Re:Balance -- Jim Peterson

Audit “Reform” in the UK – the Government Finally Speaks, and Says Little

On March 18, the UK government weighed in with its long-promised consultation paper (the “Consultation), “Restoring Trust in Audit and Corporate Governance.” Ninety-eight questions, spread over 232 pages, contain much that is cautious and little that is innovative. The problem is, what is cautious would not innovate, and what would innovate is not cautious.

For another day, the Consultation’s fulsome treatment of such worthy topics as the re-purposing of the UK’s audit regulator, the performance and accountability of corporate directors, and the very purpose of corporate information assurance. On the central topic of public concern since the failure of Carillion back in January 2018 -- the structure and performance of Big Audit itself -- the Consultation offers on only two items.

These are the “operational separation” of the Big Four’s audit and advisory practices, and the threatened imposition on FTSE 350 companies of “managed shared audits” – a novel concept unknown to either professional standards or actual practice.

The first is easily disposed of, as an insubstantial exercise in optics. The second, to be further discussed, is ill-conceived and deeply flawed.

“Operational separation” should have been recognized as a trifling matter the instant it was mooted (see § 6 of the April 2019 Final Report of the Competition & Markets Authority on its Statutory Audit Market Study).

That’s because the UK critics have neither the will nor the authority to force the Big Four networks to expel either of these core UK components from their global structures – disruptions that would disable them from the breadth of services demanded by the complex auditing of the world’s large public companies. Attempted “full legal separation” at the UK level, in other words, would be either or both legally impossible and globally inconsequential.

Moreover, it’s no surprise that the Big Four would accede to the Financial Reporting Council’s quest for public display of their audit leadership, governance and financial reporting. The simple reason was that they already had such structures and metrics in place -– essential tools for managing these four large businesses -- audit practices having published 2019 revenues of between £ 453 and £ 713 million.

Back to “managed shared audits” -- the Consultation contemplates (¶¶ 8.1.15-.16) that a FTSE 350 client of the Big Four would be obliged in its audit tender process to identify a “meaningful proportion” of its statutory audit -- not less than 10% and desirably closer to 30%, by metrics including audit fees, group revenues, assets and profits – to be performed by one of the so-called “challengers” – that is, a firm below the Big Four in size, yet brave enough to deem itself qualified to propose.    

Whisper who dares: in a triangular relationship among an issuing company, its lead auditor and a “challenger,” such an arrangement could satisfy none of the three.

Because the Consultation would not allow for joint bidding (¶ 8.1.17), a Big Four firm preparing to take the lead would start from an untenable position –- not even knowing the identity of the smaller firm, much less its qualifications, reputation or resources by either industry or geography. Despite which, that lead auditor would, under applicable professional standards and the liability regimes to which its global-level work and overall opinion would be exposed, bear full responsibility for the results of the group audit including the work performed and up-streamed by the “challenger.”

Passing for the moment whether such inhibitions would implicate a scope restriction on the lead auditor’s acceptance and planning (see International Standard on Auditing 300), a lead firm’s risk manager would have cardiac arrest at any lesser level of involvement than essentially 100% re-performance of the work of the “challenger.”

As for the company under audit, its management and audit committee could scarcely with comfort identify between 10% and 30% of its operations to be devolved for audit by a “challenger” whose capability and experience at the FTSE level would range from untested to non-existent.

Complicating the risk assessments of both the company and the lead auditor are two issues that inhere in the globalized nature of the large-company environment. First, a recent study estimates that 62% of the sales of FTSE 100 companies (and 35% for the FTSE 250) are generated in locations and operations outside the UK – beyond the geographic scope of a UK-based audit team. That means either that a “challenger” would be obliged to bring its own global resources to bear at the same level of multi-national scope and scale as its putative client – as the Big Four do now -- or that a company would essentially devolve what it could of its UK-based operations, leaving the lead auditor to carry out the ex-UK work and perform the eventual audit and reporting on the consolidation.

Also on the global front, affecting each leg of the triangle is the FTSE 350’s trading of their securities not just in the UK but in other major markets – especially the US where, as put in a recent cautionary article, American Depository Receipts are offered to investors “for over 200 UK companies including most of the country’s large cap companies.” The long US history of high-cost shareholder and other lawsuits presages liability exposures for which the “challengers” are woefully unequipped, and for which the Big Four would have no appetite to carry the burden of their smaller brethren.

Finally there is the unavoidable but compelling matter of the scale and capability of the “challengers” themselves – who audit none of the FTSE 100 and but ten of the next smaller FTSE 250 (see Figure 38, p. 48, of the Financial Reporting Council’s “Key Facts and Trends in the Accountancy Profession,” October 2020).  

In a 210-page Impact Assessment accompanying the Consultation, a model is cobbled together to support an aggressively optimistic position on the growth potential of the “challengers.” Using historical audit fee income for the five largest, ranging from 1% to 4% (page 127), a “conservative assumption (is made) that annual capacity growth of 2-4% can be safely sustained by challenger firms.”

Two problems – one of method and one of supply – are fatal.

For the first, the model disregards the Big Four-dominated growth of overall FTSE audit fees, as shown by two relevant data points: the 2018-2019 growth in Big Four audit fee income of 6.9% (page 46 of the FRC’s “Key Facts and Trends”) and the UK audit practice growth figures for 2020 reported separately by the Big Four, ranging from 3% to 8.7%.

Bluntly put – at the “challenger” growth rates assumed by the Consultation model, and the faster rates actually achieved by the Big Four -- the “challengers” would be losing market share, not gaining. Not assumed, but indeed omitted, would be the inability of the challengers in this zero-sum environment to grow relatively, enough faster than the Big Four to achieve an actual shift in their market share.

To which must be added a further and final point -- the supply side problem of the “challengers” to grow their necessary rosters of experienced partners. Within the Consultation’s timetable, their only available recruitment sources are the Big Four themselves, where individual partners would understandably question a poacher’s overture: reduced profitability and lower compensation, lesser industry experience and technical support, and uncertain financial resources in the face of expanded liability exposure.

The “managed shared audit” proposal would exacerbate those concerns -- because the partner-level obligations and responsibilities at a lead firm would expand in the execution of an engagement involving a “challenger.”

That is, in a single-firm engagement, a signing partner (and the other partners on a complex job) have the benefit of the coherence, cohesion and efficiency of working with a team of subordinates sharing a common set of methodologies, documentation, vocabulary and communications. Delegations can be made, and expectations set, in the relative confidence of shared membership in a common enterprise.

Not so, where that lead partner would be obliged to receive, review, and accept ultimate responsibility for ten to thirty percent of an engagement as staffed and performed by strangers – for which there could be no solution but to increase dramatically the level of partner time, energy, and attention.

At the broad market level, such a shared-audit concern would anticipate major partner-driven fee increases at the lead firm. At the personal level, Big Four audit partners would expect to see their value enhanced, not diminished, by the forced carving out of portions of their FTSE company portfolios – with a concomitant further reduction in a poacher’s attractiveness.

Shot through as the Consultation is with other failures and short-comings of vision – to be addressed here anon – it is earnestly to be hoped that its proposal of “managed shared audit” will promptly and deservedly be dismissed as impractical and unachievable, lest it crash in unintended consequences if an attempt is actually made to put it in place.

 

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A Reality Check at the UK Audit Regulator: The Big Four Are Here to Stay – For Now

“If the fans don’t want to come to the ballpark, you can’t stop them.”       

Hall-of-Fame baseball player and philosopher/sage Yogi Berra

 And if the audit regulators don’t want to grasp an issue beyond their reach, you can’t stop them either.

Although, a problem postponed is not one avoided, but only kicked temporarily into the ditch.

That’s why it matters that Richard Moriarty, newly installed chief executive of Britain’s Financial Reporting Council, has accepted – as reported by the Financial Times –  that “it would not be a failure if Deloitte, EY, KPMG and PwC still audited almost all of the FTSE 100 by the end of his term.” 

In other words, quits at last for the ill-founded rhetoric, since Carillion’s collapse back in January 2018, that reductions in the Big Four’s dominant share of the large-company audit market would somehow be desirable or beneficial.

The position was blared to the skies: Labour MP Rachel Reeves, on her own and as chair of Parliament’s select Business, Energy and Industrial Strategy Committee, the Competition & Markets Authority as then led by Sir Andrew Tyrie, the FRC itself in its strategic plan of March 2018, and the Labour party’s shadow chancellor John McDonnell. 

