Journalist
Share this content
Deloitte
istock_deloitte_tzahiV

Challenger firms wilt under Big Four audit dominance

by

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.

11th Nov 2021
Journalist
Share this content

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.

Experts are split, and reaction from both the Big Four and the challengers to the prospect of shared audits has been hostile

“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.

Investment needed

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.”

Watered down

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.

Replies (16)

Please login or register to join the discussion.

avatar
By Justin Bryant
11th Nov 2021 16:05

They are all basically as bad as each other coz they all have a conflict of interest (as the client is effectively paying the relevant audit partner(s) and they cannot afford to upset the client as otherwise they cannot afford their mortgage, divorce bill, whatever). If the NAO did these audits there would be no such problems (or they would be far less frequent) I assure you.

Thanks (4)
Replying to Justin Bryant:
By jon_griffey
11th Nov 2021 17:31

Justin Bryant wrote:

They are all basically as bad as each other coz they all have a conflict of interest (as the client is effectively paying the relevant audit partner(s) and they cannot afford to upset the client as otherwise they cannot afford their mortgage, divorce bill, whatever). If the NAO did these audits there would be no such problems (or they would be far less frequent) I assure you.

That is exactly right . This irreducible conflict of interest is the elephant in the room that no amount of increased audit regulation can ever hope to overcome. Auditors need to be appointed by a statutory body on a rota and imposed on the client, free from the fear of being sacked, they will have no qualms about asking the awkward questions.

Thanks (4)
Replying to jon_griffey:
avatar
By paul.benny
12th Nov 2021 08:36

Every service provider - lawyers, property agents, advertising agents, financial advisers has some conflict of interest between earning their fee and acting in best interests of client. That's why we have regulation and ethical guidance, particularly on independence.

It's not just the big firms - they're just the ones we hear about because of the profile of their clients. You only have to read the Any Answers pages to see the small practitioners anguishing over whether to walk away from a couple of thousands of fee from iffy clients or struggling with bad work by a predecessor or successor. The differences, they will never hit any headlines.

Thanks (4)
Replying to paul.benny:
By jon_griffey
12th Nov 2021 09:37

That is very true but it is different for auditors. They have a statutory role which requires their independence. They are in the very odd position of reporting on the stewardship of one group of people - the directors, to another group of people - the shareholders, yet in reality it is the former that agrees their fee and hires and fires them. It's like having the judge and jury appointed and paid for by the defendant.

Thanks (4)
Replying to jon_griffey:
avatar
By Justin Bryant
12th Nov 2021 10:47

That's right. It's a totally ridiculous argument to say there is no elephant in the room conflict as non-audit client work suffers from the same conflict.

Auditing is a totally different kettle of fish. A bit like how expert witnesses's duty is to the court, not those instructing them, yet they charge those instructing them and for that reason more often than not forget their duty to the court to be impartial and instead "descend into the arena" and argue their client's case on a totally biased basis. Outside such court work there is no such conflict in the 1st place.

Thanks (0)
Replying to jon_griffey:
avatar
By paul.benny
12th Nov 2021 10:49

jon_griffey wrote:
...auditors.. [are] reporting on the stewardship of one group of people - the directors, to another group of people - the shareholders

That's not quite right. The auditors are reporting on the directors' own account of their stewardship, specifically whether the annual report and financial statements show a true and fair view.

If directors end up appointing the auditors - as is almost always the case - that is because the shareholders neglect their right to vote on the appointment. That's not the fault of auditor or directors.

Thanks (1)
Replying to paul.benny:
avatar
By Justin Bryant
12th Nov 2021 11:25

All that is totally beside the above elephant in the room conflict point.

Thanks (0)
Replying to Justin Bryant:
avatar
By paul.benny
12th Nov 2021 12:23

Disagree.

Everybody recognises the inherent conflict of interest. That's why auditors of public companies and others are not allowed to provide non-audit services. That's why we have mandatory partner rotation. That's why we have ethical guidance. That's why fee dependency is limited.

Ultimately we're talking about company failures. Plenty of companies have bad audits and thrive and plenty fail irrespective of audit quality. But no company fails because of a bad audit.

BHS failed because it had been run into the ground and was acquired by someone who hadn't a clue and didn't realise how dire it was. Carillion failed because of greedy management. PV failed because of management fraud (alleged). Certainly their respective auditors could/should have identified the failings sooner. But it's moot whether that would have prevented failure.

Big firm auditors get blamed (partly) because they're seen as fat cats, even by other accountants. But how many directors of failed companies get meaningful censure or penalty. We should be pointing the finger where the blame truly lies

Thanks (2)
Replying to paul.benny:
avatar
By Justin Bryant
12th Nov 2021 12:45

You fail to understand the basic nature of the elephant in the room conflict we are talking about. Consider a large audit company client owned and controlled by H&W directors. It's more or less the same conflict issue. Just coz the shareholders in that case may not be prejudiced does not mean other stakeholders (particularly creditors, employees (company pensioners), etc.) cannot be prejudiced is the basic conflict point.

It's also beside the point in practice re other cases as stated in PC's comment below.

Thanks (0)
Replying to Justin Bryant:
avatar
By paul.benny
12th Nov 2021 14:04

I'm sure you're well aware that auditors have no responsibility in law to stakeholders other than shareholders. Whether they should have is another matter.

Directors do, of course, have responsibilities whether or not they are also shareholders. But for the most part compliance with those is not within scope of audit of the financial statements.

Thanks (1)
Replying to paul.benny:
avatar
By Justin Bryant
12th Nov 2021 16:33

So are you saying only shareholders can sue auditors and a bank lender cannot sue PwC say for a muppety, half-baked audit that causes the bank a foreseeable loss on its reasonable reliance on those accounts?

And what's that got to do anyway with the underlying conflict problem that causes all these duff audits in the 1st place?

Thanks (0)
Replying to Justin Bryant:
avatar
By paul.benny
13th Nov 2021 08:54

From current generic audit report:

This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed.

Where do you think this gives a lender any rights against the auditor?

As for independence and audit quality, I've already addressed that - see my post of 12 Nov at 12:23.

Thanks (0)
Replying to paul.benny:
avatar
By Justin Bryant
13th Nov 2021 09:35

That hardly answers my above legal liability point does it? If anything it confirms it, as why would such a limitation be needed in the 1st place?

Your post of 12 Nov at 12:23 is a pretty naïve view of things, putting it mildly. If you were right, there would be little if any point in audits in the 1st place.

Thanks (0)
Replying to jon_griffey:
avatar
By Paul Crowley
12th Nov 2021 11:11

Superb analogy
Voting at an AGM is a foregone conclusion

Thanks (2)
avatar
By Ian Bee
12th Nov 2021 12:19

Totally agree with the points made regarding conflicts, and it reaches down to partner level. You don't want to be explaining the loss of a large client to the other partners if you can possibly avoid it.

Above all it is a crazy set up to have a quasi regulatory position held by firms in a competitive market.

Thanks (2)
avatar
By AndrewV12
24th Nov 2021 11:48

people do not generally like to change accountants, no matter how crap, I think its the same for Auditors, no one from either side is going to rock the boat.

Thanks (0)