Should the Big Four Have Audited Financial Statements? Should the Cobbler’s Children Have Shoes?

The Public Company Accounting Oversight Board’s member Steven Harris proposed on March 20 “that the large accounting firms make their audited financial statements available to the public.”

Harris observes that “many find it ironic that auditing firms in the United States…resist providing their own financial statements,” and sees no reason “that the auditing firms that act as gatekeepers to our securities markets should not be as transparent to investors as the companies they audit.”

“Irony spotting” not being a trait of Washington functionaries, Harris did not observe this coincidence – that he was two weeks ahead of the PCAOB’s two days of public meetings to further address its 2011 proposal for reconsideration of the manifest inadequacy of today’s auditor reporting, about which Harris himself said in September 2011:

“Investors clearly do not believe the current three paragraph, largely boilerplate, binary audit report, is either sufficiently informative or serves their needs.”

Suppose -- instead of his agency’s dreary record of spotty inspection coverage, confusing metrics and failed initiatives – that the Harris proposal to impose on the Big Four an obsolete and ineffectual assurance model were actually taken up and debated seriously.

The foxes would be truly set among the chickens.

First of all, it can be done. Some local firms of the large networks already publish IFRS-based financial statements, audited and reported on by their colleagues (in the UK, see Deloitte, EY, KPMG and PwC).

Problems of scale and substance raise immediate questions, but it’s to be noted right here – and on which more anon – that back in the late 1970’s, Arthur Andersen’s global financial statements were audited and reported on by Haskins & Sells – as the Deloitte firm in the US was then branded.

Should the Big Four voluntarily offer such disclosures and assurance? Or should they be required to do so? The cross-currents and antagonisms in those discussions would be worth the admission price.

Over the profession’s long-standing resistance, there could be considerable public education, both from the information to be disclosed, and from that not furnished.

Consider an extension to the US of the Big Four’s UK audited disclosures: for 2013, country-level revenue ranging (in millions) from £ 1,721 to £ 2,689, with UK firm profits from £ 455 to £ 740.

Those UK data mainly serve to reinforce a point urged here for years – that the Big Four’s business model, running on client receivables and egg-shell-thin capital, is not designed or robust to withstand the ten-figure financial shock that would be inflicted by a truly bad-case litigation or law enforcement outcome.

As to information that similarly-designed US disclosure would not make available – two gaping holes:

The first is that, just like the world’s other large enterprises – and noting that the Big Four’s reported aggregate global revenues for 2013 exceed $ 113 billion -- their UK statements are opaque on the extent and quantification of litigation claims and contingency exposures.

The same would be true in the US – where the modus vivendi between the accounting standards-setters and the litigation defense lawyers has forever permitted a shroud of confidentiality over the uncertainties of publicly predicted litigation outcomes.

And second, the UK experience makes clear the limited amount of world-wide information to be gleaned from country-level reporting – which offers only the most passing reference, in either words or numbers, to the local firms’ membership or participation in the business and funding of their global networks.

The Big Four continue to work the two sides of this structural issue, of course, as they are both obliged and permitted to do under the parochial nature of the profession’s organization, regulation and oversight. They proclaim both their revenues and their commitments to seamless service on a global scale, but they pull back to local-country descriptions for purposes of risk acceptance and cross-border liability.

So this point requires public acknowledgement: although Arthur Andersen was alone in ever submitting its statements to independent audit, its global network fell in 2002 like a house of cards, under the unwillingness of its ex-US firms to support the US firm in its time of Enron-based travail.

Which calls for one final and irony-tinged observation. Those urging the extension of Big Four reporting transparency would no doubt press Harris and the PCAOB to require the Big Four to follow the initiative of Andersen’s global reporting from a generation ago, as could be done, under the PCAOB’s authority over non-US audit firms participating in the audits of public companies filing in the US.

But whereas the Big Four’s UK firms are audited by firms in the next smaller tiers – who have no significant share of the market for audit services to the world’s largest global companies – the only auditors having the geographic scope and scale to report on the Big Four’s global networks would be those very four networks themselves.

If put in place, that round-robin of mutual examination and reporting would not find favor, it could be surmised, among the unremitting critics of the accounting profession who see malign cartel behavior at every turn.

So – bravo for the Steve Harris initiative. Let both the hand-wringing and the stone-throwing begin at once. And see who comes out on the other side.

 

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Comments

[Mike Corcoran]

How about stress tests to make sure partner capital is sufficient in a regulators mind?

[Paul Gillis]

The Big Four are public interest entities. Although private, society has a keen interest in making certain the firms are solvent and capable of long term survival.

All PCAOB registered firms should be required to provide audited financial statements to evidence their capability to serve as auditors of public companies. That includes the foreign affiliates.

[Jim Peterson]

Thanks -- but the difficulty with the comments above from Corcoran and Gillis is that the existential problems that confront the Big Four are not susceptible to either evaluation or mitigation, neither by "stress tests" nor by published financial statements. The types of short-comings in business models that would be revealed, for a bank's capital under exigent conditions or for degraded performance that would call for a going-concern opinion, are not what would kill off a Big Four firm; it's the indictment or the "worst-case" shock of a several billion dollar litigation hit -- neither of which fits these proferred "solutions.