Generously read, Moriarty’s fresh perspective can be taken for recognition that the challenges of auditor scale, geographic coverage, and distribution and accessibility of industry and other expertise – all left unaddressed by the cited critics as they kept silent on the means by which the mooted market disruptions might be accomplished - mean the end of the threats to displace the Big Four tetrapoly any time soon.

Or viewed slightly aslant, the persistent lack of political will, official energy and legislative attention to the accounting profession – manifest in the passage of nearly six years of inaction post-Carillion, and the acknowledged retreat by the government of Rishi Sunak from attempts to overhaul either the audit sector itself or its regulator – has intersected with the dawning realization that officialdom simply lacks the tools by which to re-shape the Big Four’s share of FTSE 350 audits.

In the months after Carillion’s demise, I addressed the vigorous hostility aimed at the auditors. A series of blog posts (here to here) came together in my short book, DOA: Can Big Audit Survive the UK Regulators? (Amazon 2019). There I laid out in detail the impossibility of re-distributing large company audits, whether by forced participation of smaller firms in joint engagements or in actual re-allocation of full-fledged lead auditor execution and responsibility.

In summary, the data starkly demonstrate the limits of the smaller firms – most succinctly captured in their global revenues:

• Although increasingly trailing its brethren, KPMG as it pushes toward $ 40 billion is still three times larger than BDO, at $ 13 billion the largest of the so-called “challenger” firms.

• And at $ 65 billion at the top of the table, Deloitte is some fifty to one hundred times larger than the firms implausibly included in the “challenger” roster.

My central points of four years ago were straightforward:

• “Concerns over the suitability of the Big Audit model cannot be addressed by attempted forcing of shrinkage on the large firms” (page 36).

• “Conceding the legitimacy of the concerns over audit quality, these will not be addressed by moving either clients or personnel from the Big Four to the smaller firms” (page 38).

• “The challenges of scale – geographic coverage, depth of expertise, personnel demands and financial resources – represent barriers to the emergence or creation of new players of Big Four size that are both natural and insurmountable. Those limitations – definitive on the prospects for either market share re-distribution or imposition of joint auditors with the involvement of the challengers – are no less conclusive on the question of ‘split up’” (page 49).

• “The demands of complex multi-country engagements will outstrip the capabilities of networks oriented to serve a small-country client base with limited personnel resources” (page 43).

• “The impact of scale is critical. No number of hours at the controls of a single-engine airplane can qualify its pilot, however skilled, to command a wide-body jet – much less a helicopter or a stealth drone or a space shuttle” (page 41).

• “No network smaller than the Big Four has a prayer of achieving the scale and resources to clamber into a competitive position” (page 37).

Looking back, what matters now is not the arrival of relief after years of Cassandra-like messaging, against a wall of denial, ignorance, and animus toward the Big Four. Rather, it’s what is to come. From the foreword of DOA: 

“Outbreaks of financial malfeasance and scandal are nothing new. They are both cyclical and inevitable in the operation of the capital markets – functions of the frailties and cupidity of human nature and the pendulum effects of less-than-efficient market mechanisms.”

Nor should the views here be taken as advocacy for the immunization of the Big Audit model from either criticism or the forces of change:

“The question is not whether the Big Four can survive in a form still fundamentally similar to that invented by their Victorian namesakes. It should be plain that under the combined public, regulatory and legal exposures, they cannot. The large firms have no inherent right to the preservation of their franchise in its current form – they are no more immune to the inevitable forces of evolution than were the dinosaurs or the steam locomotives.”

What deserves present recognition – although unlikely to be officially registered or acted upon – is that fresh financial scandals are gestating even now within the darker corners of the capital markets, only awaiting the conditions for their delivery. When the turn of that next predictable cycle does come, as it will with the certainty that has marked its predecessors for decades, the howls of public protest will sound as if fresh, “Where were the auditors?”

• The still-emerging impacts of the COVID pandemic and the dramatic uplift in interest rates are combining to put stresses on companies struggling to survive. They foreshadow a dramatic increase in company failures and bankruptcies, with resort by the unscrupulous to manipulations and chicanery aimed at evading reality, and with painful impact on investors and other sources of capital.

• Increasing numbers of auditor changes are the result of both adjustments of their client rosters by the larger firms and the expansionist ambitions of the smaller firms – all in the context of history’s lesson that problems in audit quality and performance are most frequently seen in the early years of a replacement auditor’s engagement.

• The current disengagement of the regulators from the basic issues will assure that the unlearned lessons available from the recent past will be sprung as if newly-invented when they befall a fresh generation of inexperienced bureaucrats.

To conclude – Richard Moriarty’s recognition of the structural imperative of the Big Four – under the current model – is a helpful and welcome step.

But there’s a basis for the emphasized qualifier. What Moriarty has achieved should not be over-stated. Critical concerns remain over both the value and the sustainability of the Big Audit model. And all the warnings remain vital and relevant.   

 

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Dispatch from the UK: KPMG Settles Carillion –- Whiners Are Not Happy

Guest posted today on Francine McKenna's Substack, The Dig -- a pleasure as always.

 

KPMG has settled the £ 1.3 bn claim brought against it by the liquidators of its client Carillion, the UK outsourcing behemoth whose spectacular collapse in January 2018 triggered an outpouring of the too-familiar criticism, “Where were the auditors?”

Five years on, the entire sorry story is playing yet again to the same tired script.

When the long-anticipated claim was officially commenced, in February 2022, the reaction from KPMG’s leadership was the usual attempted bravado and blame-shifting:  

“We believe this claim is without merit and we will robustly defend the case. Responsibility for the failure of Carillion lies solely with the company’s board and management, who set the strategy and ran the business.”

Now has followed the latest and fully predictable statement of capitulation, from UK CEO John Holt on February 13, 2023 --- which could have been drafted in 2018 and sealed in an envelope marked “Open when needed”: 

“I am pleased that we have been able to resolve this claim. Carillion was an extreme and serious corporate failure, and it is important that we all learn the lessons from its collapse.”     

For want of Mr. Holt’s specification of those “lessons,” let us ask what has been learned –- if anything?

To start, what is not disclosed for the public’s learning is the amount of KPMG’s exit price –- the UK firm using the frequent American tactic of costuming its settlement in a shroud of confidentiality (see the trustees’ claims against KPMG in New Century and against Deloitte in Taylor Bean & Whitaker, and MF Global / PwC).    

Next, depressingly, although there are surely specific lessons available from Carillion about improvements in the technical and complicated reporting, accounting and assurance for large, long-term contracts, none have emerged to inform investors and the capital markets. Not least, that is because the accounting profession has never developed a common forum or other means by which such catastrophes can be put to expert analysis, to be shared for the benefit of all concerned, as is widely done across the business spectrum -- e.g., in aviation safety, structural engineering, medical care, and manufacturing processes.  

One thing we do learn is that the expedient Mr. Holt has reduced by one the number of pending litigation threats against the Big Four that, at their worst, are large enough to be life-threatening. That population now includes, at least, Wirecard in Germany and NMC Health in the UK for EY, and for PwC, Evergrande in China and Americanas in Brazil.

With that small comfort, we also are reminded –- not having needed to learn -– that despite the massive volumes of perfervid critical rhetoric, nothing has been done over the last five years to have any substantive impact on the actual operation of Big Audit, the model by which the Big Four audit all but one of the FTSE 100 and 87% of the FTSE 250.

What has been learned instead is that across the entire body of players, there is a complete lack of will to alter the model:

• The large firms themselves display no discomfort with the current structure of their franchise –- their single gesture having been ready agreement to “operational separation” -- the optically appealing if substantively negligible evolution of expanded disclosure of the organizational and operating distance between their assurance and consulting practices.

• The comprehensive and insightful report and recommendations of Sir Donald Brydon’s “Independent Review into the Quality and Effectiveness of Audit” (December 2019), which recognized the necessity of evolving the assurance model and the qualifications of its professionals, failed to achieve any traction but instead sank without a trace.

• The Financial Reporting Council as the UK’s audit regulator has been shifting its furniture around within what Sir John Kingman described in his December 2018 “Independent Review of the Financial Reporting Council” as its “ramshackle house.” But the prospects that Parliament will actually legislate to re-name and re-configure the FRC as a new Audit, Reporting and Governance Authority –- dead-on-arrival through the years of Boris Johnson and the weeks of Liz Truss –- show no signs of life in the early but distracted and pre-occupied government of Rishi Sunak. Meanwhile as long mooted, Jon Thompson, the FRC’s leader through these fallow years, has chosen to swap one poisoned chalice for another by taking the chair at troubled rail link HS2.

