“The CMA has recognized the benefits of an integrated audit model and is right to ignore misplaced calls for a break-up of the major firms,” said Matthew Fell, chief U.K. policy director for the Confederation of British Industry. “At the heart of this reset must be a focus on tackling the expectation gap that is undermining trust in corporate reporting.”

To encourage more competition, the CMA said it currently preferred to have the largest companies require joint reviews -- with two audit firms signing off on the accounts -- rather than a market share cap on the auditors.

It’s not the first time that antitrust regulators have looked at the market power of big audit firms. Just four years ago, authorities ruled that U.K. corporations must re-tender audits every 10 years. The EU has also threatened to split off auditors’ consulting arms in recent years, before adopting watered-down proposals.

The CMA said it would accept comments on the proposals until Jan. 21.

Under Kingman’s proposals, likely to be adopted by the government, accountants would move away from self-regulation. So much so, that the new watchdog should be empowered to look for "warning signs" at U.K. companies, he said.

"This is and should think of itself as a regulator," said Kingman, who is chairman of Legal & General Group Plc, the U.K.’s largest manager of pension assets. The FRC was "a hangover from a different world that needs to be fixed."

Among the other changes:

  • The regulator will have a new board. The FRC head Stephen Haddrill has already announced he would be stepping down in late 2019
  • It should be funded by the firms it regulates
  • It will directly regulate major audit firms with stronger enforcement powers that also cover directors who are not members of professional bodies
  • The new regulator, ARGA, will need to develop a market intelligence function to publish reports that could require a change of auditor or a restatement of accounts
  • In yet another review, the U.K. government said it asked London Stock Exchange Group Plc’s outgoing chairman Donald Brydon to consider how auditors verify the information they are signing off

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