Challenger firms wilt under Big Four audit dominanceby
Despite making inroads at the top end of the market, middle tier auditors have found themselves under greater scrutiny than ever, triggering a litany of investigations and criticism from the accounting regulator over poor standards.
The recent promotion of cybersecurity company Darktrace to the FTSE 100 marked the first time in more than two years a firm with non-Big Four auditor is listed on the index.
Grant Thornton has broken the stranglehold Deloitte, KPMG, PricewaterhouseCooper and EY had as auditors of the top UK-listed entities, but the landmark occasion has been overshadowed in recent weeks by the level of enforcement activity currently centred on challenger audit firms.
Reshaping the scandal-struck sector has been a priority for the government, but attempts to champion mid-tier firms and improve competition have been undermined by failings from the auditors lined up to take business from the Big Four.
Last month, Grant Thornton was fined £2.6m for sloppy audits of collapsed bakery chain Patisserie Valerie where the regulator chided the challenger firm for “a serious lack of competence”.
This month, the UK’s sixth largest auditor stung again and criticised for failures in the audit of support services giant Interserve. Grant Thornton is currently under investigation in two separate Financial Reporting Council (FRC) probes, along with French challenger Mazars, which is being probed for questionable audits of troubled clothing brand French Connection.
The FRC announced on the same day an investigation into the audits of music streaming service Akazoo carried out by Crowe. Adding insult to injury for Mazars, both it and BDO, the largest of the challenger firms, were rapped by the FRC for the poor quality of their audits following inspection.
“In their efforts to break the dominance of the Big Four in the UK’s audit market, mid-tier accountancy firms are facing increasing regulatory pressure,” said Paul Brehony, partner at Signature Litigation law firm.
The glacial pace of the incoming government reforms hasn’t helped, but there has been little sign of mantle grasping from firms outside the Big Four following the high-profile collapses of Carillion, BHS and other auditing fiascos that triggered the shake-up of the market.
“Those same challenger firms are now themselves encountering greater regulatory scrutiny as they conduct increasingly complex audits in a more stringent regulatory environment - often without historic advantages at the scale enjoyed by the Big Four,” said Brehony.
Grant Thornton, BDO and RSM declined to offer comment when approached by AccountingWEB to discuss their strategies for making further inroads into the FTSE 100.
Joint audit resistance
Last year, the five largest non-Big Four accounting firms conducted about 8% of audits in the FTSE 250, which includes the next largest 250 public companies by market cap after the FTSE 100, according to the regulator. That is a rise from about 5% in 2019. Change will not come without regulatory intervention, but there is a “chicken and egg” problem, according to the Competition and Markets Authority (CMA), the antitrust watchdog driving some of the changes.
Unless smaller auditors are handed responsibility to audit large, complex companies, they cannot expect to gain the experience necessary to win business at the top of the table. Yet without that experience, they are unlikely to be chosen by a company to replace a Big Four auditor.
As a result, one contentious aspect of the intended reforms involves proposals to mandate shared audits for large companies that will involve challengers working with KPMG, Deloitte, PwC and EY.
“Is it a case of asking turkeys to vote for Christmas? No,” said Chris Biggs, partner at Theta Global Advisors. “It's no surprise that the 'shared audits' proposals are not meeting much support. Shared audits offer their own inherent risks, increased costs and impracticalities. Keeping the current auditor and future pool of auditors totally independent is critical,” he said.
Industry experts also feel it could be detrimental to the companies being audited, with higher costs and more legal complications, especially for SMEs.
“The reality may be that tighter regulation and increased regulatory scrutiny – and the significant litigation risk inherent in major audits – could make auditing the largest companies simply too big a risk for mid-tier challenger firms to take on,” said Brehony.
The head of the FRC, Jon Thompson, wants to cap the number of large listed companies that can be audited by a single firm. BDO has indicated it supports this idea, which suggests the joint audit idea may be parked.
“To be open, there are many who consider that managed shared audit might not be capable of being implemented in the UK, but instead they very heavily prefer this market caps idea – the idea that the regulator would limit the Big Four and their share of the market,” Thompson said at an ICAEW event.
The next step will be for the challengers to prove they are up to the task, although this will require a significant expansion and hundreds of millions in financing to build the kind of teams necessary to audit a multinational conglomerate.
Professor Atul Shah, accounting lecturer at City University believes no amount of money spent can fix the rot at the heart of the sector, which afflicts firms of all sizes. “Auditors used to have a sense of public interest but the whole industry has now become highly corporatized. Audit quality depends on being suspicious.”
Audit quality depends a lot on people, culture and incentives, said Shah. “In commercial firms driven by revenue and profits, these qualities increase costs and destroy client friendships,” he said. “The best way to change the future is to put some accounting leaders behind bars and to completely separate audit from consulting.”
The latest rumblings from inside the business department indicate penalties for transgressions will be lessened, rather than increased, which has incensed some industry voices.
Financial press reports indicate the proposals are to be more “business friendly” following pushback from the corporate sector of costs relating to implementation of responsibility and governance changes.
“If any one of the pillars of this reform programme is weakened then the whole package is at risk of falling down,” said Michael Izza, chief executive of the ICAEW.
The white paper on reforms “recognised that tighter regulation of audit would not be enough by itself, and it set out an ambitious and balanced package of measures which included a new reporting requirement for internal controls,” he added.
Business secretary Kwasi Kwarteng has not signed off the changes, and no firm decisions have yet been taken, a spokesman for the business department said.