None of this has stopped the whiners, whose petulant voices are heard yet again:

• Annop Rehal of the Haines Watts audit firm (14^th in the UK table -- at £ 105 m in revenue, approximately 2% the size of leaders PwC and Deloitte): the “issue of negligence at the top of the market (is) caused by the lack of ‘real competitors to challenge them’.”

• Gavin Hayes of the Chartered Institute for Internal Auditors: “there is no doubt that there are fundamental issues around a lack of competition in the market.”

For this topic, what has not been learned, or at least is not acknowledged, is the sterility of the discussion on auditor choice and competition, as the advocates for enforced re-structuring of the Big Four’s market dominance have yet to face the reality that the smaller firms lack the capacity, scope of expertise, and risk tolerance to make achievable any such aspirations.

Instead, the complexity of large-company audit and the required range of skills and global presence defy the challenge to carve out for the small firms a portion of such engagements –- either by line of business or by geography, and whether on their own or by forced job-sharing. No assemblage of the firms below the Big Four, singly or in the aggregate, has the necessary capability:

• Performance evaluations by the regulator, and the mix of investigative and enforcement actions involving the smaller UK firms, both caution the prospect of degraded audit quality, should actions be taken to force those firms upon the FTSE-indexed environment.

• A significant reminder regarding audit quality, if needed, is that the case has never been seriously advanced –- much less established –- that “smaller is better.” To the contrary, flares of financial and corporate misfeasance are reported around the globe, all involving the smaller firms: the crypto fiasco of FTX, the Gupta companies in the UK, Lex Greensill’s far-flung structure of companies, and the Adani group in India.

Neither the accounting profession itself nor its hand-wringing critics are heard to advance the difficult if realistic and achievable actions by which to re-engineer a model for large-company assurance that is fit for future purpose. The necessary holistic discussion among all the players awaits.  

 

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UK Audit Reform: The Boris Johnson Government Flies A White Flag

Fifteen long months after launching its consultative White Paper, “Restoring Trust in Audit and Corporate Governance, the UK government of Boris Johnson has surrendered on the “audit “ portion.

That’s on reading the Response of May 31, 2022, from Kwasi Kwarteng, Secretary of State for Business, Energy and Industrial Strategy.

His Ministerial Foreward promises “ambitious plans to further strengthen the UK’s audit and corporate governance framework” (p.3). But a slog through its 197 pages reveals a mélange of delay, retreat, and withdrawal.

Four years and counting after the January 2018 collapse of Carillion that triggered this latest spasm of public dissatisfaction with the functioning of Big Audit, the Response devotes massive verbiage to corporate governance, but a mere nine pages to the only two topics with direct bearing on the performance of large-company audits.

Even for the former, the Response natters on, its proposals reflecting a “built-in scope for fine tuning” (p.4) that is euphemistic for “who knows what may work, or what the unintended consequences may be.”

Readers are largely left to speculate –- generously assuming that Johnson can stay in office in the face of a dramatic loss of confidence in his leadership -- on the particulars that may be expected in possible legislation to be put to an unspecified future session of Parliament, by way of possible legislation to replace the discredited Financial Reporting Council as the profession’s regulator with a new Audit, Reporting and Governance Authority.

Among the multiple examples of what the ICAEW generously called on May 31 a “half-hearted” Response:

• The absence of Sarbanes/Oxley-style corporate reporting and assurance on internal controls (§2.1.27).
• The absence in the new proposal for a corporate Resilience Statement of a similar statement by statutory auditors (§3).
• Leaving for the market the consideration of widened financial information assurance (§6.1.48).
• The absence of commitment to the new qualification of “corporate auditor,” as proposed in Sir Donald Brydon’s December 2019 report (§6.1.48-49).
• Leaving with the accountancy bodies the consideration of auditor training, qualification and skills (§6.1.54).
• Explicitly taking a “wait and see” view on the intractable problems with fraud detection and prevention (§6.2.16).
• Passing entirely on the existential threat posed under the existing regime for auditor liability (§6.1.70).

On the lesser topic bearing on the audit firms –- “operational separation” of Big Four audit and consulting (§8.2) -– the air has long since gone out of any energy for further change; authorizing ARGA to legislate on what is already in process would be inconsequential.  

On the second -- competition, market share and auditor choice -- the Response would inject the challenger firms into FTSE 350 audits by legislating ARGA’s power to set the terms: the percentage of a FTSE 350 audit to be performed by a challenger firm (§8.1.16), definitional metrics (§8.1.17), international reach (§8.1.18), and exceptions for the unavailability of a challenger (§8.1.19).

Importantly, such steps would phase in only over the ten years of the audit tender cycle under §C.3.7 of the FRC’s Corporate Governance Code (§8.1.2). Big Four dominance of FTSE 350 audits not having budged in the nine years since imposition of that requirement, however, suggests the passage of another decade over which evidence might emerge of market share changes perhaps supporting an enforced market share cap (§8.1.15 and §8.1.20).

The necessary conclusion -- implicit in the Government’s comprehensive passivity, and in the Secretary’s explicit readiness to “(set) market participants the challenge of shaping their own future” (p.4) -- is that developments over the next generation will be shaped by already evident market dynamics:

First, KPMG’s announcement of an intent to carry out a cull of its client list, if taken seriously, could open challenger opportunities, if only:

• To the extent its Big Four colleagues were to stand aside voluntarily in the tender process.
• Subject to the challengers’ resource development, risk appetite, and survival in the face of litigation and regulatory exposures.

Second, the roaring enthusiasm for extended corporate reporting and assurance on “Sustainability,” the catch-all adopted by the newly-launched International Sustainability Standards Board, has potential. Whether the advocates are rushing headlong toward a promised land of opportunity or a cliff-edge of disaster remains to be seen, however; there are such overhanging and unresolved issues as the extent of convergence of “standards,” the permissible scope and structure of the audit firms’ ESG resources and practices, and the impact of the litigation and regulatory exposures for which the SEC’s recent enforcement actions in America for ESG reporting deficiencies by both Vale and BNY Mellon are canaries in the mine.

Last, potentially most significant and least appreciated is the very viability of the large-firm assurance franchise itself –- now brought to the fore with the news of EY’s consideration of a global separation of its audit and consulting practices.   

Not for now to ponder pro’s and con’s -- the challenges facing CEO Carmine Di Sibio and his global team are dire. The prospects should not be minimized that the outcome –- rather than a clean global split with all pieces intact and a handsomely-financed windfall for at least some groups of EY partners –- may instead be the exposure of an organization riven with anxieties and antagonisms, ill-equipped for the stresses of publicly-visible divorce proceedings.

Arthur Andersen’s unhappy history is this movie’s prequel. Briefly put, EY’s leaders have put the entire enterprise into play, with the potential that critical numbers of partners in country firms and practices may opt to serve their local and personal interests.

Should that happen, the Government Response to the question of large-firm viability -- that “to provide ARGA with the ability to operate a market share cap in the event of the failure of a major audit firm” would be “intended to give the regulator the ability to react quickly and to limit further concentration in the FTSE 350 audit market in the event of firm failure” (§8.3.23) –- would be exposed as an empty and meaningless charade.

The environment of another large-network disintegration should instead recall the late William McDonough, preparing to step down as chairman of the American PCAOB in the fall of 2005, with his warning -- never since modified or disavowed by any of the profession’s regulators -- that “none of us has a clue what to do if one of the Big Four failed.”

In which case, the irrelevance of the Government’s Response will be well and truly evident. For readers with the fortitude to follow this dreary story, there will be reason for another installment, for this look:

At the level of energy, vision and intelligence brought by the Government to this highly relevant set of issues for the capital markets, its flaccid Response is probably the best it has the capability to deliver.   

 

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Audit Reform in the UK? The Queen’s Silence Says It All

As reported in London, there were two notable absences when the Queen’s Speech was delivered on May 10, in the effulgent pomp and circumstance of the State Opening of Parliament.

Missing was the Queen herself, claiming “episodic mobility problems” –- a prudent choice, for a monarch of 96 years and in official harness since her coronation back in 1953.

Second was any mention of legislation on the parlous state of Big Audit –- the model by which assurance is provided on the financial information of large public companies –- a franchise dominated by the tetrapoly of Deloitte, EY, KPMG and PwC.  

The Queen’s substitute was Prince Charles, the longest-serving heir apparent in British history – for which, no criticism. A legislative body with 800 years of history can survive being read to by the senior member of the House of Windsor’s second team.

Less credible is that the energy for audit reform in the UK has run steadily downhill since the January 2018 collapse of the massive contracting and project supervising enterprise Carillion. The immobility of the Boris Johnson government is faced by Kwasi Kwarteng, secretary of the Business, Energy and Industrial Strategy department –- himself frozen in silence on Big Audit since his public mention in January 2021, the first month of his tenure.

