As an interested observer of and writer about business I’ve been following the story of the Big 4 audit firms  around the world over the past 15 years with a particualr focus on their operations in Australia where I am based.

I’ve been helped in this by Richard Brooks’ terrific book Bean Counters: The Triumph of the Accountants and How They Broke Capitalism.

What a terrific investigative piece of journalism! I could digress at this point, but I shall resist the urge.

I want to focus on the Big 4 in Australia (linked of course to the Big 4 worldwide), but due to their special corporate structures each operates as a specific legal entity to avoid what I call the syphilis problem: the problem of spreading liability.

While performing globally, each country’s operation is legally independent, so that while they all trade off their brand name the liability for shoddy, bad, downright negligent or complicit/illegal activities in relation to audit work is ring-fenced to the ‘country of origin’.

But back to Australia.

This could well be the tag line for the Big 4 audit (the rich) and the rest of us who are letting the audit firms — oops, no, they’re not auditors any more; they’re advisors and auditors, social media experts, insolvency experts, PPP experts… pretty much anything experts — treat us as dumbos.

Here in Australia, the Big 4 are running a significant campaign to try and convince government and business that they provide better audit quality when they can also provide non-audit services to clients. Really?

Despite the main professional body for auditors CA ANZ’s paper (in conjunction with the Association of Chartered Accountants and the International Federation of Accountants) on the subject, we all know that if it walks like a duck and sounds like a duck, it’s a duck.

The so-called multi-disciplinary firms (whoever created that term deserves the corporate speak of the year award) are inherently conflicted. Auditing a company’s accounts is a serious and important function. It should not be compromised in any way shape or form. Having the same company provide audit services and consultancy services is at its heart compromising. Professor Stuart Kells, a La Trobe Business School adjunct professor and co-author of The Big Four, nailed it when he said “The auditor’s latest defence of diversification conflates multiple ideas: the scope of independent audit, the breath of expertise inside audit teams and whether the independent auditor should be allowed to provide services that undermine independence or are inconsistent with it.”

Here in Australia, the best response that the CA ANZ could muster about the conflict of interest was:

“It is important for multi-disciplinary firms to establish the right culture and incentives for quality audits and be able to demonstrate this to markets and the public to maintain confidence”.

They even commissioned their own research to prove it.

Yeah, right.

Let’s take a brief look at the accounting world from the GFC onwards.

In Europe

2019. KPMG paid €44 million in fines to settle allegations by the U.S. Securities and Exchange Commission (SEC) that the audit firm inappropriately altered already complete audits.[1]

There was an EY investigation into Realia as its auditors for improperly using an unconventional accounting method to deliberately devalue the company — thus permitting its majority shareholder, Mexican billionaire Carlos Slim, to acquire additional stakes at cut prices.

In April 2019, EY was referred to the Danish fraud squad for its part in the Danske Bank scandal, which has shaken the European financial establishment. According to the Danish Business Authority, EY had access to information which “should have prompted it to carry out further investigations” and contact money laundering authorities — yet the audit firm did nothing.

Back in 2007, Deloitte had to pay €130.8 million to Parmalat, to settle a suit regarding their role in the Italian dairy giant’s collapse. The startling case involved Parmalat suddenly realising in December 2003 that the €3.9 billion it thought it had in a bank account did not, in fact, exist. 

PricewaterhouseCoopers was hit with a €548.9 million charge — PwC later settled out of court to reduce this sum — for failing to uncover fraud in Colonial Bank, a failure which contributed to the global financial crash of 2007. Other scandals attached to PwC include a €8.25 million fine over its role in the collapse of British Home Stores and its involvement in setting up tax shelters, uncovered by the Panama Papers.[2]

In the UK

Back in the GFC period three banks came a cropper and almost took the UK finanical system with it: Northern Rock (PwC), Royal Bank of Scotland (auditor Deloitte), HBOS (auditor KPMG).

More recently, KPMG was fined £5 million in 2018 over its audits of Quindell and Ted Baker, £12.3 million for sloppy practices regarding Cooperative Bank and Equity Red Star, and is under investigation for its role in the collapse of construction firm Carillion. This is on top of a major investigation in South Africa in relation to the Gupta family that involved political smear campaigns and cost the national economy tens of billions of euros.

In 2017, PwC was fined £5.1m for its poor audit of fellow auditor RSM Tenon, and £5m for its audit of collapsed property services group Connaught.

In 2018 PwC was fined a record £6.5m for its failed audit of BHS. It had signed off on the health of the retailer days before it was sold for £1. [3]

Deloitte was fined £6.5 million for its Serco audit, and the UK FRC fines across all audit companies topped £42.9 million for the year ending 2019.[4]

In the USA

Who were the auditors of Lehmann Brothers - (EY) and AIG - (PwC).

