UK Lords on an audit profession run amok
A nice quotation from Lord Lawson of Blaby, from the UK parliament's record Hansard:
"It is more than 50 years since I was the senior writer of the Lex column in the Financial Times, and I have watched with concern the decline in moral standards in the City of London and in finance. It might be part of a decline in the whole community, which we are not here to discuss now. However, the matter is particularly serious in the case of banking."
Indeed. The subject matter under debate is the audit profession, and particularly the Big Four accountancy firms. This profession represents what Professor Prem Sikka has accurately called the private police force of capitalism (and read this article for some further background) and it is a matter of utmost importance to the way the economy works.
One part of the debate focuses on the issue of monopolistic or oligopolistic practices in the audit profession, and reveals such gems as the fact that the Big Four audit 99 of the largest firms listed in the FTSE 100 index, and that in the case of banking it's more like the Big Three, since Ernst & Young does not audit banks in the UK. As Lord MacGregor of Pulham Market notes:
"This does not look like a competitive market."
No, it doesn't look like one - because it isn't one. These gigantic firms can gouge businesses and consumers because of their dominance, they dodge large amounts of tax because of their supreme skills in the dark arts of offshore finance, and they of course help many others avoid tax. In the world view of these firms, tax is bad - and whenever journalists ring them up to try and understand some complex tax story, this 'tax is bad' ethic is subtly (or not) but steadily disseminated into the mainstream. We have seen protests against the banks, and quite rightly so. We need to see protesters paying far more attention to these monsters.
Here are a few more astonishing facts and quotes that were presented in parliament:
- An auditor to a FTSE 100 client remains in place for 48 years on average.
- Barclays has had the same auditor, PwC or its predecessors, since 1896
- In most EU member states the Big Four audit more than 85 per cent of large listed companies
- Banks were audited and certified as going concerns just before they had to be rescued by taxpayers to avoid collapse. (This is well known, but the section provides some useful details.) "We were not particularly impressed by the defences produced by the auditing firms themselves."
- "The senior partner of PwC told us: "It's not the job of the auditor ... to look at the business model of a business". This, as we conclude in our report, appears disconcertingly complacent. It is simply not good enough for the auditors to stand aside."
- The introduction in 2005 of international financial reporting standards (IFRS) to replace old British generally accepted accounting principles (GAAP) led to sharp reductions in the quality and reliability of large-firm audits, especially of banks. Under IFRS, auditors cared more about compliance with rules than with exercising professional scepticism and careful judgment. "The auditor's abiding principle is now box-ticking instead of prudence." (And "for the auditors, this approach makes life a little easier. There is less likelihood of litigation.")
- "The new chief executive of the Royal Bank of Scotland has recently referred to the Alice in Wonderland nature of some aspects of the bank's results."
- "We were shocked to discover that [essential confidential dialogue between auditors and bank regulators] -- which was required by statute under the Banking Act 1987. . . was virtually non-existent in the run-up to the crisis."
- A report last week by the UK's Financial Services Authority (FSA) slamming Halifax Bank of Scotland (HBOS) said the bank was guilty of 'gross misconduct' and criticised a culture 'of optimism at the expense of prudence.' This report didn't get the coverage it deserved, though it did get some.
- Lord Lawson: "What were the auditors-in this case KPMG, but I do not think that KPMG was any worse than any of the others-doing? To all intents and purposes it was doing nothing."
- Lord Lawson, on the hopeless fudge that involves creating a "ring fence" between retail and investment banking. "Bankers are very clever, or most of them are, and they will find ways round it. We are also talking about culture, and the prudent culture of retail banking and the adventurous culture of investment banking are two diametrically opposed cultures. With the best will in the world it is difficult to see how we can have two quite different and opposed cultures within the same corporate entity. There should be a complete separation, not just the ring-fence." Well said that Lord.
- A fragmented and unwieldy regulatory structure governs accountancy and audit in the United Kingdom, with overlapping organisations and functions. This "seems to offer too much scope for regulatory capture, especially since present or former big four partners hold so many positions on the various bodies and committees."
- They recommended that the Government and regulators should promote the introduction of living wills for big four auditors (that is an idea that has hitherto largely been touted for banks, not auditors).
There is much more in here, for audit and accountancy nerds: mark to mark accounting, the tax treatment of debt versus equity, and more. Shocking, shocking stuff. When will people pay proper attention to this industry: a profession recklessly out of control.
And if you want a really ugly case study about the audit firms, take a look at the Jersey chapter in Treasure Islands, about the LLP law. (Or read a different version of this story, from page 25 here.) And read the Sikka / Dunn monograph Auditors: Keeping the Public in the Dark. Which says, among many other things:
"Auditors do not owe a duty of care to any individual stakeholder. Neither are they subjected to any independent regulation. The institutional and market pressures to make auditors accountable are virtually absent."