The absentee BEIS secretary’s disinterest would be consistent with years of official attitude, in the face of a roster of reports and criticisms: Sir John Kingman’s final report of December 18, 2018, which characterized the UK’s audit regulator --  the Financial Reporting Council -- as ramshackle and shambolic; the Competition & Markets Authority’s Update Paper, finalized on April 28, 2019; the Parliamentary BEIS committee’s report, “The Future of Audit,” of April 2, 2019; and Sir Donald Brydon’s December 2019 report, on his “Independent Review Into the Quality and Effectiveness of Audit.”

With that fulsome body of material in full view, the BEIS department launched its consultation, “Restoring Trust in Audit and Corporate Governance,” in March 2021; with its prompt closure that July, there has been dead silence since.

Political concerns are said to dominate, as the government’s concerns and priorities lie elsewhere. Audit reform is characterized as “boring” by contrast to “wedge issues” designed to “go down well with voters.”

That’s as may be, although it is no less plausible that reality has intruded and that Whitehall may actually realize that its kit is empty of tools.

That is, in the entirety of the proposals floated by the various critics, there are only two with possible direct effect on the business model and performance of the handful of firms that dominate Big Audit.

The first is “operational separation,” by which the Big Four firms have agreed with the FRC to identify distinct leadership, governance, and performance metrics for their audit practices. That insubstantial undertaking was from the start never more than an exercise in optics, as the firms were already running their businesses that way, indeed with considerable public disclosure.

The second was the critics’ notion that both audit quality and large-company auditor selection would somehow benefit if the Big Four were forced to yield up a material portion of their dominant share of the FTSE 350 audit market. The barriers to such a fancied “solution” have been comprehensively laid out, centering on the lack of both appetite and resources on the part of the unfortunately-labelled mid-tier “challenger firms.”

Laid beside the official paralysis, it matters that while evolution in Big Audit is not possible without the participation of all the players -- issuers, auditors, providers of capital, standard setters, regulators and the legal systems and agencies of law enforcement -- each of those has its own vested interest in resisting change, preserving and maintaining a status quo that is viewed as working tolerably well. 

In that context, an observer would be justifiably anxious that any official policy action could deliver unintended consequences all too familiar from earlier efforts –- the hasty passage of the Sarbanes/Oxley law in the US in 2002, the UK’s mandating of auditor re-tender in 2012, and the EU’s parallel imposition of mandatory rotation in 2014.

Not only should the interested parties look to limit official action to the “do no harm” variety, they would well recognize that while the official policy of inaction is in effect, no affirmative harm is being inflicted.

In other words, for those judging the government’s passivity to be fraught, it would be wise to consider the approach of Napoleon Bonaparte in his Austerlitz campaign: “Never interfere with an enemy when he is making a mistake.”

 

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PwC’s UK Head Is Unhappy -– There Could Be Relief

“When sorrows come, they come not single spies, but in battalions.”

                    -- Claudius, Shakespeare’s Hamlet (IV, v)

How much concern do we feel for Kevin Ellis? He should sit pretty -- senior partner of the UK firm of PwC, which in 2021 clocked up record global revenue of $ 45 billion. The average profit of his UK partners was a league-leading £ 868,000, and Ellis himself in 2020 took home a handsome £ 4.4 million.

Instead, this week’s press attention finds him in a double bind, triggered by the UK’s audit regulator, the Financial Reporting Council. Even in paralysis over its structure and its remit, with the whole topic of “audit reform” on hold as the Boris Johnson government totters for survival between the fiascos of Brexit and COVID, the FRC has seen fit to widen its investigation of PwC’s audits of Babcock International –- expanding from 2017 and 2018 to sweep in the last two years before the firm was replaced by Deloitte.

In the usual grim ritual, the firm’s response was the expected if defensive pledge of obeisance and cooperation:

“We will cooperate fully with the FRC in its inquiries,” said PwC in a statement. “Audit quality is of paramount importance, and we remain committed to our ongoing program to enhance audit quality and to the delivery of consistently high-quality audits.

“The FRC’s annual reviews of our audit work, policies, and procedures show a continued trend of improvement in our work, and we use their insights, together with our own reviews, to continuously improve how we deliver high-quality audits.”

Ellis chose at the same time a gratuitous reprise of his frustration as previously aired to the Financial Times:

“(C)riticism of the audit industry from politicians and regulators was harming the profession and risked making it more difficult to attract new recruits.

“Retaining qualified auditors also ‘becomes much harder, if there’s a current of external negativity,’ he said.”

PwC’s prosperity in the COVID era considered, critics would be tempted to charge Ellis with tone-deaf ingratitude, except that his distress lies in the inability of Big Audit to accommodate two conflicting positions: The profession’s leaders self-confidently resist the recognition of atypical but inevitable instances of sub-optimal performance, while the public’s pointed question in any case of significant scandal is, “Where were the auditors?” 

Little wonder, there is skepticism about the profession’s legitimacy -- among investors and other users, with new graduates exploring their career paths, and as maturing staff decide where to commit their energies and their fortunes.

History teaches that the accounting profession has never rested easily in its relationship with its regulators. In the 1860s, the nascent profession -- counting among its leaders both Messrs. Price and Waterhouse -- fought off legislative attempts to require that government should audit the UK railroads. Its franchise of privately-provided audits of public companies was only later secured with passage of the core American securities laws of 1933 and 1934.

It’s been downhill since. Indeed, with this month’s fourth anniversary of the collapse of Carillion, Ellis might appreciate the FRC’s pointing its limited artillery at KPMG’s former partner and staff, who have turned on each other under charges of manufacturing and post-dating Carillion working papers and other engagement documentation.

Possible relief for Ellis’s dour pessimism is available, although it would require legislation, cooperation, and deep changes in attitude on the part of all the players –- starting with the auditors and including companies, information users, legislators, and regulators.

That is, it is to the profession’s discredit that Big Audit lacks a forum in which audit performance quality can with credibility be investigated, evaluated, and if necessary sanctioned. The available tools are not serving. The FRC -- derided in the post-Carillion studies as “a ramshackle house,” and “toothless and passive” -- is perceived as non-transparent, inefficient, and ineffective. And the legal systems that continue to threaten “joint and several” liability on the scale that destroyed Arthur Andersen in 2002 are seen as ponderous, erratic, and unpredictable.

To address these issues, a tribunal could be designed for “audit failure study” -– drawing on a long and successful history among the other professions. In hospital surgeries and emergency rooms, engineering studies of infrastructure collapse, assembly line disruptions and air and rail accidents, learning emerges in the study of catastrophe, from the inadequate number of lifeboats on the Titanic to the construction deficiencies in the World Trade Center.[1]  

The outputs of a well-constructed body -- given a broad remit, a legislative mandate, and the necessary expert and staff resources –- would:

• Enhance the credibility of corporate issuers’ commitments to quality reporting.
• Support the accountants’ legitimate aspirations and claims of improved performance.
• Provide guidance for standard-setters.
• Offer clarity and transparency to investors and agencies of government.

Resistance would of course be expected. Inertia and preservation of the status quo are never easy to displace. The profession’s leaders and the communities of information issuers and users would all be required as willing participants –- endorsing the value of such a tribunal as a matter of mutual trust and appreciation of its value.

As for Kevin Ellis and his concerns, a credible body for the study of his profession’s quality issues would provide a point of reference to which he would steer the interests of his audiences –- sparing himself the impossible task of preaching to the unconverted and allowing him to focus on more productive efforts. 

 

[1] For an extended examination of the complexities, challenges, and benefits of “failure study,” please see pages 285-292 of my 2017 book, “Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms” (Emerald Books 2d ed.)

 

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Hazards in the UK Audit Market – A Parable for the Holidays

Bidding farewell to this dismal year, it’s my long experience with the holiday season in the United Kingdom that a significant matter open on the solstice will not receive attention through Christmas, Boxing Day and the New Years celebration, until after the arrival of the Three Kings.

So today’s news is welcome, that Boris Johnson’s beleaguered government actually has a candidate -- the seasoned Jan du Plessis, late of BT and Rio Tinto -- to chair the Financial Reporting Council. But the post requires parliamentary committee approval to head the audit regulator, an agency itself hostage to the absence of legislation to relieve its “ramshackle” condition. Further official delays and inaction look inevitable, well into 2022, in untangling the complexities contained in the depressing question, “Where were the auditors?”

