Deloitte's Audit Ban in Saudi Arabia -- And Its Global Effects?

This week’s report that the Capital Market Regulator in Saudi Arabia will ban Deloitte’s firm from auditing public companies there as of next June 1, on account of its work for the targeted loss-making company MMG, will not be going down well for the largest of the global Big Four accounting networks.

Much more ominously, a collateral outcome of the Saudi black-ball may be the long-feared destabilizing of the Big Four’s trust-based franchise to audit the world’s largest companies, by a disruptive event in a location mistakenly assumed to be peripheral.

It has been well-enough recognized, since 2002 when Arthur Andersen’s leaders fatally failed to placate the US Department of Justice over conduct related to Enron, that it hurts to be on the wrong side of angry life-or-death power. Conversely, there are ample examples of the Big Four’s escape from scrutiny in settings too small to be consequential.

It’s the combination that is dangerous: an authority without a mature history of regulatory predictability, but with enough influence to unsettle the Big Audit model.

For some illustrations:

• In 2000, the Italian antitrust authority had the then-Big Six firms dead in its sights, with charges of price-fixing and other coordinated anti-competitive conduct. Lacking either the will or the motivation to push for practice prohibitions or other changed behavior, however – and who knows about “Italian justice” -- the agency was content to tap the firms gently on their wrists.

• PwC’s firm in Russia spent several years in litigation over its 2002-2004 audits of Yukos, under potential threat to its license to practice. But as now reported, PwC having remitted its fees to the government in settlement, it is comfortably persona grata, as shown by its engagements for Gazprom and Sperbank.

• PwC also suffered the inconvenient protracted incarceration of two of its Indian partners and their lengthy criminal trial, over the billion-dollar “ghost employees” scheme confessed in 2009 by Ramalinga Raju, founder and CEO of Satyam Computer Services. Results of the trial are expected at the end of this month. But it would seem unlikely that PwC‘s global chief Dennis Nally would have travelled to Delhi last month to head up his firm’s vigorous pimping a Goldilocks view of the country’s economy under Prime Minister Modi, unless he was thoroughly comfortable that the expected outcome would not disturb his firm’s presence there.

What is important is that none of these countries are large and important enough to matter. The Big Four’s global networks could survive worst-case exclusion from local practice in Russia or Italy or India.

It could have been a different and life-threatening story, by contrast, if in 2006, the sanctions imposed on PwC in Japan for its work on Kanebo had not been so flexible. With the size and global connectedness of the Japanese economy, PwC dodged a fatal bullet, permitted to survive the forced closure of its local firm by organizing a new local affiliate – which came to absorb many of its personnel and, vitally, by which it was able to continue both local work for foreign clients and ex-Japan work for its clients there.   

Which comes back to Saudi Arabia – where, incidentally or not, Deloitte also audits the Saudi-listed telephone provider Mobily, another investigation target after profit cuts, a stock price collapse and the suspension of its chief executive officer.

What is now unknowable is how far abroad the Saudi sanctions will run. In mature regulatory environments, official enforcement would not cascade into private sanctions across a Big Four client list. Leadership of a CalPers or PIMCO or Vanguard would resist imposing a ban on one of the Big Four that would cause self-inflicted disruption to the companies making up their massive fund portfolios.

Could the same be said of the global holdings of the Saudi royal family?

Demonstrably sensitive to any suggestion of lack of transparency, Prince Alwaleed Bin Talal is the chairman of the Kingdom Holding Company. On his watch, Deloitte’s consignment to pariah status in his country must be of concern, for example, to Deloitte’s firm in the UK, as auditor of one of the Kingdom’s premier real estate holdings, the massive Canary Wharf development in London.

More’s to the point, it might safely be predicted that, if the Prince has any say in the matter, only if Riyadh freezes over will Deloitte compete successfully against the incumbents for audit engagements of such prize Saudi holdings as Citigroup (KPMG), EuroDisney (PwC) or News Corp (EY).

The rippling effects of Deloitte’s Saudi-originated punishment may be grave enough. Further, with the acute pressures on auditor choice and replacement arising from mandatory re-tender requirements in the UK, and the rotations mandated under new legislation in the European Union, the structural impacts beyond a single unpredictable country can only be … well … unpredictable.

 

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Comments

[Joe Conneely]

What your article leads me to conclude Jim is that using your Saudi example, the wider move of power over audit appointments may move from its older historical base in USA & main EU countries (and even a lot quicker than assumed before). If you apply the approach you mention to recent major global capital investment flows, the growth in power over the last decade of sovereign funds and the power they might potentially wield arises.

Would one see in addition to Saudi Arabia, the likes of Norway, Abu Dhabi, China, Kuwait and Singapore as being that powerful a concern to major audit firms in 2000 compared with their global financial reach now? Plus the issue quickly becomes a political one as USA and Germany start making laws to address this trend!