Supplementary memorandum by The Lord Sharman
POSSIBLE MEASURES THAT MIGHT ASSIST IN WIDENING
CHOICE IN THE AUDIT MARKETPUT FORWARD BY WITNESSES TO THE
1. Reforms to achieve fair and regular public
tendering (perhaps once every five years) with independent oversight
to provide opportunities for firms to increase their market share.
Mazars in their written Evidence suggest the tendering might be
2-stage `providing for the submission of a short document at the
first stage by a number of firms from which a shortlist would
be selected for the final presentation.' Kingston Smith in their
written Evidence suggest that at least one non-`Big 4' firm should
be included in the tendering process.
I think that this has merit, as I said in my
evidence I would require Audit Committees to carry out a formal
evaluation of their audit relationship every five years, and if
it was decided not to tender, then to explain the reasons therefore
in the Audit Committee report.
2. Mandatory rotation of audit firms as in
Italy (but, if specified inappropriately, mandatory rotation of
all audits might compound the problem of market concentration
if it led to `Big 4' firms supplanting `Mid-Tier' firmsnot
a problem if mandatory rotation limited to FTSE 350).
I don't think that there is any evidence that
this has improved matters in Italy. In the case of Singapore where
it was introduced it has been reversed.
3. Greater rotation of auditors (FSA)
4. Transformation of the Audit Commission
into a large audit firm.
This has some attractions, particularly if its
focus was on the public/private interface. The C&AG has since
The 2006 Companies Act had the power to audit limited companies,
so far I don't see much evidence of the moving outside the public
sector, although I have always believed that there is a strong
case for them auditing certain public interest enterprises eg
The Big Four, who are audited by 2nd Tier firms.
5. Removal of the mandatory requirement for
an audit, leaving it to market forces. It has been argued that
government intervention has stifled competition in the audit market
and is responsible for the market concentration.
If this is so, then this Inquiry needs to be cautious about recommending
measures which would entail further government intervention.
I don't agree with this assertion, I can see
no basis for it.
6. Greater use of shared audits by leading
I can't see shared (as opposed to joint) audits
working-the extra cost involved in the principal auditor reviewing
and validating the work of the second auditor would make it economically
7. Mandatory requirement for joint audits
(as distinct from shared audits) of large companies or just of
large financial entities. Possibly mandatory joint audits with
one of the two firms required to be a `non Big 4 + 2' `Mid-Tier'
firm (Mazars evidence). With a joint (as distinct from `shared')
audit, both audit firms provide the overall audit report and opinion,
and the audit work would be required to be shared equitably in
order to encourage the `Mid-Tier' firms to grow. Joint audits
make it less likely that the auditors develop a too-trusting `cosy'
relationship with the client. Mandatory joint audits would create
`regulatory capital' for non-`Big 4' firms (Oral evidence on 07Dec10).
Although I am not greatly in favour of joint
audits, I think that they are expensive and inefficient, they
have worked in the past and in other parts of the world. If they
worked so as to open up the big four international networks to
second tier firms this would be worth pursuing.
8. A regulatory code of conduct promoting
the use of non-`Big 4' firms: this might be as auditors of subsidiaries
within large, public groups.
I don't for the reasons set out in 6 above think
that this is viable.
9. Board's risk committee of large companies
should be advised by someone who isn't the firm's auditor (another
source of advice which would not require the same sort of global
network and could therefore be provided by a non-Big 4 firm. A
bit like a joint audit. (Baroness Hogg, 9th November).
I support this for both the risk and the audit
committees. The adviser does not necessarily need to be an audit
`BIG 4' DOMINANCE
10. Placing limits on the market share of
firms measured by the number of appointments held, say, over a
five year period, monitored by representatives from regulators
and investors (Grant Thornton's suggestion in their written Evidence
to this Inquiry)
This seems to me to be a classic competition
solution (limit market share) I can't see why it would not work.
11. Elimination of covenants restricting
choice of auditor, which even sometimes stipulate which of the
`Big 4' should be used.
I'm not aware of this as a major issue, but
I agree the proposal is sensible.
12. The audit committee's report to explain
why they considered the need to appoint a `Big 4' firm.
This is a sensible proposal (see 1 above)
13. According to Standard Life's March 2009
response to the EC's consultation on `control structures in audit
firms and their consequence on the audit market', Standard Life
considers another catalyst to accelerate access to international
audit markets would be for boards and/or their audit committees
[to] disclose when and how periodic formal evaluations of the
internal and external auditors were undertaken and the key conclusions
Again sensible (see 1 above)
14. Strengthen audit committees and require
them to report/justify publicly their work and rationale re. audit
and no-tendering decisions.