While the prospects are slight that the arrival of du Plessis will herald a secular epiphany, there is at least a learning opportunity in the recent reporting that HSBC’s approaching obligation to put its audit out for tender may well attract no proposals save from incumbent PwC. 

That is, the needless distractions over auditor tenure –- under UK and EU rules that have been in place long enough to demonstrate the absence of discernible effect on either audit quality or competition and choice -- are relevant to the still-pending possibility that the UK government’s long-delayed action on its consultation of March 18, 2021, will include either “managed shared audits” for FTSE 350 companies, with the forced participation of the smaller firms, or attempts to impose “caps” on the Big Four firms’ market share.

Namely, with the indicated lack of enthusiasm among PwC’s three large brethren,  the unlikelihood of change at HSBC is further confirmed, according to the Financial Times, as “senior auditors at two challengers said mid-tier firms would not pitch to audit the entire HSBC group because of its size and the associated regulatory risk.”

No surprise at all. HSBC is the largest bank in the FTSE 100. PwC’s audit and related fees of $ 130 million last year are, as the FT put it, “more than the entire UK audit revenues of any challenger other than BDO and Grant Thornton.”

Which said, the story in the numbers is not the only way to consider the structural inability of the smaller firms to expand their large-company market share. For a perspective on such an attempt, here follows a first-hand experience, with implications if a “challenger” firm actually tried –- that is, had the chutzpah or the reckless courage -– to propose.  

It was a long time ago, in a galaxy far away –- so far in the past that all statutes of limitations on the telling are long since expired. A small-city office of a then-Big Eight firm wrenched the audit of a complex financial institution away from its main local competitor -- to be the successful aggressor’s only local client in the sector.

With abundant confidence and complete good faith, the newly-arriving firm cobbled together an engagement team headed by the office’s senior audit partner –- experienced and respected in the local community, known for his probity and his leadership, although with a blank slate of specific industry experience. His supporting lead manager’s briefing into the new role was to attend the firm’s internal industry training classes.

The first two years went smoothly enough, save for the weight on the engagement of the expected and greater than normal resort to the national office.

In year three, however, the client pushed into a major new product line, an ambition burdened by start-up operational glitches and accounting complexities beyond the experience and resources of its own CFO and staff.

As for the audit team, this new business went observed but unremarked. Hindsight was later to reveal that they failed to grasp or even recognize the risks and complexities of a business environment they had no way ever to have seen before. 

The finger pointing and blame attribution between client and auditor were intense and unpleasant. The inevitable rupture of the relationship was nasty, including extended litigation and ample unpleasant gossip in the city’s civic venues and country clubs.

Developments in behavioral psychology and economics provide the framework for this parable. At play is the Dunning-Kruger effect -– the cognitive bias under which catastrophically erroneous risk-related decisions are made, where the actors are ignorant of the scope of their own ignorance.

“Not knowing what they didn’t know,” in other words, both the client and the audit team were exposed to fatal defects in their decision-making capability.

Dunning-Kruger is wonderfully powerful as a means for better decisions, but only if recognized in the specific context:

• Applications start with the simple and entertaining -- if told to draw a picture of a giraffe, you have no chance if you’ve never seen one before.
• Scaling up the example to a multi-million-dollar business challenge -- even a highly-skilled professional, unless specifically trained and experienced, cannot conceive, much less carry out, the judgments involved, eg., in fixing and accounting for a realization reserve on the assumption of a portfolio of exotic financial instruments.

In the hypothetical future world of “managed shared audits” or capped market share, the engagement partner of a mid-tier audit firm with big-table aspirations would hang from a limb of uncertain length and weakness. The questions “who can I call?” and “where is my help?” would come back unanswered. 

The various versions of the clichéd doom that awaits those who forget history have even greater force for those never learning in the first place. For future problems of newly-presented scope and complexity, the consequences will be no prettier than they were in my old case a generation ago.   

  

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Cap the Big Four’s UK Audit Market Share? A Message From the Facts

It’s nearly four years since Carillion's collapse in the United Kingdom triggered the latest wave -– “Where were the auditors?” While that question is pursued in the Official Receiver's £ 1 billion lawsuit launched against KPMG on November 19, what passes for broader discussion on the Big Audit model has come down to this:

Proposals for “managed shared audits” -- by which the smaller audit firms would perform a material portion of the audits of the FTSE 350 public companies –- have failed to achieve any traction. Is there an alternative?

Still floated with varying degrees of enthusiasm is the idea of a “market cap” –- enforced reduction of the Big Four’s currently dominant share of the large audits -– cited by, among others, the financial press (here and here), the ICAEW, and the chief executive of the UK’s audit regulator, the Financial Reporting Council.

To be taken seriously?

Nope. A rude reality check would await an FRC ukase to forcibly reduce Big Four market share. However wishful or earnest the attempt, there is no other source.

For the multiple reasons why managed shared audits so lack favor, the same limitations exist no less for the unfortunately-described “challengers” –- BDO, Grant Thornton, Mazars, and the other smaller firms in rapidly-descending size –- and the even greater complexities of their taking on full audit performance and responsibility.

My practice in confronting such a conundrum is to consult my academic colleague, Professor A Fortiori.

He begins with the context: Under the indifference of the Boris Johnson government, and the functional absence of the secretary for business, energy and industrial strategy, Kwasi Kwarteng, the prospects for substantial change of any kind are minimal. Not least, the likelihood of Parliamentary attention, much less actual legislation, necessary to replace the shambolic history of the FRC with the mooted new ARGA, ranks somewhere below the chances that the British will return to Greece the Parthenon marbles looted by Lord Elgin two centuries ago.

Nor is there any real wrangling over changes in the audit model, attention having long dissipated to the post-Carillion trio of official reports and the admirable work of Sir Donald Brydon.[1] Rather than active engagement among the parties, the faint glow of the public discourse has not generated heat enough to brew a tempest in a teapot.

The estimable A Fortiori commends these points:

“Audit quality” being ostensibly the ultimate goal, commentators (as referenced above) point to the spate of recent company failures and regulatory investigations and sanctions against the auditors both small and large, needless to repeat here. With that list, the position of the head of audit at one of the “challengers” -– that “audit firm size isn’t necessarily correlated to quality” –- should bear the qualifier, “one way or the other.”  

The same holds for FRC audit inspections -– summarized by the Financial Times to “not help the challengers’ case” –- although caution in extracting conclusions from the numbers is always appropriate, when a compliance-enforcement agency can design and apply its own procedures and then grades the results of its own work.

More importantly, the inhibitions on the “challengers” actually to assume the up-scaled responsibilities of managed shared audits have not been answered. As sketched out here last April 21, those include: the difficulty for a reporting company to identify operations or subsidiaries to be audited within the capabilities of the smaller firm; the burden on a lead auditor of full responsibility for the work of a “challenger,” with the prospect of expensive duplication or re-performance of work; the geographic constraints on the smaller firms of the globalized operations of the large UK-based companies; and the auditors’ cross-border litigation exposure for companies whose securities trade in multiple jurisdictions, notably the lawsuit-friendly United States.

The glancing mention of market share caps has yet to address the yawning resources gaps of the “challengers” -- industry and technical expertise, geographic presence, experienced partners and managers at the line level, investment funding, financial and risk-oriented resources, that such explosive growth would require.

Further, those invoking the possibility of steps to cap the market share of the Big Four have yet to grasp the enormity of the numbers -– not to say, the practical impossibility of the task.

As outlined here on August 23, audit clients of the “challengers” presently comprise a mere 1.6% of the FTSE 350's total market capitalization of £ 2.219 trillion –- a figure undisturbed by the rapid rise of Grant Thornton client Darktrace from its April IPO through its prompt entry to the FTSE 250 and further October index bump-up. The available numbers indicate that the capacity building obligation of the smaller firms to take on a mooted 20% of  FTSE 350 audit work, over ten years, would require them to add clients with capitalization of £ 41 billion, each year if evenly spread, or if done gradually, at an unrealistic annual growth rate of some 29%.

With all that, a Big Four market share reduction is even less practical or achievable than managed shared audits –- so says the wry A Fortiori.

Although he also notes that continued inattention to the compelling facts on the market structure of Big Audit is likely, as the observably dreary environment in the UK makes it predictable that the entire topic will continue to be kicked even further into the tall grass.

Where it will lie, ignored and unattended, until the inevitable “next time.”

                

[1] Sir John Kingman’s Independent Review of the Financial Reporting Council (December 18, 2018).

The BEIS select committee report, ”The Future of Audit” (April 2, 2019).

The Final Report of the Competition & Markets Authority on its Statutory Audit Market Study (April 18, 2019).