In 2019, the Public Company Accounting Oversight Board (PCAOB) reported that the Big 4 accounting firms had messed up 31 per cent of the most recent US audits it had analysed.

Yet, despite their abysmal findings, the Oversight Board, empowered by the US government to police the audit firms, has rarely taken action against them. In its 16-year history, the PCAOB has made only 18 enforcement cases against KPMG, Deloitte, EY and PwC, according to an investigation published recently by the Project on Government Oversight (POGO).[5]

And then there are the tax avoidance schemes exposed in 2010 that ensnared some of the biggest companies in the world and PwC. In 2015, the UK Public Accounts Committee published the report Tax avoidance: the role of large accountancy firms. The Chairwoman of the Committee, Margaret Hodge, commented that PwC’s activities represented "nothing short of the promotion of tax avoidance on an industrial scale."

Back in Australia

No such thing as fines here yet. No requirement to break up their auditing and advisory practices yet. As with their international counterparts, in Australia the Big 4 tend to settle actions where they can and throw the kitchen sink where they can’t.

Deloitte – two shareholder class actions over Dick Smith; court action over Hastie and a settlement over Ashley Services

EY – LM First Mortgage Income Trust (in the courts now), Sons of Gwalia ($125 million settlement), Penrice Soda and Quintis

KPMG – the settlement king at the moment over Discovery Metals, Equittrust, AllCo ($40 million), Premium Income Fund ($30 million), GDI Investment Management

PwC – Vocation, Centro (part settlement of $67 million), Provident (part of a $44.25 million settlement).[6]

When an ‘understanding’ is not an ‘understanding’

Meanwhile Graeme Samuel, the former Chairman of the ACCC and now Professorial Fellow at Monash Business School, commented that audit independence standards are changing and that “the best thing” these bodies [the industry associations] can do is help them to adapt to the new reality.

That ‘new reality’ is that audit firms should not be making gazillions of fees from non-audit activities for the companies that they are auditing. And they should not be providing ‘consulting services’ to government where they are providing non-audit services to companies that benefit directly from the outcome of such advice.

Auditing is the Trojan horse for the Big 4, and they’ve got the listed company market sewn up.

The Big 4 audit 95 per cent of the top 100 companies – sorry I mean ‘multi-disciplinary firms'. Are you an audit firm or are you providing advice?

In October 2019 the CA ANZ decided they would not review the quality of the Big 4's audit work because they believed that would duplicate the work of the corporate regulator. An unidentified spokeswoman for CA ANZ publicly commented “As we operate in a co-regulatory environment, there is an understanding with ASIC that Chartered Accountants ANZ, along with CPA Australia, will not duplicate their processes by doing secondary inspections of large audit firms – that is, where the firms were inspected in the same annual or three-year cycle.”

The only thing is that ASIC was apparently not aware of any such arrangement. And ASIC has repeatedly questioned the quality of audits.

Appalling audit quality

In January ASIC reported that one in five audits (20 per cent) reviewed lacked the desired assurance that company financial statements were free from material error in their 2017-18 audit inspection program. And this was down from the 29 per cent from a review in December 2016.[7]

In 2016 Greg Medcraft, outgoing Chairman of ASIC, said that the quality of auditing in Australia was “appalling”.

ASIC Commissioner John Price has also been blunt in his criticism:

“The fundamental rule is, you should not be auditing your own work.”

In February the joint committee on corporations and financial services noted “ongoing concern” about the “deep-rooted problems in the audit market”, and that the Big 4 had become “corporate insiders embedded within the business world”, meaning their role as “independent outsiders scrutinising the accounts of major corporations” was being compromised.

The Financial Reporting Council (FRC) has also got in on the act, but actually delegated responsibility to ASIC. To its credit it did recommend that ASIC name and shame companies with substandard audits, and suspend and/or fine companies that perform defective audits. However these ‘suggestions’ have not yet been followed.

Accounting academic, James Guthrie of Macquarie University notes:

“I am surprised that Chartered Accountants ANZ do not subject their members in the Big 4 to their quality review programme.” Or would this be like letting the fox into the chicken coop?

The performance of the Big 4 audit firms is substandard

ASIC, a parliamentary inquiry and the FRC all agree the performance of the Big 4 is substandard, and there’s significant risk in the multi-disciplinary nature of these firms. Even the UK recognises this and now requires firms to split their audit and advisory operations.

However, CA ANZ are mostly funded by Deloitte, EY, KPMG and PwC, and not forthcoming about whether they have conducted any reviews of the quality control systems of the Big 4 in the past five years.

