Can Midsize Auditors be Turned into Big Ones?
Published in the International Herald Tribune on October 20, 2007
Cinderella has been invited to the ball. Or so you might be tempted to think, if you were the leader of a middle-sized accounting firm.
Tuesday saw the release of "Choice in the U.K. Audit Market," a report from the profession's regulator in Britain, the Financial Reporting Council. To give large companies a greater choice of auditors, the FRC - playing the role of Fairy Godmother - proposes to allow any firm smaller than the dominant Big Four accounting networks to be hired to audit the largest companies, releasing them in the process from their perceived state of drudgery and inferiority.
The FRC would make the smaller firms more attractive by opening their ownership to the outside capital needed to expand their capacity, and by jaw-boning both large companies and their bankers into offering audit work to these newly empowered firms.
Trouble is, the historic trend goes straight the other way. Audits for large companies are dominated by the Big Four, including all of the FTSE 100 in Britain. So although the FRC explicitly plumps for "market-led" solutions to this state of concentration, the market's own reaction has been a kind of cringing distaste - sort of like when your best friend asks you to take his little sister to the dance.
Also, there are signs that the mid-sized firms themselves may not be quite up for the big partying. Instead of standing alone and growing beyond the current limitations on their geographic scope and economic strength, as the FRC's program would encourage, the smaller firms are moving in the opposite direction.
In France recently, the Constantin network - 30 local firms spread over 60 offices - forswore its middle-market niche to unite its 500 employees with the 5,000 at Deloitte. In Britain, the RSM network has seen its affiliate Robson Rhodes run off into the arms of Grant Thornton, the No. 4 firm.
The FRC's second concern - to reduce the risk of another large-firm collapse, or to mitigate the effect if that should happen - is even chancier than the smaller-firm issues.
Despite the good news that the judge handling the Parmalat litigation in the United States has thrown out the claims of non-U.S. plaintiffs, Grant Thornton, whose Italian affiliate had been Parmalat's auditor, still confronts potentially deadly litigation from the collapse of Refco, the high-flying commodities broker in Chicago that Grants picked up as a client after the demise of Arthur Andersen in 2002.
I spoke this week with Paul Boyle, chief executive of the FRC, from his office in London. Boyle's modest aspiration is that the report's recommendations might make the world of financial assurance "a little less risky, and a little safer."
He has in mind the real probability of the disintegration of another large network, like Laventhol in 1989 and Andersen in 2002, under litigation liabilities that their capital cannot cover. That brings to the fore the prospect that a loss of another of the Big Four would lead not to a sustainable Big Three, but "four-to-zero" - a complete
collapse of the franchise of large-company audit assurance.
To prevent or mitigate that result, the regulators' available tools are "very limited," Boyle acknowledged. And as the recent tumult in the credit markets has proven, when a meltdown is underway, neither regulators nor the elusive "market" are always capable of bring things back under control.
Instead, if another Big Four collapse is imminent, Cinderella's coach becomes a pumpkin again - there being no agency or authority with the vision, the interest or the capability to stop it.
So take the FRC report as serious bedtime reading. And sweet dreams.
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