Sir Donald Brydon’s Independent Review into the Quality and Effectiveness of Audit (December 2019).

 

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Audit Market Caps in the United Kingdom – The Financial Times Fails a Math Test

 “The Glacial Pace of Audit Reform Needs To Speed Up”

The Financial Times might wish to reconsider this headline, above its editorial of late last week.

Global climate change considered, the metaphor may be more apt than intended, as the likely fate of the world’s glaciers is their tragic and accelerating collapse into muddy puddles amid massive fields of rocky rubbish.

The trope would match the UK government’s belated and sluggish response to the tumult surrounding Big Audit in the post-Carillion era. There are two main efforts in its consultation of this March, “Restoring Trust in Audit and Corporate Governance”: a floundering attempt to construct a legitimate audit regulator to succeed the shambolic Financial Reporting Council, and a single substantive proposal directly applicable to the audit firms -- “managed shared audits” for the FTSE 350 companies –- an unachievable idea that has failed to attract any measurable amount of serious support.  

The FT continues to urge a forced reduction of the Big Four’s dominance of FTSE 350 audits: a cap of 80%, within ten years time –- apparently recalibrating its earlier push for 60%.

For the premier English-language publication addressing business and the capital markets, with “Financial” as its very forename, it falls between perplexity and disappointment that the FT’s support for audit market caps pays no attention to the numbers –- bluntly, that the very structure of Big Audit makes impossible the role that would be thrust upon the unfortunately-described “challenger” audit firms.

The facts matter. Here a summary, using the market capitalization of the FTSE 350 companies as a proxy to measure the demands of personnel and resources required to perform large audit engagements:

First the FTSE 100, whose constituent companies’ total market capitalization is £ 1.814 trillion. Of these, the share of the “challenger” firms is zero. Of the far-smaller companies comprising the FTSE 250, their share is about twenty -- in flux although modestly expanded in the last year to some 9% of the total market capitalization of £ 394.6 billion or some £ 35.5 billion.

Combined across the two indices, the "challengers" hold an audit market share of the FTSE 350 by market capitalization of some 1.6%.

Into that reality, the growth necessary for the “challengers” to reach the 20% target urged by the FT may be measured in two ways:

• Yearly for ten years, they would have to add as clients a book of companies with total capitalization of some £ 41 billion –- more than double the size of their collective total client base today. That’s each and every year.

• Or, as an English major with a calculator can compute, to spread capacity-building gradually over the decade, they would have to achieve a year-on-year compound growth rate of 29%.

To this bleak picture, little needs be added. The underlying reasons why the “challengers” have no growth path on that impossible scale do not implicate performance quality. It’s personnel, expertise, geographic presence, and financial and risk support.[1] The stark numbers themselves tell the story -- it’s not going to happen.

Giving these figures no recognition, the FT presses a set of unlikely premises (all emphasis added):

First, the FT assumes a ten-year process “once the reforms are in place” –- a benchmark unanchored to the unlikely fulfillment of the government’s plans at all. So far there is no evidence of the legislation necessary to transform the FRC –- described by the acerbic Labour MP Rachel Reeves as “toothless and passive” –- while her pungent description might well apply to the government’s own process, given its “glacial” –- not to say backwards –- movement on the basics of populating the FRC’s board of directors and filling the office of chairman.[2]  

Second, the FT urges that smaller-company audits might be “assigned” to the “challengers” –- a prospect inconsistent with the obligation on both auditors and companies that client engagement acceptance be at the mutual judgment and acceptance of each.

Third, the FT describes the Big Four as “themselves split on the best way forward, though none is enthused by the government’s proposal for managed shared audits.” This, while perhaps not reaching the level of misrepresentation, mis-conveys what was more forthrightly surveyed by the FT’s own Michael O’Dwyer on August 15, that the Big Four “have refused to back” the proposal for shared audits.    

As reported by O’Dwyer, their message is clear enough, although if bobbing and weaving were an Olympic sport, the Big Four would be medal contenders: with the candor permissible behind closed doors, the take on shared audits would be somewhere between “no” and “hell no.”

Fairly put, however, the Big Four need not go publicly beyond the perhaps characteristic British euphemism. Given the UK government’s paralysis, their simply expressed distaste for shared audits –- a position held in common with the business community and indeed at least some of the “challengers” –- will adjourn any real confrontation with the impossibility of audit market caps to the arrival of the next global ice age.

Finally and most egregiously, the FT leaps to the position that “a transition period where challengers start to mature and incumbents give up a part of their dominant position is inevitable.”

No –- it is not. Several scenarios, no less unappealing, are at least as likely.

A wager on the more likely to first occur: as between actual achievement by the “challengers” of a 20% market share, or (i) the collapse or failure of one or more of the “challengers,” under the weight of their over-hanging litigation and performance quality issues or otherwise, so that their sector falls below critical mass, or (ii) the disintegration of another of the Big Four, as doomed Arthur Andersen in 2002, which would bring about the total collapse of today’s Big Audit model.  

If offered a voice, the world’s glaciers would opt for relief from the malign effects of human interference. No less, the inability of the editorial writers at the Financial Times to appreciate the actual structure of Big Audit impairs the value of their contribution to the discussion.

 

[1] For the details, please see my blog posts of April 21, 2021 and June 1, 2021, and the extended treatment in my book, “DOA: Can Big Audit Survive the UK Regulators?” (Amazon 2019).

[2] At this writing, the FRC’s interim chair is to leave in October, the full-time post being unfilled for over a year since its last occupancy for a mere eight months, while there are two new arrivals on the board and a second empty board seat (here).

 

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Audit "Reform" in the UK: Hello…Is Anybody There?

Does anybody really know what time it is?

Does anybody really care?

-- The band Chicago’s debut album, 1969

 It’s one thing to discuss the breadth of the UK government’s March 18 consultation paper, “Restoring Trust in Audit and Corporate Governance,” with its 98 questions spread over 232 pages, as I did recently in a conference mixing academics and practitioners.

It’s quite another, and thoroughly dispiriting, to observe the public silence on the likelihood of sustainable change in the model for large-company audits, so roundly criticized since the fall of Carillion back in January 2018 – now more than three years ago.

On the available evidence, the Consultation is being kicked so far into the long grass that it would only be flushed by game drivers and a pack of hounds. One reason for pessimism is the absence of leadership and advocacy.

That’s disappointing, but no surprise. Transformative change always confronts the inertia, indifference, and resistance of those with self-interest in protecting the status quo.

For a list of those missing, start at the top. Kwasi Kwarteng, Boris Johnson’s cabinet secretary for Business, Energy & Industrial Strategy, has spent the last two months at photo ops and shout-outs on behalf of British business -- particularly life sciences, technology and renewable energy – without so much as a mention on his otherwise busy Twitter feed of the Consultation issued under his signature.

The flat-line level of commitment of Kwarteng and his boss at No 10 Downing Street is readable in the silence on audit reform within the legislative program presented by the Queen in her traditional speech on May 11 – an otherwise ambitious list spanning election schedules, national ID cards and NHS funding. That matters, because the Consultation would rely on Parliamentary action to address such major topics as the re-engineering of the audit regulator itself, extension of the duties and accountability of company directors, and the liability regime under which changes to the scope of assurance might be implemented.

Given the complex process in booking law-making time on Parliament's calendar, legislative silence today bespeaks extended future deferral at best, with likely default to indefinite inaction.

Further, while legislation for the replacement of the Financial Reporting Council lies in Parliamentary limbo, Sir Jon Thompson, chief executive of that discredited agency, has avoided taking the bully pulpit of his office to urge an activist role for his agency even under his place-holder leadership on the evolution of large-company reporting and assurance.

That multi-faceted topic, laid out in the perspicacious report offered in December 2019 by Sir Donald Brydon, “Independent Review Into the Quality and Effectiveness of Audit,” with its innovative proposal for the design and recognition of a newly-defined “corporate auditor,” lacks active sponsorship and looks unfortunately destined to gather dust. Sir Donald himself has done valuable and worthy service, but he speaks for no constituency – instead like Oscar Wilde arriving in America to confront its customs authorities, he has “nothing to declare but (his) genius.”

Elsewhere at the agency level, the aggressive position urged by the Competition & Markets Authority, that the dominant position of the Big Four in auditing the FTSE 350 should be forcibly reduced, is left for dead by the Consultation, while the author of that view, then-CMA chairman Andrew Tyrie, was defenestrated in 2020 and has since returned to his political consultancy with a London law firm.

