Muscling in on the Big Four?

The Big Four accounting firms have long enjoyed the auditing pick of the FTSE 100, but could this monopoly be under threat with a new company to the list bringing with it its own auditor - a mid-tier firm, no less? Is this just one more example of a sea-change occurring within the auditing sector? asks Michelle Perry

A deep-seated tradition around audit hierarchy of the largest public companies altered slightly this summer, marking a change that regulators have been urging for several years.

The landmark entry of PartyGaming, the world’s leading on-line casino, straight into the FTSE 100 on its flotation in June, not only shook up the FTSE 100 but also the perception that only the Big Four have the resources and skills to audit the world’s largest listed companies.

With PartyGaming’s move into the world of the FTSE, it took with it its auditors, UK mid-tier firm BDO. The other 99 companies in the FTSE 100 are audited solely by the Big Four firms.

If this marks the beginning of a trend in auditing then regulators, stakeholders and government officials will be able to breathe a sigh of relief after four years of mounting worry and debate over competition and choice in the audit market.

Since 2001, when widescale fraud was uncovered at US energy giant Enron, leading to the ignominious collapse of Arthur Andersen, one of the then Big Five audit firms, regulators on both sides of the Atlantic have been faced with mounting concerns about reduced choice in the audit market.

Simmering concern shifted up a notch to heightened panic a few months ago when the US Justice Department said it was considering criminal charges against KPMG, one of the world’s Big Four firms, after discovering that a number of its now former US partners illegally sold abusive tax schemes to wealthy clients in the 1990s.

The very real threat that choice could further be reduced to three firms auditing the world’s largest companies is of great concern, not just to regulators and government authorities, but to all stakeholders including the accountancy profession itself.

Such is the worry that the UK’s Department of Trade and Industry and the Financial Reporting Council, the UK accountancy industry’s watchdog, spurred on by the financial community, has embarked on research aimed at understanding the reasons behind the high degree of concentration in the audit market and what can be done to move it on.

Paul George, director of the new Professional Oversight Board for Accountancy under the aegis of the FRC, says: “There is a concern that with the strengthening of ethical standards it makes it harder for large companies to have choice.”

Despite clear acknowledgment in the financial community that BDO has the resources and skills to conduct a FTSE audit, the firm downplays its success in becoming the only UK accountancy firm outside the Big Four to audit a FTSE 100 company.

No strategy

Jeremy Newman, BDO managing partner, says that PartyGaming’s decision to retain the firm as its auditors is long overdue recognition that a mid-tier firm can do this work proficiently. But he rejects the suggestion that it is a formal strategy of the mid-tier to muscle in on a traditional audit territory of the Big Four.

Rather, Newman says, it is the firm strategy to focus on building up “strength and depth” in industry sectors. “If we were to gain other audits it would be in sectors where we have strengths; not just to gain more companies.”

It is a point that Allen Blewitt, ACCA chief executive, raises. “A number of the mid-tier firms are targeting specific industry sectors. They understand their business needs and risks.

“But we haven’t seen any aggressive hunting for audits.”

Worryingly, this self-confidence among the mid-tier seems to have escaped large listed companies and their advisers. And this, says Giles Murphy, head of assurance and business services at Smith & Williamson, the UK’s tenth largest firm, is the crux of the problem.

“It helps that there’s a trigger to look at Group A firms as an alternative [to the Big Four] but there’s still an institutional prejudice in favour of the Big Four. It’s ignorance and apathy among institutional investors that force a Big Four choice,” says Murphy.

Blewitt agrees that many public companies and their financial advisers suffer from the perception that it could be a “hassle” to opt for a firm other than the Big Four and perhaps lose their institutional investors.

Prejudice among institutional investors is an issue raised in a report by the audit quality forum (hosted by the Institute of Chartered Accountants in England and Wales), which aims to bring together all sectors of the financial community to look at competition and choice in the audit market.

In its fifth report, released in July, the forum said that perceptions of investors, brokers, advisers and audit committees is an area, among others, that needed to be looked at urgently.

Nevertheless, this problem doesn’t appear to exist where non-audit work is concerned. Stricter ethical rules mean that large listed companies are increasingly turning to mid-tier firms for services, such as tax and corporate finance, in the wake of a series of corporate scandals in the US and Europe between 2001 and 2004, which led to regulators tightening up rules on services which non-audit services firms could carry out for their audit clients without jeopardising their independence.

Indeed, it is among the mid-tier firms in the UK accounting industry that the most exceptional growth has occurred this year. Several of the firms, including BDO, Tenon and RSM Robson Rhodes, experienced double digit growth, far outweighing that of the Big Four firms.

Newman says: “Where it’s not so visible who you are using for other services, companies find it easier to use mid-tier firms.”

People issues are another area that should come under the spotlight. “There’s a gravitational pull to the Big Four [by large listed companies] because often the finance directors have come from one of the Big Four firms,” says Newman.

Uncertainty

Still, with the current uncertainty over auditor liability, do mid-tier firms potentially want to risk their livelihoods for the sake of the kudos that goes with a FTSE 100 audit?

Indeed, the mid-tier appear quite content to pick up the lucrative, less risky, non-audit work from the large companies where the Big Four are conflicted out.

Phil Crooks, audit partner and assistant head of assurance at Grant Thornton, says that with the current ambiguity over auditor liability, risk is very much a concern for his firm.

“As long as we have the current regime, risk is still an issue,” says Crooks.

There’s also size to consider. The difference in resources and skills between the Big Four and the Group A firms is no small matter and this is often a problem for large public companies.

Increasingly, multi-nationals need firms that are able to work with them across the world in any region in which they operate, as the need for harmonisation has been enhanced with the heightened focus on internal controls.

To get round this, some of the mid-tier firms have developed international networks. But outside the Big Four, BDO has the largest global network.

Another idea under debate to improve choice is joint audits. But we’ve been here before, and several times. Previous research has revealed that joint audits increase costs for companies and often confuse an already complex area.

Blewitt says that although there is much enthusiasm for joint audits in France, his doubts over its success in the UK remain. “My instinct is that there’s a fair degree of duplication in this. And trying to manage an audit with two firms could prove difficult.”

One thing is clear: auditing is changing. It has to change. Many smaller firms are opting out of the audit market altogether at the smaller end of the scale. With KPMG still stuck in the quagmire in which its former tax partners left it, convention must be shunned. Could the current dilemma be partly solved with the development of pure audit networks made up of small firms? The possibility is no longer so unrealistic.

Michelle Perry is a freelance journalist specialising in financial and business issues.