Audit contract rules set for huge upheaval

THE ASSUMPTION that the Big Four is a cartel hogging the majority of listed company audits has turned out to be a somewhat specious one, according to findings in a Competition Commission report.

Although the commission has argued there are several changes that are needed to increase diversity in the stagnant market, it has largely been held that the Big Four do not engage in tacit collusion, bundle audit and non-audit services together to raise barriers to expansion in other firms, target customers of mid-tier firms with  low prices, or exercise undue influence over regulatory bodies through their extensive alumni networks.

Yet, the report did find that competition is being restricted by the high cost of switching auditor, the difficulty of comparing alternative auditors, as well as experience and reputational barriers for mid-tier firms into the FTSE 350 audit market.

Variety is the spice of life

The findings do not let the large firms off the hook that easily either. The commission found that 31% of FTSE 100 companies and 20% of FTSE 250 companies have had the same auditor for more than 20 years. Mandatory rotation is just one of several suggestions made, but is one of the most hotly debated in the profession. Companies could be forced to switch auditors every seven, ten or 14 years under various proposals.

The lack of competition is thought to lead to higher prices, lower quality and less innovation for companies as well as a failure to meet the demands of shareholders and investors, according to the report.

Although audit rotation is relatively popular, the thorny issue is how long the set period should be. In September last year, a group of about 30 European national shareholders, which represent about €732bn (£631.7bn) of company assets, suggested that the audit committees themselves should set a time limit on audit rotation dependent on company size and complexity, with an upper limit of 15 years to safeguard shareholders’ long-term interest and a cooling-off period of five years before reappointment.

There are also suggestions of mandatory tendering as well as rotation, increasing information and transparency with more frequent reviews and extended reporting requirements, strengthening accountability and independence by giving audit committees and shareholders greater control of external audit.

Large audit firms were also accused of focusing on satisfying management interests over those of shareholders, with Laura Carstensen, chair of the Audit Investigation Group claiming: “Shareholders play very little role in appointing auditors compared to executive management – and despite the presence of audit committees and other safeguards, audit firms naturally focus more on meeting management interests. The result is a rather static market.”

The sentiment was, not surprisingly, refuted by the Big Four firms, with KPMG’s chairman and senior partner Simon Collins arguing that “they just got that wrong”.

Ernst & Young, PwC and Deloitte all issued vehement rebuttals. “We categorically disagree that auditors typically place the interests of management over shareholders,” was one typical response – from Deloitte’s head of public policy and managing partner David Barnes.

However, the sentiment was also echoed by the mid-tier firms. Grant Thornton head of external professional affairs Steve Maslin argued that there are few mechanisms for shareholders to get involved in the auditor appointment. Mazars’ head of public interest markets David Herbinet said the problem is that investors want to be reconnected.

Although this issue will be debated for several months yet, change is imminent. The European Commission published a working paper on proposed audit reforms, which also includes mandatory rotation – although it currently proposes rotation every six years unless the company has joint auditors, in which case rotation can be extended to nine years. Somewhat confusingly, the EU’s Econ committee has voted for seven-year rotation, which will require another level of ratification.

However, the Commission failed to mention any suggested changes to non-audit services and fees, which has been cause for concern in Europe. British MEP Sajjad Karim, who is currently steering the European Commission’s reforms through the European Parliament, said: “The provision of non-audit services remains a point for discussion at the European level. However, we agree with the CC that introducing unnecessary restrictions based around fees would harm not help the market for audit services.”

The EU proposals, initially tabled by internal markets commissioner Michel Barnier, were expected to be voted on by European Parliament in February, but the vote was delayed until June, with many claiming the delay was to ensure the Competition Commission findings were published first.

Responses to remedies for the Competition Commission investigation were submitted by 18 March and responses to the provisional report findings by 21 March. The final Competition Commission report is due to be published on 20 October.