CHAPTER 3: Changes to the Legislative/Regulatory
Framework Governing Audit |
What has been done to increase
28. The dearth of competition in auditing is
vividly illustrated by how rarely blue chip companies change auditors.
A FTSE 100 auditor remains in place for about 48 years on average;
for the FTSE 250 the average is 36 years. Nearly all these companies
have Big Four auditors.
For example, Barclays has used PwC or its predecessors since 1896,
and since 1978 as sole auditor.
These figures do not sit well with the view of the Big Four (paragraph
19 above) that the large firm audit market is highly competitive.
29. The Financial Reporting Council (FRC) created
the Market Participants' Group which issued 15 recommendations
in 2007 aimed at reducing risk and bolstering competition in auditing.
Amongst these were recommendations that audit committees explain
their choice of auditor; that shareholders take a greater interest
in audit selection; and that the FRC promote understanding of
audit quality. It was hoped greater transparency and shareholder
engagement would lead to more choice in the audit market.
30. The majority of these recommendations have
been implemented but they lack teeth. Many recommendations are
only guidance, which companies can all too easily ignore. For
example, more than half of listed companies surveyed by the FRC
ignored guidance that audit committees should provide information
on frequency of audit tenders and on tenure of incumbent auditor.
Even amongst those that sought to comply, the information was
of little use in many cases. The FRC reported that "many
... failed to state exactly how long the relationship had lasted",
only saying the auditor had been in place "for many years"
or "a number of years."
31. Hence, as outlined in Chapter 2, the Big
Four are as dominant as ever. Grant Thornton characterised the
measures as "soft touch initiatives [that] have demonstrably
Even the FRC confessed to their "minimal impact on market
32. The Institute of Chartered Accountants in
England and Wales attempted to defend the measures, suggesting
that more time was needed for some recommendations to take effect.
But this was a minority view. Many witnesses argued that more
action is needed to reduce market concentration. Mr Guy Jubb,
Head of Corporate Governance at Standard Life Investments, said:
"We are no longer comfortable with relying on market forces
to create the resolution to this. We do believe that there has
to be some regulatory or governmental intervention."
Baker Tilly argued: "It was commercially-led market mergers
that caused the contraction and it will take positive discrimination
in favour of potential competitors to now change it."
Baroness Hogg, Chairman of the FRC, said: "The time has come
to consider more radical measures".
33. Attempts to introduce greater competition
into the audit market have so far failed. Market concentration
is as great as ever. The last set of recommendations from the
Financial Reporting Council's Market Participants Group in 2007
lacked teeth. It has had no effect in lessening the dominance
of the Big Four.
34. Mr Edward Davey MP, Minister for Employment
Relations, Consumer and Postal Affairs, at the Department for
Business, Innovation and Skills, said of reducing market concentration:
"There are some approaches that are quite regulatory, but
we are not attracted to a very heavy-handed approach." He
"would put a lot more emphasis" on less heavy-handed
measures to do with "transparency and disclosure" in
areas such as how a company chooses an auditor and how long a
firm has had an existing auditor.
35. Measures envisaged by Mr Edward Davey
MP, Minister at the Department for Business, Innovation and Skills,
focus on transparency and disclosure. These echo the approach
of the FRC Market Participants Groupan approach that has
palpably failed. We were disappointed that the Minister is not
more ambitious. We would expect exactly the same result for the
measures he advocated to our Committee as the FRC's measures have
had. It may be sensible to introduce these measures on their own
merits. But they do not add up to a policy of creating greater
competition and choice, of altering the current oligopolistic
situation, or of addressing the risks of the Big Four coming down
to a Big Three.
36. We received many proposals for reducing market
concentration. Witnesses' more radical proposals included limiting
the market share of the Big Four as measured by the number of
appointments held over a five year period.
A few witnesses said the authorities should consider breaking
up the Big Four.
The FRC said the Government and competition authorities should
make clear that in the event of one of the Big Four collapsing,
the Big Three would be broken up.
Others suggested less radical measures such as joint audits and
mandatory tendering of audit contracts to give non-Big Four firms
more opportunities to compete. All proposals made to us are listed
in Appendix 3. The main ones are discussed below:
37. Joint auditswhere two auditors sign
off accountsare required in France and, proponents argue,
would give a foothold to non-Big Four auditors amongst large clients,
if the requirement were specified appropriately.
38. Mr David Herbinet, Partner at Mazars
which has a strong presence in France, said joint audits could
make changing auditors easier by offering some continuity: "What
you can do with a joint audit is stagger the appointments whereby
you can change one of the two without putting the whole audit
at risk." Joint
audits were well suited to banks because of their systemic risks,
complexity and "the inherent subjectivity in their financial
39. But joint audits had plenty of critics. Mr Simon
Michaels, Managing Partner at BDO, feared his firm would be "seen
as being appointed as the poor relation of the Big Four to make
up the numbers."
