For today’s episode of “What Can We Rag on Big 4 Firms For” we’re going to dive into this article I came across this morning in Fair Observer, an independent outlet which I’ve never heard of but hey, any article that bashes Big 4 firms is OK in my book. Let’s be real, visiting Going Concern for objective, unbiased reporting is like reading Playboy for the articles.
You’ll note the article references the UK arms of the four horsemen of capital markets but they might as well be talking about US firms because C+ auditing is a cornerstone of professional services firms regardless of specific geography (except for PwC, PwC gets bragging rights for at least a year with their nearly flawless PCAOB inspection report). With that out of the way …
The UK economy is beginning 2022 on a somewhat shaky footing. Signs of an economic slowdown were cropping up even before the Omicron variant threw fresh uncertainty into the mix and raised fears that “Britain’s nightmare economy of the 1970s,” characterized by a noxious mixture of high inflation and stagnant economic growth, is set for a comeback. One particular industry, however, is doing brisk business: The so-called Big Four professional services firms are experiencing a remarkable boom.
HUH. This sounds eerily familiar. In 2008 when companies were bleeding jobs and people were getting their precariously-financed homes snatched out from under them, there were at least two labor sectors thriving: government and accounting. There were probably others too but we’re not here to talk about them because who cares. Some like to say accounting is recession-proof but no profession is truly recession-proof, rather the profession is recession-repellent. Like a Scotchguarded sofa. The world always needs accountants, audits still have to be done, corporations still file taxes … you get it. You were likely told this years ago when you were considering majors and some business professor bamboozled you into thinking accounting was a good career and you’d always have a good job. Moving on:
How sustainable this period of prosperity will prove, however, is another question. Indeed, while the four major auditors — Deloitte, KPMG, PwC and Ernst & Young — are registering their strongest collective financial performance since the Enron scandal 20 years ago, the industry has yet to undergo the systemic overhaul necessary to ward off another Enron-scale incident. As high-profile scandals and legal battles have multiplied, it’s ever clearer that the UK must implement more robust and meaningful regulation of the auditing industry.
An outside observer who knows nothing about professional services firms might assume that audit firms making more money is somehow tied to audit quality (more money = doing better audits); of course we know better. Still, dude has a point. Audits exist to get a third-party opinion on whether or not what the company has reported is reasonable. The article is essentially asking if these third-party opinions are valuable considering how many times the third parties have gotten it wrong.
Unfortunately, this impressive financial performance hasn’t been matched by a corresponding uptick in standards. While auditors have tried to deflect blame — the UK boss of PwC recently complained that criticism of the audit industry from politicians and regulators is damaging the sector’s reputation — there’s little doubt that the industry continues to be embroiled in scandals, with all four firms associated with high-profile cases.
The author goes on to list several examples of said scandals, some of these names are no doubt familiar to you:
- Private equity firm Abraaj (KPMG)
- Carillion (KPMG)
- NMC Health (EY)
- Wirecard (EY)
- Stagecoach (EY)
- Autonomy (Deloitte)
- JP Morgan (PwC)
- JD Classics (PwC)
Alright. So we have proof firms could do better. What is the solution, according to the author?
Indeed, it is long past time to carry out a thorough overhaul of financial services regulation in the UK and install robust corporate governance to prevent another crisis on par with Enron. As American investigative journalist David Hilzenrath has argued, there are critical lessons to be learned from Enron, such as the imperative to end the multiple conflicts of interest that exist within the auditing sector, including close relationships and even “revolving doors” that develop between companies, auditors and regulators.
These can be tackled with measures such as ensuring that auditors are independently assigned rather than company-appointed, frequently rotating auditors, and instituting a politically accountable regulator with the power to implement penalties at an earlier stage before the damage has been done.
That last dig was pointed at the Financial Reporting Council, the UK’s “rather ramshackle” regulator. The last batch of FRC inspections were not great, and KPMG in particular got a shout-out for piss-poor auditing of bank clients. Nearly one-third of audits inspected by the FRC required improvement or significant improvement.
There’s no doubt audit quality is an ongoing issue in the profession. The question is, can it be fixed? And do firm revenues reflect the quality of service these firms are providing? The answer to that last one depends on who you ask.
Auditing Firms’ Strong Performance Masks Unsolved Issues [Fair Observer]