Monday, December 06, 2010

UK Parliamentary Committee Hears Testimony on Audit Concentration and Joint Audits from the Big Four

Audit concentration in the Big Four global audit firms is not likely to change any time soon and mandating joint audits is not the answer, according to testimony by Big Four senior officers before a UK Parliamentary select committee. There is also a growing global consensus on the beneficiality of the UK Audit Firm Governance Code. Ian Powell, Chair of the UK firm of PwC, noted that the current audit concentration is the result of market choice. The audit of a global company’s financial statements is a very complex product, he said, and the market looks at the scale and reach of the services that it needs. As client companies have become more global, as they become more multi-national, they look for that sort of degree of coverage from the audit firms that service them. In addition, given the level of investment that’s required across the world, he observed, it is understandable that it has come down to a relatively few firms that can afford that level of investment.

Scott Halliday, the UK and Ireland Managing Partner of Ernst & Young, testified that the audit profession would be improved by having increased choice in the market for auditor services. Legislation could help by removing the ``only Big Four clause’’ from any banking agreements. In addition, audit committees should be encouraged to step back and take a look at the complexity of the audit that they need to have executed by the audit firm and challenge themselves whether a second tier firm could really be well positioned to execute that audit versus one of the Big Four. Part of the solution also has to be for the second tier firms to really rise up and continue to invest to build the global network that the Big Four are part of. With the Big Four firms, they need to continue to invest and scale up their business globally.

With the European Commission having recently proposed to aid the growth of medium- sized audit practices by requiring joint audits of large companies, John-Griffith Jones, Chair of KPMG in the UK, noted that the only country that really has a major interest in joint audit is France. He does not believe that joint audits, per se, enhance competition and questions whether they improve quality. While the French contend that the system works perfectly satisfactorily for them, he noted, there have been examples in the UK, while not necessarily joint audits in the sense of being joint at the top, but having more than one audit firm involved, where fraud has deliberately got through the cracks by playing the two firms off against each other in different jurisdictions or different year ends. He said that BCCI is probably the most famous example. While there is no strong evidence either way that two firms are better than one, he emphasized, there is some evidence that two firms can lead to a weakening of the audit relationship where someone is deliberately trying to commit fraud.

Scott Halliday emphasized that E&Y strongly believes that having a single auditor will resolve in the best communication with the board, the best communication with management and in the highest quality audit. If you just think about two vendors or two firms having to have two dialogues with management, two dialogues with the board, he noted, there is then an opportunity for gaps to exist. You could even argue that joint audit poses a more systemic risk because if something went wrong with the audited company and there was damage to the brand of the two firms that audited that company, the result could be the collapse of two firms.

Mr. Powell of PwC noted tht there is nothing currently preventing a joint audit. The market, over a period of time, has decided that joint audits are not as efficient and maybe not beneficial from a quality perspective as well. But the choice is there if people want to have a joint audit, he said, the market has decided that joint audits are not something they would want to buy.

Responding to the committee’s query on the extent to which outside auditors dialogue with large shareholders of large companies, Mr. Griffith-Jones of KPMG said rarely, if at all, adding that the audit committee is taken to represent and act in the interests of the shareholders. The shareholders are not very active in coming to general meetings with Big Four audit firms, he said, even though the firms offer to meet them on a general basis. The issue of meeting on a specific client basis is clearly confidentiality, he continued, because what they want to know is something of market advantage to themselves and clearly, unless you had all the shareholders in the room at the same time, to talk to one group of shareholders in advance of another and to give qualitative views on one’s clients would not fit comfortably into the rules in the way they are operated at the moment.

Mr. Powell of PwC noted that one of the requirements under the new Audit Firm Governance Code is to facilitate the dialogue between investors and auditors. However, there is not much guidance in the Code as to the best way to do that. PwC has put together a public interest group composed of five senior people and is trying to decide what is the best way to meet that Code requirement. There will need to be some dialogue between investors and auditors, he emphasized, the firm just needs to design the best way to do it.

The Code provides that audit firms should commit to a dialogue with shareholders at the companies whose financial statements they audit. This principle is based on the belief that an audit firm's continued ability to maintain confidence in its audits depends on good two-way communications between the firm and its shareholders. The audit firm code also establishes a core principle that audit firms should appoint independent non-executives within their governance structure and deeply involve them in the governance of the audit firm.

Mr. Halliday of E&Y praised the new Audit Firm Governance Code and said that it is being adopted and looked at across the globe right now. E&Y has decided to implement the Audit Firm Governance Code at a global level and is in the process of placing independent, non-executive directors as required by the Code, with one domiciled in the UK, one from the Americas, one from the continent of Europe and one from the Far East. The Code is consistent with the global nature of the firm, he said.

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