Professor Stella Fearnley, of the University of Bournemouth,
added that a joint auditor could be another Big Four firm, so
that market concentration would not be reduced.
Mr Charles Tilley, Chief Executive of the Chartered Institute
of Management Accountants (CIMA), warned joint audits created
the "risk of things falling through the cracks ... it can
become a bureaucratic nightmare". Mr Iain McLaren, Senior
Vice-President of the Institute of Chartered Accountants in Scotland
(ICAS), and Mr Russell McBurnie, Finance Director of RSM
Tenon, expressed similar views.
Some French companies had told the FRC that joint audits were
a "nightmare", according to its Chief Executive, Mr Stephen
Haddrill, because "auditors spend all their time passing
the buck". Other French companies said auditors worked well
together with benefits from two sets of eyes. Mr Haddrill
said: "The evidence we've seen in the UK has been that it's
been relatively inefficient in terms of the way the audit is conducted."
40. One suggested way to enhance competition
would be to introduce mandatory joint audit where each audit firm
signs off the audit report and opinion. The Committee is not convinced
that this would deliver better accounts. It would certainly add
bureaucracy and cost. It has only been applied in very few countries
where the results do not amount to a resounding recommendation
in their favour. But if it were promoted in the UK as a means
to reduce market concentration, it should be on the basis that
at least one joint auditor was a non-Big Four firm.
REGULAR MANDATORY TENDERING OF AUDIT CONTRACTS
41. As noted at paragraph 28, companies rarely
change auditors. Many witnesses proposed mandatory tendering to
give non-Big Four firms the opportunity to compete,
though some would exclude banks because of the specialist expertise
42. Other witnesses doubted that mandatory tendering,
or the more radical suggestion of mandatory rotation after a fixed
period, would work. Clients could simply switch Big Four auditors,
with no effect on market concentration.
Some expressed concerns that changes of auditors not only increased
costs but reduced quality in the early years of a new audit.
Mr Jonathan Hayward, director of corporate governance consultants
Independent Audit, cited a study of the mandatory rotation regime
in Italy which "concluded that the risks of audit failure
in the early years, after a change, were greater than the risks
of audit failure in the later years".
43. Mr Paul Lee, Director of Hermes Equity
Ownership Services, took the opposite view, arguing that audit
quality improved as the new auditor put in more work.
The Office of Fair Trading (OFT) thought that any negative fallout
from changing auditors could be lessened by outgoing auditors
providing incoming auditors with information in a standard format.
44. The very long tenure of auditors at large
companies is evidence of the lack of competition and choice in
the market for the provision of audit services. A regular tender,
with a non Big Four auditor invited to participate, should promote
greater competition to the benefit of both cost and quality. We
recommend that FTSE 350 companies carry out a mandatory tender
of their audit contract every 5 years. The Audit Committee should
be required to include detailed reasons for their choice of auditors
in their report to shareholders.
INVESTOR INVOLVEMENT IN APPOINTMENT OF AUDITORS
45. Shareholders mostly approve the board's recommendation
on the appointment of auditors at annual general meetings with
little or no discussion. Lord Myners said this was because investor
apathy was endemic: "The average institutional investor has
about as much interest in the companies in which it has invested
its client's funds, as somebody buying a betting ticket on a 2.30
horse at Plumpton. Passionately interested in what happens for
the next three minutes, but not much interested in what happens
to the horse thereafter."
46. But a relatively small number of institutional
investors play an active role in the companies where they hold
shares. Mr Iain Richards, Head of Governance at Aviva Investors,
defended his institution's record. They did "vote against
a notable number of [auditor] appointments". But he added:
"The difficulty is not enough of us do ... I think companies
know that we are in such a small minority that they shrug their
Lack of information was also cited as a reason for not challenging
Mr Jubb suggested audit committees should discuss with principal
shareholders every five years "the quality of service and
other aspects surrounding the auditors."
47. Mazars suggested investor scrutiny might
be strengthened by forming independent shareholder panels to choose
the auditors. BDO recommended direct shareholder representation
throughout the appointment and review process rather than only
at the end. Mr Steve
Maslin, Partner at Grant Thornton, would like the Financial Reporting
Council "to convene a group of the UK's largest institutional
investors to get some focused action on the companies in which
they investand that might be in the FTSE 250to give
a very strong signal to those companies to move more audits to
firms outside of the Big Four."
48. There was wide support from witnesses for
audit committee reporting to be more transparent about the rationale
for audit tendering and audit choice decisions. There was also
support for audit committees to report on significant financial
reporting issues arising during the course of the audit, since
the auditors' report cannot be relied upon to do so. Mr Davey
said: "Maybe there is a role for further development of the
relatively new Stewardship Code in this area. Is there a role
for the FRC's guidance on audit committees to be looked at and
possibly made mandatory?"