Everyone but CA ANZ agrees there’s an issue and something needs to be done about it, but just who will do what has yet to be announced.

What all this means is that the Big 4 fund the official industry organisation, but don’t govern or oversee themselves, and obfuscate the regulators and government. Therefore our government has inquiries and statutory bodies that recommend action and nothing happens.

CA ANZ aren’t checking the quality of the audits of its own companies, because they thought ASIC was doing them and ASIC did not know they were meant to.

In a recent article Greg Medcraft, former Chairman of the ACCC, admitted that the corporate regulator went too soft on the auditing sector during his tenure and warned that the global move for tougher laws in the sector is only a “finger in the dyke” against impending corporate collapses.[8]

He also declared a “profound lack of competition” in the audit sector that is holding back quality.

“We need to recognise that industry lobbying has played a role in keeping oversight light, but auditors are really doing themselves a disservice by preventing positive change coming from regulators, while making only gradual improvements in the industry to what is a significant and widespread issue.

“The profession has failed to actually really confront the issue head on. It’s starting to happen, but frankly it’s been too slow.

Audit oversight regulators feel like they’re putting a finger in the dyke to a major problem. When things blow up, we want to be able to say: look we have recognised there’s a problem; the industry recognises there is a problem.”[9]

Corporate capture of government

And of course there’s a capture of government at both state and federal levels. As noted in the Australian Financial Review, separate data showed the Big 4 earned $1.7 billion from the federal government between 2012-13 and 2016-17.[10]

During this time, the Big 4 have also emerged as major political donors. In the six years to 2018, the firms gave more than $4 million to the major political parties.[11]

A shame that the parliamentary inquiry into the use of consultants and contractors by the federal government was allowed to lapse without releasing a report.

But there’s a glimmer of hope.

The inquiry into the quality of auditing will report in March 2020. Submissions close on 28 October, so you’d better be quick if you want to be involved. Hopefully the inquiry’s report will lay bare the inherently conflicted nature of the Big 4 business model, their ‘all care and stuff all responsibility’ approach to their audit work, the lack of effective governance and the contradictory role of the profession’s own professional body, the corporate capture of government, and the lurking issue of annuity payments to former partners (watch for my next article on this one).

And ASIC has now stated that it will bring its why-not-litigate approach to its policing of audit quality and make use of a new fault-based criminal offence for registered auditors who fail to carry out their role properly. With a maximum penalty of just $50,400 or two years’ imprisonment or both, I reckon most of the Big 4 will take the risk given the fees they are charging.

And it’ll be interesting to see if partners at Deloitte and PwC can avoid handing over documents in relation to audits of companies that have since collapsed on the basis of self-incrimination. This again raises the issue of the partnership model (that contains liability to the country of origin) and the inappropriate use of the legal shields.

It's time for the audit firms to provide a level of transparency and accountability here in Australia and around the world and stop hiding behind the opaque and 'technically legal' structures they've created to be unaccountable.

[1] https://www.european-views.com/2019/07/massive-kpmg-fine-the-straw-that-breaks-the-big-fours-back/

[2] https://www.european-views.com/2019/07/massive-kpmg-fine-the-straw-that-breaks-the-big-fours-back/

[3] https://www.bbc.com/news/business-47074971

[4] https://www.accountancydaily.co/regulator-hands-out-record-ps43m-fines-bad-audit

[5] https://qz.com/1705744/big-four-accounting-firms-are-bungling-a-third-of-us-audits/

[6] AFR Hannah Wootton, 16 October 2019, page 28, https://www.afr.com/companies/professional-services/court-actions-against-deloitte-ey-kpmg-and-pwc-20190404-p51avg

[7] https://www.afr.com/companies/professional-services/one-in-five-audits-lack-necessary-rigour-asics-latest-review-finds-20190124-h1aewb

[8] https://www.theaustralian.com.au/business/asic-too-soft-on-audit-firms-medcraft-admits/news-story/cf5cd0440d288020e948c4a50ae43d3e

[9] https://www.theaustralian.com.au/business/asic-too-soft-on-audit-firms-medcraft-admits/news-story/cf5cd0440d288020e948c4a50ae43d3e

[10] https://www.afr.com/technology/federal-government-s-50b-outsourcing-bill-faces-new-auditor-probe-20190717-p527xl

 [11] https://www.afr.com/companies/professional-services/government-shuts-down-consulting-inquiry-without-a-report-20190414-p51e1w

 #EY #Deloitte #KPMG #PwC #accounting #Big4 #knowledgesharing #jaquilane

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