The biggest accounting firms would be split up and forced to drop many of their audit clients under Labour Party proposals to reform the industry in the U.K..
“These are not radical proposals,” Prem Sikka, the Sheffield University accounting professor who led the party’s review of the audit market, published Dec. 14, told Bloomberg Tax by phone.
“Many of these things have been discussed for 30 years but reform has been stymied by the Big Four’s financial and political influence,” Sikka said, referring to Deloitte LLP, Ernst & Young LLP, KPMG LLP, and PwC, also known as PricewaterhouseCoopers LLP.
Sikka’s report, commissioned by Labour shadow chancellor John McDonnell, would force the biggest firms to split out their audit arms and cap their share of the audit market for the FTSE 350 biggest companies at 50 per cent.
Drop Biggest Audit Clients
This would force the Big Four, which audit all but 10 of the FTSE 350 companies, to drop many of their biggest audit clients.
Announcing the launch of the Sikka review in May, McDonnell promised tough action against the accounting industry following a string of auditing scandals in the country, such as the collapse of the outsourcing company Carillion Plc shortly after issuing reports without qualifications.
“It is essential that we have a crackdown on poor practices in the accounting and auditing industry,“ McDonnell said in May. ”Under the next Labour government the big six firms will not be allowed to continue to act like a cartel that prevents new market entrants or drive down standards.”
Labour is pushing for an election that could see it take power if the minority government of Prime Minister Theresa May fails to force a controversial Brexit deal through parliament.
Independent Audit Assignments
As well as forcing the Big Four to split and give up many of their audit clients, the report calls for the creation of an independent body to hire and pay corporate auditors.
It also calls for large financial companies, such as banks, to be audited by a public body rather than by private accounting firms.
“The state could become the fifth biggest provider of audit services in the U.K.,” Sikka said.
“Audit is a public service, not a private business,” Sikka said. “Auditors are riddled with conflicts of interest.”
Taking away many of the Big Four’s audit clients—including the large banks—and splitting out their audit arms would slash them in size to the extent that mid-sized firms could compete for clients, Sikka said.
“We’re also saying that joint auditors should be required for all of the U.K.’s 7,500 big companies,” Sikka said.
“That will bring mid-sized auditors into the market and give them the experience for large audits,” Sikka said. “It’s essential they are there to fill the gap if one of the Big Four collapses, as is bound to happen in time.”
Sikka cited the collapse of Arthur Andersen in 2002 and the $456 million fine levied on KPMG in the U.S. in 2005 for a tax scandal as evidence that even the biggest firms could fail.
Sikka added that the U.K. audit market had been weakly regulated.The report calls for audit firm partners to become personally, and criminally, liable for audit failures. It also calls for auditing to be overseen by Parliament, rather than by outside bodies such as the current audit watchdog, the Financial Reporting Council (FRC).
“The Kingman report into the FRC and the CMA’s study of the audit market will be published next week,” Sikka said, referring to two reports commissioned by the Conservative government earlier this year.
The Competition and Markets Authority confirmed in a statement that its report, which could also recommend splitting up the biggest firms, would be published “before Christmas.”
“The CMA might well decide to prefer measures such as market share caps to splitting up the Big Four,” Sikka said. “However, that will not be the end of the matter and this will remain under review for years to come. We recommend that the CMA re-examines the audit market every five years.”
Michael Izza, CEO of the Institute of Chartered Accountants in England and Wales, warned that some of the report’s suggestions could be counterproductive.
“The accountancy profession absolutely recognises the need for change,” Izza told Bloomberg Tax.
However, “we believe some of his recommendations would have unintended consequences. Taken as a whole, they could actually prove counter-productive to the aims of improving audit quality,” Izza said, talking about the Sikka report.
Izza said that he opposed removing companies’ right to hire their own auditors, and said that “a radical increase in auditor liability” could scare away some of the firms already active in the audit market.
The six biggest accounting firms all declined to comment on the Labour Party report.