We infer that, if audit committee guidance were to become mandatory,
the Department for Business, Innovation and Skills might support
audit committees themselves becoming mandatory for listed companies.
49. We recommend that:
i. audit committees should hold discussions
with principal shareholders every five years;
ii. the published report of the audit committee
should detail significant financial reporting issues raised during
the course of the audit;
iii. they should also explain the basis of
the decision on audit tendering and auditor choice; and
iv. the FRC's UK Corporate Governance and
Stewardship Codes should be amended accordingly.
50. Like the FRC's Market Participants' Group
measures, the changes we recommend above should be marginally
beneficial. But they would not deal with the fundamental issue
of audit market concentration. Regrettably, with the notable exception
of our investor witnesses, most shareholders appear to care little
about a company's choice of auditor. It seems improbable that
this apathy will soon be remedied. So measures which rely on shareholder
engagement to help lessen audit market concentration are unlikely
to be effective.
51. The FRC argued that Government plans to abolish
the Audit Commission might offer the opportunity for one or more
non-Big Four auditors to take on its work. As a standalone entity,
the Audit Commission would be the fifth largest audit firm in
the UK, representing about 10% of the market.
Baroness Hogg said that if the Big Four picked up the work of
the Audit Commission "that will be, at the very least, a
big missed opportunity to increase the strength of work done by
the non-Big Four firms."
Mr Maslin said that Grant Thornton "would be very enthusiastic
under the right conditions to invest in taking a substantial part
of the Audit Commission work."
If on the other hand the Audit Commission's work went to the Big
Four, market concentration would increase.
52. Preventing the Big Four from taking such
work could however breach EU laws on public procurement. The FRC
acknowledged that there were "practical difficulties that
may need to be overcome to ensure the UK complies with European
law relating to the procurement of public contracts but believe
the prize of greater competition in the market makes this proposal
worthy of further consideration."
53. Baroness Hogg told us that the expected
abolition of the Audit Commission would provide an opportunity
to increase competition and choice in the audit market if it formed
the basis of a substantial new competitor to the Big Four. We
recommend that the Government should work to encourage the emergence
of such a competitor.
PUBLIC SECTOR WORK
54. BDO argued that for the types of projects
where the Government tends to hire Big Four firms greater consideration
should be given to smaller audit firms instead.
Asked about the Government's scope for ensuring more non-Big Four
firms won public contracts, Mr Davey said: "In general,
the Government is very keen at looking at how we procure goods
and services and to see if that can be improved ... We want to
encourage a very competitive market for procurement of Government
services including audit."
55. The Government should make greater efforts,
within EU procurement rules, to enable non-Big Four firms to win
public sector work. This should include any work no longer undertaken
by the Audit Commission.
PREVENT COMPANIES RESTRICTING THEMSELVES TO BIG FOUR
56. Restrictive covenants where companies are
required by shareholders or banks to use one of the Big Four auditors
are a barrier to choice,
as the Big Four plus BDO and Grant Thornton stated in a joint
submission to the OECD: "In certain countries including the
USA, UK, Germany, Spain and Finland we have encountered clauses
or requirements in contractual agreements between companies and
their banks or underwriters that state that only the Big 4 audit
firms can provide audit services to the company. [This] can distort
the market for audit services by excluding certain audit firms
from competing in this market."
Mr Scott Halliday, Managing Partner, Ernst & Young, said:
"Removing the only Big Four clause from any banking agreements
would be a positive step."
57. Lord Sharman and Lord Smith of Kelvin doubted
that restrictive covenants were common in the UK.
The FRC nevertheless recommends "a greater level of dialogue
between the British Bankers' Association, lending institutions,
audit firms and regulators to address the issue".
The OFT is considering the launch of a market study of restrictive
bank covenants. We
consider that the OFT should conduct a market study of restrictive
bank covenants. This would form part of the wider inquiry into
the audit market which we recommend later in this report.
REFORM OF THE LAW ON UNLIMITED LIABILITY
58. Concerns about liability and insurance against
claims for damages should a client collapse could deter non-Big
Four accountants from auditing large listed companies. Auditors'
liability can be limited by contract so long as the cap is "fair
and reasonable in all the circumstances" and the client consents.
The Association of Chartered Certified Accountants (ACCA) argues
that more needs to be done as listed companies rarely consent,
mainly because US authorities view such agreements as direct threats
to audit quality. ACCA believes Germany has less market concentration
than Britain because of a long-standing cap on auditors' liability.
59. But Mr Stephen Kingsley, Senior Managing
Director at FTI Consulting, disagreed: "Lack of limitation
clearly concentrates the mind." He argued that unlimited
liability, had not, of itself, caused the collapse of any major
firm, not even Arthur Andersen.