Nor can minority support be expected from the political opposition. Acerbic Labour MP Rachel Reeves, who chaired a BEIS select sub-committee with an aggressive report of its own and who was razor-like in gutting evidence presented by the large firm leaders, has been booted up to the post of Shadow Chancellor.

As for the large firms themselves, sliced and diced at the Reeves committee hearings and on the receiving end of the perpetual scandal-driven question, “where were the auditors?” – it remains the case that ever since the firms locked up their public company assurance franchise with passage of the American securities laws in the early 1930s, the profession has been reactive and defensive in its uneasy relationship with the regulators – an attitude manifest in the UK today in their gentle maneuvering through the process of “operational separation” of their audit and advisory practices.

With all these players retreated to the wings – cometh the hour, cometh the man?

More likely, to adapt the query attributed to Richard Nixon’s secretary of state Henry Kissinger in his sarcastic frustration about talking to Europe – if in search for an effective audit reform advocate, whom should we call?

 

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Audit “Reform” in the UK: Much to be Modest About

“Parturient montes, nascetur ridiculus mus”

 (The mountains labored, and a ridiculous mouse was born)

            -- Horace, 1^st century AD Roman poet

On March 18, the UK government produced its paper, “Restoring Trust in Audit and Corporate Governance” (the Consultation”), eleven chapters and ninety-eight questions, spread over 232 pages plus an additional 300-odd of Impact Assessment and Key Facts and Trends.

Most of its hefty bulk addresses matters of worth, even in respects beneficial, but at two or three removes from actual large-company auditor performance -- the core of public discussion since the failure of Carillion more than three years ago:[1]

• The re-purposing of the UK’s audit regulator.
• The performance and accountability of corporate directors.
• The potential to re-engineer the purpose and scope of corporate information assurance itself.

On these, the right honorable secretary for Business, Energy and Industrial Strategy has borrowed a “conservative” strategy from the medical field. Retreating from or pushing off for later days a lengthy list of more aggressive actions -- none unachievable or likely to have positive effect -- BEIS Secretary Kwasi Kwarteng’s Hippocratic approach is at least likely to “do no harm.”

Although the Consultation introduces itself with chest-thumping self-confidence, aspiring to proceed “quickly” (¶ 1) with “decisive changes” and “significant, targeted measures” (¶ 1.1.2), its substance is almost resolutely modest. In the tones of Wilde’s Lady Bracknell, no manifesto this watery could possibly be accidental – perhaps reflecting both the inevitable push-back from the affected parties, and the limits of the Johnson government’s own available energy.

Space constraints do not permit an exhaustive catalog of the Consultation’s “less is more” approach, but only examples:

Rather than broadly advocating advanced exploration of the “purpose of audit,” as detailed in the December 2019 report of Sir Donald Brydon on his Independent Review Into the Quality and Effectiveness of Audit, and taking on such thorny issues as the interpretation and applicability of established case law (¶ 6.1.16), the Consultation would content itself (¶ 6.1.19) with asking issuers for a “non-binding purpose statement that could evolve over time.”

Rather than endorse and design a properly composed and well-staffed expert forum for detailed lessons-learning from incidents of audit performance deficiencies – “failure study” as well known in other fields such as aviation and medicine – it would timidly establish a “register” (¶ 6.4.10), picking up the high-level suggestion of the Brydon report (¶ 14.3-.4).

A first step this may be, optimistically, although unless designed and authorized to overcome the resistance expected from all quarters, the likely prospect is another mere repository for notifications of non-compliance – a place where opportunities for real learning will go to die.

Rather than examine the reasons why liability limitation agreements have not been used in auditor-client engagements, the Consultation’s abbreviated four-paragraph attention to auditor liability (¶ 6.8) foregoes the opportunity, making only the (concededly useful) suggestion (¶ 6.8.4) that auditor liability in the up-coming expansion into new forms of assurance ought not to be extended beyond that presently in place for statutory audit.

Rather than obliging the large international accounting networks to demonstrate their “resilience” for the benefit of information users, the Consultation would take a tentative and partial step – namely, to charge the anticipated Audit, Regulatory and Governance Authority to seek information from the large UK firms on their financial resources, including their capital and insurance (¶ 8.3.15).

This is in context of the absence of publicly disclosed global financial statements for the large networks, leaving them like the cobbler’s barefoot children, although full-fledged audited statements would be both achievable and informative, as was the several-year experience of the Arthur Andersen global network in the 1970s.

Rather than take up the aggressive critics’ urgings for forced re-structuring of the Big Four dominance of the FTSE 350 audit market – here, credit where clearly due – the Consultation effectively takes the “market cap” notion off the table.

A future review is contemplated (¶ 8.1.14 and ¶¶ 8.1.27-.30), but only after five to nine years of experience (¶ 8.1.26) that would not even commence until regulations had been in effect during the early years of tender and rotation. Thus any such review would not occur until the early part of the 2030s – by which time all current participants will have left the stage, and market and economic conditions will have evolved entirely beyond today’s ability to predict.

Rather than get deeply to grips with the long-running and intractable problem of usable guidance on the prevention and detection of corporate fraud, the Consultation quotes and endorses (¶ 6.4.4) the position in the Brydon report (¶ 14.1.5) that “it is the obligation of an auditor to endeavor to detect material fraud in all reasonable ways.”

Compare. International Standard on Audit 240 states (¶ 5) that the auditor “is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.”

In the US, the PCAOB’s Audit Standard 1001.02 provides that “the auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.”

None of these three articulations is self-operating as a matter of auditor liability. The significant scrutiny of an auditor’s actual response to indicia of fraud or malfeasance comes in a litigation context, with hindsight allegations of some form of shortcoming. Judges must parse these pronouncements like the medieval theologians debating the number of angels dancing on needle-points. Was an “endeavor (done) in all reasonable ways”? If under the US standard, was “plan and perform” done to a level acceptable in the legal system? Under what standard was the performance “reasonable”?

Information users and practitioners have been dissatisfied for decades. And the language of the Consultation offers no improvement.

Rather than -- to conclude, for now at least, with the subject of internal corporate controls – imposing on UK companies the American requirements under the Sarbanes/Oxley law of 2002, by which controls are signed off by senior executives whose assessments are then attested by the auditors (¶ 2.1.4), the Consultation’s preferred position would leave as optional the question of auditor views on the company’s own assertions (¶ 2.1.41).

Here again, credit where due for restraint. In the 19-year history since the passage of Sarbanes/Oxley, enforcement proceedings and litigation under its provisions on controls have been rare to the point of non-existence. That’s because the Sarbanes/Oxley layering of additional company representations is essentially redundant of the antifraud provisions at the core of the American securities laws, which since the 1930s have made illegal the making of materially misleading statements in the purchase or sale of securities – including in the financial statements required to be signed off by senior corporate executives – making it a doubtful model for the UK’s emulation.  

In sum, over the longer run, the timetable and future prospects for change under the temporizing strategy of Secretary Kwarteng extend down a lengthy road to a dim and misty future.

In the short run, any immediate effect will be akin to that of the little boy in the church pew, suffering loss of bladder control in his dark blue suit: the result is scarcely visible, and does no permanent harm, but it allows the lad to feel relieved and warm all over.    

 

[1] On the two topics that would have direct effect – “operational separation” of the Big Four audit and advisory practices, and the threat to impose “managed shared audits” on the FTSE 350 -- please see my post of April 21.

 

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Is Audit Reform Truly a UK Priority? Good Luck With That

Kwasi Kwarteng wasted no time, upon taking office on January 8 as the UK’s new Secretary of State of Business, Energy and Industrial Strategy, in asserting that audit reform was “one of his initial priorities.”

The sounds of earnest innocence might be rather touching, from a government servant, freshly elevated from his Energy remit to become chief minder of the entire sprawling BEIS portfolio. Forbearance for a learning curve may be indicated, as reinforced by a CV that does not reveal experience with the issues afflicting Big Audit.

For the moment, however, and presuming good in Kwarteng’s intentions, queries on his earliest signals are in order. See his first Twitter message, following one of appreciation for his appointment – shouting out a £ 10 million investment to support carbon emissions reduction by the whiskey distillers (@kwasikwarteng), as “something we can all raise a glass to.”

Unfair to compare -- few glasses have ever been raised to salute the auditors, in the centuries since the invention of double-entry bookkeeping. But neither did audit reform rate a mention in the BEIS coverage of Kwarteng’s January 11 telephonic discussion of his priorities with five different British business organizations.

Post-Brexit trade relations with the EU and the state of the COVID vaccine roll-out naturally headed that list, on which audit reform did not appear – these having pre-occupied Kwarteng’s short-lived predecessor in office, Alok Sharma. Which said, the realities underlying the intense criticism of Big Audit in the UK that erupted with the collapse of Carillion in January 2018 now confront the anodyne language of the new Secretary’s introduction.