Agreed (see 1 above)
15. Break up of one or more of the Big 4.
If this were to be considered (again a classic
competition measure) it needs to be looked at by reference to
audit market share and not the total size of the firms measured
by say revenues. It could be achieved in the context of 10 above
by requiring divestment of audits to 2nd tier firms.
16. Relaxing the limit to the amount of outside
capital of an audit firm (currently set at less than 50% by the
EC). Ownership rules of auditing firms need to be changed (FRC9
I think that this would be helpful.
17. Increased investment by, or mergers of,
non-`Big 4' firms in order to create one or more larger ones (Mr.
Ashley Almanza, Hundred Group and BG in oral evidence on 07Dec10).
I think 16 would be necessary which I think
18. `Second-tier' firms must be encouraged
to invest more (to enhance their international networks, etc)
(Lord Sharman's oral evidence14th December).
I think 16 would be necessary which I think
19. Defection of a large number of specialist
bank auditors from a `Big 4' firm to a `mid-tier' firm.
I would leave this to the market, if 16/17/18
were to be achieved then the environment for this to happen would
have been created. This should include specialist auditors in
20. A workable mechanism for the limitation
of auditor liability, so that the risks of auditing large entities
do not outweigh the benefits. Possibly a cap on auditor liability
(as in Austria, Germany, Greece) and also the introduction of
This is highly desirable, and is already viable
as a result of The 2006 Companies Act. I am not in favour of a
cap as opposed to proportionate liability, nor I suspect would
Institutional Investors be either.
21. Alternative appointment processes for
auditors, eg involving shareholder panels, or appointment by regulator.
These could be viable, but I believe that any
move to disenfranchise the shareholders in the process is wrong.
22. The audit committee to appoint the auditors,
as in the US under Sarbanes-Oxley and report in some detail their
decision (E&Y witness).
This works but UK law requires appointment by
the shareholders in general meeting, this can be achieved by the
audit committee recommending to the AGM the appointment and explaining
the reasons therefor.
23. Introduce a financial statements insurance
approach as an optional alternative to the present audit.
An interesting concept which would need to be
explored with say Lloyds of London to see if the market would
be willing to underwrite such risks.
24. Reduce complexity of financial reporting
and auditing standards to better enable smaller audit firms to
cope with the audits of large companies.
Given where we are I don't see this as viable.
25. Narrow the scope of the annual audit,
so that companies can get other advice from other firms, so allowing
mid-tier firms to compete better.
I think that this would be a retrograde step,
we need broader assurance including looking forward not more narrow
26. Consistency/alignment of the regulatory
framework globally would help, but may be insufficient (Shell:
oral evidence, 7 December 2010).
This is desirable but won't be the solution.
27. Make sure that regulators of cross-border
activities do not act as an effective barrier to using non-`Big
4' audit firms.
This is a valid aim.
28. The regulator should be less burdensome
of the profession (Q50 of transcript of 19 October 2010 sessionanswer
by Mr. Hodgkinson of ICAEW: `Oblige regulators to consider how
regulation affects availability of choice. Make it a criterion
for regulatory action because it is clearly of public interest.')
I don't agree. By contrast with other regulators,
the FRC has not in my opinion been overly burdensome.
29. The regulator needs a contingency plan
for orderly transition of audit clients if a Big 4 firm fails
(Mr. Ashley Almanza, Hundred Group and BG in oral evidence on
30. Develop living wills for the largest
audit firms to mitigate the risk of any exiting the audit market
Again I agree
31. Find a way of ensuring that the largest
institutional investors act together to influence large companies
to consider `Mid-Tier' audit firms, as `they usually get the changes
they are looking for'
This would be desirable, they have and continue
to be very effective on remuneration issues. Perhaps shareholder
committees is one way forward.
32. The FRC should convene a group of large
institutional investors to come up with audit market intervention
It will be interesting to see what they come
33. Ignore the present system and build
an alternative in parallel, alongside the present system.
Great in theory, but where do you start and
what sort of a system would you seek to build?
34. First, work to reduce market concentration
in FTSE 250 audits so as to build a sustainable platform for the
`Mid-Tier' firms to be able later to compete effectively for FTSE
This would be good in process terms but the
2nd tier need to understand that The FTSE 100 is the aim.
9 Benedikt Koehler, (2006): `Audit Market Failure',
in Economic Affairs, journal of The Institute of Economic Affairs. Back
Joshua Ronen, (2010): `Corporate Audits and How to Fix Them',
in Journal of Economic Perspectives, Spring, vol. 24, no. 2, pps