Mr Davey said the Government's "conclusion is that we
shouldn't put a cap on [liability]. We have no plans to do so".
He added: "Liability does drive quality of audit, and there
is quite strong evidence from the academics in this regard."
60. Auditors' unlimited liability needs to
be investigated to determine whether it deters non-Big Four auditors
from taking on large listed clients. This too could form part
of an Office of Fair Trading (OFT) investigation into the audit
market which we recommend later in the report.
CHANGE IN OWNERSHIP ARRANGEMENTS FOR AUDITORS
61. The FRC believes that changes to the ownership
ruleswhich are set at EU level and preclude non-auditors
from holding more than 49% of the voting rights in an audit firmwould
"make it easier for firms to invest to allow them to expand
into the market for the audits of the largest companies".
The Government is pressing for changes to the EU ownership rules.
The EU is considering whether the ownership rules should be relaxed,
according to a Green Paper from Mr Michel Barnier, the Commissioner
for Internal Market and Services.
62. Surprisingly, BDO and Grant Thorntonthe
largest non-Big Four auditorssay they have no need for
greater access to capital to expand. Grant Thornton said they
would not need to raise additional capital to expand into audit
of the FTSE 250 listed companies, now dominated by the Big Four.
Mr Michaels of BDO declared: "Investment is not holding
us back." The
OFT suggested that there was a deterrent to investment by audit
firms: "Investment may not be attractive to older partners
due to the limit that retirement imposes on the period in which
they can receive a return."
63. The ABI argued that liberalising ownership
rules could enable non-auditors to help recapitalise an audit
firm on the brink of collapse.
Mr Davey, the BIS Minister, said the Government might examine
this option, as an
alternative to the further market concentration which would result
from a takeover by another Big Four firm.
64. The leading second-tier audit firms have
told us that their scope for growth is not constrained by any
problems of access to capital. So we see no immediate grounds
to change the law to lift limits on shareholdings by non-auditors
in audit firms, especially since such a change would carry the
risk that auditors might become less independent. The OFT should
also examine limits on share ownership as part of its investigation.
RISK COMMITTEE ADVISER
65. In his review of corporate governance in
UK banks and other financial industry entities, published in November
2009, Sir David Walker recommended that "the board of
a FTSE 100-listed bank or life insurance company should establish
a board risk committee separately from the audit committee. The
board risk committee should have responsibility for oversight
and advice to the board on the current risk exposures of the entity
and future risk strategy, including strategy for capital and liquidity
management, and the embedding and maintenance throughout the entity
of a supportive culture in relation to the management of risk
alongside established prescriptive rules and procedures."
It could be argued that such risk committees, composed largely
of non-executive directors but with expert advice, might have
prevented or at least mitigated some of the decisions taken by
these institutions which led to the financial crisis.
66. The assessment of risk, whether by separate
risk committees or as part of the audit committee, is becoming
a more prominent feature of corporate governance not only in the
banks and financial institutions but also in other major companies
where appropriate. As the Walker report said: "This seems
a welcome development in particular in the light of recent experience,
much of which can be characterised as marking a failure by boards
to identify and give appropriate weight to risks on which they
had not previously focused." The report also suggested the
use of a "high-quality source of external advice."
67. In its evidence to us, the FRC wished to
encourage banks and other systemic institutions to use non-Big
Four firms as a source of advice to these risk committees. The
FRC argued that this would give such firms an exposure to large
companies they might not otherwise have access to and might in
time provide them with the opportunity to tender for the audits
of some of these entities. Baroness Hogg argued that such risk
committeesreporting to the board about the levels of risk
facing different parts of the business and how these can be containedshould
be advised by a firm other than the company's auditors, and that
such a measure might enable non-Big Four auditors to enter the
big company market.
Mr John Connolly, Senior Partner and Chief Executive, Deloitte
said: "I think the concept of independent advisers advising
risk committees is a good one. If that was adopted, I think that
is a good change."
Mr John Griffith-Jones, Chairman, KPMG agreed that the auditor
should not be the risk committee's adviser but added that nonetheless
"auditors have an important potential role to play around
the risk area."
Lord Sharman said: "I have found ... that the appointment
of an independent advisor to both the audit committee and the
risk committee, separate from the external auditors, separate
from the internal auditor, and separate from anybody else in the
organisation ... is particularly helpful." When asked, "How
general is it?" he replied, "I suspect it's not very
68. Whether such risk assessment is done by a
separate risk committee or as part of the audit committee work,
we can see considerable benefits in expert external advice being
increasingly used. It should not be provided by the firm's own
auditors. It will increasingly involve the use of specialist advice
and experience quite distinct from that involved in audit work
and could provide an opportunity for non-Big Four firms to build
up such expertise and as an entree to FTSE 100 companies.
69. We strongly support the development of
separate risk committees in banks and major financial institutions.
Other large companies should institute them where appropriate.
