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Tuesday 29 January 2019

Tortoise Take

Bring them to book  

The Big Four audit firms have failed in their public duty. We need better bean-counters

The audit firms have failed in their public duty. They are supposed to be the honest brokers who tell us that a company that says it is not bust is good for the money. Auditors are meant to check whether a company’s reported figures give a “true and fair” representation of its finances, so the rest of us can be confident that businesses we trust are not about to disappear.

But where were they during the financial scandals at Autonomy, Carillion, Cattles, Conviviality, BHS, BT, Tesco, Quindell and Patisserie Valerie? In each case, auditors collected enormous fees and delivered no value. They failed to do the bare minimum. Those scandals will cost thousands of people jobs, pensions and their investments.

This is not a problem with small fly-by-night firms. The UK’s audit regulator found in its last annual review that half of KPMG’s audits of major companies failed to meet standards. Globally, the International Forum of Independent Audit Regulators found problems with 40 per cent of the 918 audits of public companies it inspected last year.

There is one obvious answer in circulation: a survey, published this week, found that breaking the auditors up is popular. KPMG, EY, PwC, and Deloitte account for half the US and UK audit markets. Last year, KPMG’s UK chairman described the audit sector as an “oligopoly” – a market where a few players dominate. While break-up may be where we end up, it is not the place to start.

If we simply increase the commercial pressure on auditors by making more of them, we might well reduce the price of the service for companies. But some of the problems within the sector are not related to the lack of competition. Given that companies appoint their own auditors, they could end up competing harder – which could lead to yet lower standards. That, rather than the cost of audit, is the big problem.

So how to make audit better?

Audit is a state-guaranteed market: medium-to-large entities are required by law to submit to an audit. But auditors are left to regulate themselves too much – with predictable results. In 2015, Britain’s audit regulator proposed removing rules that would prevent companies from paying dividends when they did not actually have any cash that they could safely distribute. In doing so, they proposed abolishing the very rules that modern auditors were introduced to enforce. The world needs stronger, more independent regulation.

Furthermore, all too often, auditors make more money charging their clients large consultancy fees than by auditing their books. The two roles are in conflict. An auditor should feel free to make declarations about a company’s strategy that might discomfit it. But if that strategy were devised by an auditor’s colleague, would they be so bold?

There is a similar problem with auditors who work for the same clients for years: yes, the auditors will get to know the business. But will they become beholden to their longstanding clients? If they find something one year that they missed in earlier audits, will they feel compelled to defend older judgments – or will they come clean, and acknowledge the earlier error?

We also need a cultural shift. Auditors, as a profession, ought to feel profound shame when it emerges that a company has been allowed to mislead the world about its solvency. But it has become technocratic and light-touch, done by graduates looking at aggregate data rather than by experienced accountants who know how to ferret out irregularities.

Auditors today hide: they blame their failure to detect irregularities on financial statements handed to them by company managements. They say they are watchdogs, not bloodhounds. Let us be clear: that is not what we need of them. They are not there to protect their clients, but to find out what their clients are up to.

It may be that we end up breaking up the auditors: we certainly do not think they deserve particular protection. If the audit market is uncompetitive, get the trust-busters in. But a lack of competition is not the core of the problem that worries us. Our concern is that, even though it is currently relatively easy for big auditors to make scads of money, auditors are not providing the basic service that we demand of them.

Auditors should be doing a harder job for less money – and enjoy pricklier relationships with their clients. They may not want to move to that world. But if they will not go there willingly out of a sense of professional obligation, legislators should force them to.