Such committees will increasingly require specialist skills and
external advice. This advice should not be provided by the firm
which is the company's auditor. Providing it could open opportunities
for non-Big Four accountancy firms to enter the large company
market in a way which they have found difficult to do.
70. We believe that every bank should have
a properly constituted and effective Risk Committee of the Board.
It should be one of the duties of the external auditor to ensure
that this is done, by making clear that if it is not, the auditor
will say so in a qualification to the accounts. This is best dealt
with by rules made and guidance issued by the FRC rather than
by being made a statutory requirement. Reference should however
be made to it in legislation on the relationship between financial
supervisors and auditors, to which we return later in the report.
Should audit remain mandatory?
71. Audits are mandatory for most companies except
the smallest for which the burden and benefits are deemed disproportionate.
There is a case for reduced mandatory audit requirements, while
enabling companies to opt for more detailed audits to reassure
investors. This could provide opportunities for non-Big Four auditors.
The OFT said: "Reducing the requirements of statutory audit
might stimulate switching to smaller auditors that are able to
undertake a more limited audit. Doing this might also reduce auditor
liability for errors and hence auditors' risk of failure."
72. Independent Audit argued for the removal
of the requirement for an audit. It would then be for boards to
take responsibility for their financial statements, perhaps also
opting to have them audited.
Mr Davey said: "The Government believes, there is a
strong case for taking away the mandatory requirement for an audit
from medium-sized companies."
If enacted, this change would apply to 32,385 companies.
(A company is classified as medium-sized if it meets two out of
the three criteria set by the EU: turnover between £6.5m
and £25.9m; total assets from £3.26m to £12.9m;
and 50 to 250 employees.)
73. However, most shareholders and lenders would
insist on full audited accounts for listed companies. Professor Michael
Power of the London School of Economics saw a more widespread
removal of the requirement for audit as "just simply unthinkable
for a whole range of institutions at the moment."
Investors also outlined the importance of audits. Mr David Pitt-Watson
of Hermes said: "Audit and accountancy are absolutely fundamental
to the integrity of our capital markets and the good governance
of our companies." Mr Richards of Aviva said: "The
fact that we have an audit is valued by investors."
74. We raised with witnesses the scope for financial
statements insurance drawn to our attention by business consultants
Z/Yen and also proposed
by Professor Joshua Ronen of New York University's Stern
School of Business.
One attraction of this is that it would create a parallel market
to compete with the existing audit market that has proved resistant
to widening choice. Under this system, companies could opt to
seek insurance for their investors against losses caused by below
par financial statements, as an alternative to the existing audit
regime. The insurer would assess the company to determine the
risk and then set a price for offering such insurance. It is hoped
auditors would want to build a strong reputation to make sure
that insurers hired them; and the interests of the insurers, who
would want to pay out as few claims as possible would be aligned
with shareholders. Mr John Connolly of Deloitte dismissed
financial statements insurance as containing "a lot of very
impractical features". He suggested it would be costly and
availability of insurance cover against audit failure would be
limited. He said: "There is not enough insurance in the insurance
market to cover the market capitalisation of a single FTSE 100
company, let alone the whole market, so I do not know why there
is the view that this insurance would exist."
75. In order to lower regulatory costs, there
is a strong case for some reduction in the audit requirement on
smaller companies. This is unlikely to reduce audit market concentration,
since the audit requirement would remain in place for the large
listed companies where the Big Four predominate.
Should auditors give broader assurance?
76. We heard much evidence that audits should
change to be more useful to investors. The Institute of Chartered
Accountants in Australia wanted 'closer to the event', more up-to-date
argued for widening audit's scope from financial statements to
embrace risk management, corporate governance, and the business
model. CIMA believe
auditors should also offer some form of assurance on the narrative
operating and financial review.
Mr McLaren of ICAS said that assurance on these lines would
be to a standard of 'balanced and reasonable' rather than 'true
and fair'. BDO
saw a case for listed companies assurance, especially for large
financial institutions, to extend to analyst briefings and other
communications with investors.
77. Independent Audit argued for the rules and
regulations concerning narrative statements, such as reviews of
business operations in companies' annual reports, to be further
developed to close the "expectations gap" between what
the general public want auditors to do and what they actually
do in terms of providing assurance. Audits of narrative reports
should give a qualitative commentary rather than a yes or no 'binary'
opinion. But even Independent Audit warned that audit firms "are
much less well-equipped to form a view on the subjective and sensitive
topics that lie outside the financial statements."
78. Mr Ashley Almanza, Chairman of The Hundred
Group (of Finance Directors of FTSE 100 companies) and Chief Financial
Officer of BG Group did not support any widening of auditors'
assurance because "whatever product they produced, would
have to be so heavily qualified I query whether investors would
get real value."
79. Investors and others demand that audit
should provide broader, more up-to-date, assurance on such matters
as risk management, the firm's business model and the business
review. This additional assurance would help the audit to meet
the current expectations of investors and the wider public. Any
widening of auditors' assurance would radically change their role.
Again the OFT should address this issue as part of its broader
review of the workings of the audit market.
Should auditors do less non-audit
work and internal audit?
80. There has long been concern about conflict
of interest if an external auditor also provides other services
to the same client. Under the current rules certain work for an
audit client is prohibitedanything that would involve auditing
one's own work, acting in a management capacity or acting as an
advocate for an audit client. Some services such as advice on
tax issues and acquisitions may only be provided by partners with
no knowledge of their colleagues' audit for the same clientthe
Chinese wall. But accountancy firms are generally free to offer
consultancy services to their audit clients, although listed companies
disclose in annual reports fees paid to auditors for consultancy
work. Northern Rock was a case in point. In addition to auditing
Northern Rock, PwC received some £700,000 in 2006 in consultancy
income from Northern Rock. The House of Commons Treasury Select
Committee referred to this as an apparent conflict of interest.
81. Earlier, in 2005, a former Chief Economist
of PwC joined the Northern Rock Board as an independent director
and the following year was appointed to its Audit Committee. She
resigned from the committee after one meeting following concern
expressed by PwC but rejoined early in 2007.
Northern Rock and their auditors were subject to conflict of interest
criteria in both the US and the UK. Although this arrangement
does not seem to have breached the letter of US or UK criteria,
PwC is to be commended for focusing on their substance rather
than their form. We note however that compliance with the UK's
Corporate Governance Code is at the discretion of companies, unenforced
82. Professor Kevin McMeeking of Exeter
University stated that prohibition of all consultancy advice to
audit clients was "the only failsafe solution" to avoiding
the potential for conflict.
83. Dr Sarah Blackburn of the Chartered Institute
of Internal Auditors said "internal audit should not come
from the external auditors of the company" and that "it's
useful to have more than one source of assurance and more than
one point of view."
84. Mr Timothy Bush, Investment Management
Association nominated representative on the Urgent Issues Task
Force of the Accounting Standards Board, raised concerns about
companies receiving tax advice from their audit firm: "I
would be concerned where there's a skeleton in the cupboard that
the auditor isn't incentivised to uncover, and I think some tax
planning can tie companies in knots for years, and if that is
audited by the same firm that advised on the tax planning, then
you're going to have a real problem."
85. Accountancy groups, unsurprisingly, believed
the current rules require at most minor tinkering.
They also saw benefits in staff acquiring wider experience. Mr Ian
Powell, Chairman and Senior Partner, PwC said of auditors working
in non-audit parts of the firm: "As they move back into audit
practice, they are much better auditors because of the quality
of the training and the experience that they've had."
Baker Tilly entered one proviso: if the client could create systemic
risk to capital marketssuch as a large bankthen
auditors should face stricter rules in what non-audit services
they could supply.
86. Accountancy groups saw no demand to prevent
accountants from supplying other services to their audit clients.
For smaller companies it may be cheaper to get non-audit advice
from their auditors than from elsewhere.
ACCA cited figures from listed company accounts showing that the
ratio of non-audit to audit fees has fallen from 191% in 2002
to 71% in 2008,
still a high figure.
87. We are not convinced that a complete ban
on audit firms carrying out non-audit work for clients whose accounts
they audit is justified. But we recommend that a firm's external
auditors should be banned from providing internal audit, tax advisory
services and advice to the risk committee for that firm. We also
recommend that the Office of Fair Trading should examine whether
any other services should be banned from being carried out by
a firm's external auditors.
Big Four to Big Three?
88. As outlined in Chapter 2, there is always
the possibility that for whatever reason one of the Big Four might
leave the audit market. Mr Almanza said that going down to the
Big Three would be "an unwelcome change".
The OFT said in such circumstances "existing competition
problems in the market could be exacerbated".
Some companies, especially in riskier industries, might not be
able to obtain audit services in the short term. This could trigger
a loss of confidence in financial statements among investors.
89. Any move from the Big Four to a Big Three
would create an unacceptable degree of market concentration. Choice
and competition in the audit market would be seriously undermined.
90. Mr Almanza recommended that the authorities
should have a contingency plan for the orderly transition of clients
to another auditor if one of the Big Four collapsed.
Mr Graham Roberts, Finance Director of British Land, writing
in a personal capacity, argued that auditors should draw up 'living
wills', similar to those proposed for banks, which would detail
how a failing institution could be wound-up with the least possible
disruption to the financial system.
The FRC also advocates 'living wills': "These would set out
how a firm would segregate, under regulatory supervision, how
good and failing parts of the business will be separated and funded."
91. By setting out an orderly process of dismantling,
living wills should also help ensure that no audit firm was regarded
as too big to fail. Even without living wills the FRC is keen
to dispel any idea that the Big Four are too big to fail: "We
would not moderate our actions to protect a firm from failure
but it is of concern that some believe such a risk exists."
The FRC advocates a global contingency plan for a Big Four collapse
by governments and regulators in the UK, EU and US, with two main
- Conduct of audit work in the short term;
- Long term structure for the audit market.
The FRC recommends that in the first instance the
Government should ask the Financial Stability Boardthe
global organisation that coordinates national financial authorities
and standard settersto examine the issues, "with a
view to it being discussed at G20 level in due course".
92. We recommend that the Government and regulators
should promote the introduction of living wills for Big Four auditors.
These would lay out all the information the authorities would
need to separate the good from the failing parts of an audit firm
so disruption to the financial system from a collapse would be
Referral to the Office of Fair
93. In 2002, when the large-firm audit market
became concentrated in the hands of the Big Four following the
collapse of Arthur Andersen, the OFT conducted a preliminary inquiry
into whether to launch a full-scale competition investigation
of audit. It decided not to do so, nor to refer the matter to
the Competition Commissionusually the next stage in any
full-scale competition investigation. The OFT explained its decision:
"We have not found evidence to suggest that [audit] firms
have acted to prevent, restrict or distort competition. Nor have
we had complaints that they may be doing so." The OFT considered
that the time was not right for further investigation, while great
changes were taking place in the audit market, and concluded:
"Our approach is to keep the market under review and to examine
any competition implications of regulatory proposals that may
arise from current reviews of audit and accountancy services."
94. The Big Four continue to strengthen their
position by using their financial muscle to acquire significant
parts of the home and international networks of next-tier firms.
There have been several notable acquisitions in recent years in,
for example, France and Brazil. These takeovers limit the scope
for smaller competitors to develop international networks. The
effect seems anti-competitive.
95. Lord Myners told us that if other measures
to increase choice in the audit market did not work then as a
last resort "one has to consider whether there should be
an OFT reference and whether ... there should be some action to
96. Most other witnesses opposed breaking up
the Big Four. ACCA said it could have unintended consequences
such as one of the Big Four leaving the audit market altogether;
it argued that as things stood there were enough reputational
incentives for auditors to offer objective advice and maintain
Independent Audit thought that any benefits would be uncertain,
since market pressures for scale and consolidation were unlikely
to abate. They also drew attention to the difficulty of breaking
up the Big Four given their international networks beyond UK regulators'
reach. Yet the
UK is a relatively important player in the audit world. Reforms
in the UK might in the FRC's view be "a catalyst for international
developments and debate."
97. The Committee believes radical approaches
are needed to solve the many problems with the audit market. Any
industry in which four firms share the total market (one with
40%, the others with around 20% each),
has to be one where choice is clearly restricted. As Lord Sharman
put it: "Anybody who chairs a major company, or sits as chairman
of an audit committee of a major company, cannot fail to be concerned
about the lack of choice. It's not a lack of choice among four;
quite often it comes down to the fact that you only have two that
you can possibly appoint."
Mr Philip Collins, Chairman of the OFT, said: "We consider
that the competition in the market for audit services to large
companies may be limited, as a result of barriers to entry and
expansion, switching costs and limited choice in firms. We observe
low levels of tendering and switching, high concentration and
some evidence of high fees. There may be other effects of a lack
of competition, such as low quality and lack of innovation
High concentration may also contribute to a risk of systemic failure
in the audit market. Barriers to entry might make it difficult
for mid-tier firms to step up to replace one of the Big Four firms
if it were to exit the market. Thus we think that the market,
as currently structured, may not operate in a way that works well
98. In this report we have recommended a number
of measures to reduce the dominance of the Big Four in the large
firm audit market. But within the time and the resources available
to us, we have not been able fully to address all the highly complex
issues which may stem from market concentration. These include:
i. lack of choice;
ii. higher fees than in a more competitive
iii. lower quality; and
iv. the huge risks involved if one of the
Big Four left the audit market.
A thorough review of the issues in depth and in
the round is overdue. We recommend that the OFT should conduct
such an investigation into the audit market in the UK, with a
view to a possible referral to the Competition Commission. Its
findings would need to take full account of the international
dimension, but the UK could give a lead internationally by undertaking
such a review.
28 ADT 21 (Mazars). Back
Email from Barclays' public affairs department, 11 March 2011.
Financial Reporting Council PN199, Final report of Audit Choice
Market Participants Group published, 16 October 2007. Back
Financial Reporting Council, Choice in the UK Audit Market-Fifth
Progress Report, June 2010. Back
ADT 20. Back
ADT 24. Back
ADT 6. Back
Q 407. Back
ADT 53. Back
Q 170. Back
Q 504. Back
ADT 20 (Grant Thornton),ADT 41 (Lord Sharman). Back
ADT 64 (Prof Kevin McMeeking), Q 111 (Dr Gunnar Niels). Back
ADT 27. Back
ADT 21(Mazars). Back
Q 131. Back
ADT 21 (Mazars). Back
Q 134. Back
Q 20. Back
Q 77, Q 136. Back
Q 231. Back
ADT 62 (Kingston Smith), ADT 26 (Office of Fair Trading), ADT
1 (Professor Beattie et al), Q 418 (Mr Paul Lee). Back
ADT 62 (Kingston Smith). Back
Q 418 (Mr Iain Richards), Q 420 (Mr Robert Talbut). Back
Q 329 (Mr Robin Freestone), Q 418 (Mr Iain Richards). Back
Q 418. Back
ADT 26. Back
Q 488. Back
Q 427. Back
Q 418 (Mr Robert Talbut), Q 433 (Mr Paul Lee). Back
Q 430. Back
ADT 21 (Mazars), ADT 19 (BDO). Back
Q 138. Back
Q 504. Back
ADT 24 (FRC), ADT 1 (Professor Beattie et al), Q 515 (Mr Richard
Q 192. Back
Q 139. Back
ADT 27. Back
ADT 19. Back
Q 506. Back
ADT 4 (ACCA), ADT 20 (Grant Thornton), ADT 62 (Kingston Smith). Back
OECD Policy Roundtables (2009), Competition and Regulation
in Auditing and Related Professions, Submission by Regulatory
Working Group of the Global Public Policy Committee of six major
accounting networks, page 248 Back
Q 236. Back
ADT 71 (Lord Smith), ADT 41 (Lord Sharman). Back
ADT 27. Back
ADT 49. Back
ADT 4 (ACCA), ADT 53 (Baker Tilly), ADT 7 (ICAS), ADT 62 (Kingston
Smith), ADT 69 (Professional & Business Services), ADT 41
(Lord Sharman). Back
ADT 13. Back
Q 550. Back
ADT 27. Back
QQ 519-521. Back
European Commission Green Paper COM(2010) 561, Audit Policy:
Lessons from the Crisis. Back
QQ 121-122. Back
ADT 26. Back
ADT 42. Back
Q 505. Back
Sir David Walker, A review of corporate governance in UK banks
and other financial industry entities, Final recommendations,
26 November 2009. Back
Sir David Walker, A review of corporate governance in UK banks
and other financial industry entities, Final recommendations,
26 November 2009. Back
Q 194. Back
Q 246. Back
Q 256. Back
QQ 365-367. Back
ADT 26. Back
ADT 12. Back
Q 522. Back
Q 523. Back
UK Government Response to the European Commission's Green Paper
on Audit, 8 December 2010. Back
Q 23. Back
Q 404. Back
ADT 74. Back
Joshua Ronen (2010), Corporate Audits and How to Fix Them,
Journal of Economic Perspectives, Volume 24, Number 2. Back
Q 260. Back
ADT 23. Back
ADT 4. Back
ADT 5. Back
Q 69. Back
ADT 19. Back
ADT 12. Back
Q 322. Back
ADT 24 (FRC). Back
Treasury Committee, 5th Report (2007-08): The run on the Rock
(HC 56-I). Back
Northern Rock 2005 and 2006 annual reports. Back
ADT 64. Back
Q 380. Back
Q 100. Back
ADT 4 (ACCA), ADT 19 (BDO), ADT 53 (Baker Tilly), ADT 29 (Deloitte),
ADT 6 (ICAEW), ADT 7 (ICAS), ADT 31 (KPMG), ADT 32 (PwC), ADT
69 (Professional & Business Services). Back
Q 250. Back
ADT 53. Back
ADT 4 (ACCA), Q 71 (Mr Iain McLaren and Mr Robert Hodgkinson). Back
ADT 4 (ACCA), Q 71 (Mr Robert Hodgkinson). Back
ADT 4 (ACCA). Back
Q 292. Back
ADT 26. Back
ADT 4 (ACCA), ADT 26 (OFT), ADT 24 (FRC). Back
Q 343. Back
ADT 38. Back
ADT 27. Back
ADT 24. Back
ADT 27. Back
Office of Fair Trading, Competition in audit and accountancy
services-A statement by the OFT, 22 November 2002. Back
International Accounting Bulletin, E&Y acquires Terco Grant
Thornton, 3 August 2010; Le Monde, Deloitte and BDO Marque &
Gendrot to merge (translation), 25 July 2006; Les Echos, KPMG
SA takes over Salustro Reydel (translation), 24 March 2005. Back
Q 486. Back
ADT 4. Back
ADT 12. Back
ADT 24. Back
Financial Reporting Council, Choice in the UK Audit Market-Fifth
Progress Report, June 2010. Back
Q 400. Back
Q 170. Back