Government response is awaited to a quartet of reports – Sir John Kingman (December 18, 2018) on the manifold inadequacies of the Financial Reporting Council; the Competition & Markets Authority (April 18, 2019) on the Big Four’s audit market concentration at the FTSE 350 level; the BEIS select committee chaired by MP Rachel Reeves (April 2, 2019); and the extended inquiry by Sir Donald Brydon (December 2019) on the purpose of audit.

While the critics’ array of proposed “solutions” are shelved pending official response, further outbreaks of financial scandal and irregularities, litigation and regulatory impositions have added to the intensity of public interest – both in the UK (e.g., Thomas Cook, NMC Health, Patisserie Valerie, Autonomy) and globally (e.g., Gupta, Steinhoff, Wirecard).

What confronts the prospects and the credibility of Secretary Kwarteng, unhappily, is that he brings to the battle a distinct lack of weapons. As explored in detail in my 2019 book – “DOA: Can Big Audit Survive the UK Regulators?” (Amazon) – there is quite simply nothing in the legislative or regulatory armory that can be deployed to effect fundamental change in Big Audit as presently configured.

In summary:

• Re-engineering of the FRC, decried as “toothless and useless,” into the new Audit, Reporting and Governance Authority, is hostage to necessary legislation, and in any event is aimed not at auditor performance itself but at a regulator whose impact is at best secondary and retrospective.
• Attempts to expand competition with the Big Four, by injecting the so-called “challenger firms” into either joint or shared engagements or by actual forced re-distribution of audit mandates – neither ever justified on the basis of audit quality impact – more importantly confronts the reality of the smaller firms’ limitations in size, resources, geographic scope and risk-taking capacity and tolerance.
  • Auditor changes for troubled companies, in the post-Carillion era, do not indicate optimism that those limitations are subject to relief. The replacement of Grant Thornton by RSM as auditor of Sports Direct (since re-named Frasers Group) in October 2019, after weeks of non-compliance, and the December 2020 replacement by Boohoo of PwC with the much smaller Littlejohn firm of the PKF network, do not signal endorsement that the capacity of the “challengers” is adequate to the task.
• As for the ability of the Big Four to house the ancillary skills necessary to perform audits for the world’s complex companies, in the face of calls that they should be “broken up,” the UK regulators retreated to a process of “operational separation” of the audit practices – not only because full legal separation would have been a reach too far for the UK authorities, but because the negotiated optics-oriented adjustments to the large firms’ branding, governance and internal resource deployment were readily within reach.   

To emphasize – the impotence of Kwarteng and his fellows in the face of Big Audit’s intractable issues does not counsel either cynicism or despair. The world’s capital markets will continue to seek financial information assurance that is both relevant and dependable.

The Brydon report points the way, although not without heavy lifting, as Sir Donald understandably declined to wrestle with several fundamental challenges – notably the audit firms’ presently limited financial and structural stability and the related limitations of archaic rules on independence and permissible scope of practice.

One way or another, those will be solved. Perhaps by another litigation-driven collapse, as with Arthur Andersen in 2002, and replacement of the current model with newly organized and emergent suppliers. Or, desirably but much less likely, by the collective and collaborative efforts of all the relevant players to make the deep and necessary changes.

But not, it must be said, by Secretary Kwarteng. To him, as his day of reality and reckoning awaits, the best and only offer is “good luck.”

 

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The Quality of Audit Is Strained – Sir Donald Brydon to the Rescue?

In mid-December, Sir Donald Brydon, estimable London banker and recently retired head of the London Stock Exchange, released a 135-page report, the culmination of his Independent Review Into the Quality and Effectiveness of Audit.

Tasked by the British cabinet secretary for business, his broad-ranging and insightful analysis and recommendations emerge into a UK environment of deep hostility aimed at the accounting profession. Calls for change, animated by a spate of scandals bracketed by the collapse of public contracting giant Carillion in January 2018 and travel icon Thomas Cook in September 2019, range from dissatisfaction with the Financial Reporting Council as the country’s audit regulator to proposals for the break-up or forced reduction in the dominant large-company audit market share of the Big Four.[1]  

Having no official authority of its own, the report’s prospects and impact will rest on the limited supply of political and regulatory energy to be devoted by Boris Johnson’s otherwise pre-occupied post-Brexit government.

So far, ahead of a predictable breaking wave of hostile resistance, public reaction to the substance of Sir Donald’s reasoning and advocacy has been a mild ripple of interest. There will be topics to be addressed -- most notably, his proposed new designation and certification of “corporate auditors,” and others including:

• What the report resists – e.g., mandatory joint auditors for large public companies.
• What it avoids – e.g., the financial and structural fragility and instability of the large firms.
• What it would like evolved – e.g., the current unsatisfactory form of the standard auditors’ report.

Here today, a look at the last of those, and the recommendation that the basic binary auditors’ opinion – “pass/fail,” in lay terms – be retained (¶ 2.3.7) -- although replacing the traditional British formulation that company financial statements provide a “true and fair view” with language from the global standards, that they are “presented fairly in all material respects” (¶ 2.3.2).

Herewith a dissent on the retention of “pass/fail”: As I have written elsewhere, the short-form report is an outmoded product that nobody values, at a cost that nobody wants to pay -- archaic, obsolete, unresponsive to user needs, and a candidate for the dustbin of history.[2]

Scrapped altogether, it should be replaced entirely by “bespoke” assurance – that is:

• Useful auditor reporting would be tailored in focus and content to specific user needs as determined in dialog among the company, its providers of capital, and the auditors.
• It would be sourced by the company from whichever supplier is best suited – whether a traditional audit firm, an emerging firm with a specialty niche, or a new form of provider altogether.
• Assurance engagements would be under conditions of auditor liability that allow for initiative, evolution, and appropriate measures of responsibility among the parties.  

After all, the investing public has long demonstrated disinterest in the vestigial short-form report -- whose sole surviving purpose is to satisfy the regulators of the securities markets. To make a medical comparison, its “pass/fail” language is the capital markets equivalent of the human appendix.

That is:

• Like the vermiform appendix, the “pass/fail” audit opinion serves no obvious purpose.
• Day-to-day, nobody pays it any attention.
• Very few know where it is to be found, ever seek to locate it, or understand if it actually has a function.
• Nothing in either medical science or audit capability allows for dependable predictions of failure, or the ability to prescribe preventive intervention.
• And yet, when either goes wrong – which inevitably occurs with non-zero frequency – the consequences can be grave, and even fatal.

In the end – like the human appendix that can be removed by safe and uncomplicated surgery – it could be excised and never be missed.[3]

The Brydon report’s endorsement of greatly expanded forms of assurance on publicly valued aspects of corporate performance (see generally Ch. 5) is most welcome and worthy of pursuit.

To that end, however, recognition is necessary that the narrow “pass/fail” audit opinion with its origins in the Victorian era has outlived its usefulness and stands now only as a barrier to progress.

 

[1] For a detailed view and an assessment of the UK prospects, please see my book, “DOA: Can Big Audit Survive the UK Regulators?” (Amazon, May 2019).

[2] The theme runs through my first book, “Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms” (Emerald Books 2d Ed. 2017) – Amazon here.  

[3] Before its exposure as a sham, the scandal-riven Theranos in California raised $ 750 million from investors without ever having an audit. In the UK, high street retailer Sports Direct was out of compliance for weeks with its obligation to replace the resigned Grant Thornton firm, all to no effect on its stock price.     

 

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The Challengers’ Cup – An Auditor’s Poisoned Chalice?

Two events in the last week of October are related:

On October 25 the Financial Reporting Council, the UK’s audit regulator, released its latest “Key Facts and Trends in the Accountancy Profession.” The headline was that the Big Four had increased their market share, auditing 100% of the FTSE 100 and building their audit fee income by 1.7%, while the smaller firms doing public interest entity audits saw theirs reduced by 6.7%.

Also, high street sportswear retailer Sports Direct, owned 60% by its bumptious chief executive Mike Ashley, reported on October 23 its success after six weeks of default in replacing auditor Grant Thornton, which had resigned just before the company’s annual meeting. Although Ashley had previously insisted that only a Big Four firm would do (July 26 release of preliminary yearly results, p. 11), the willing firm was RSM – seventh by size in the UK as measured by audit fee income.[1]

For context, important developments are pending in the highly charged UK environment:

• The delivery of Sir Donald Brydon’s fulsome project on “the effectiveness and quality of audit,” expected mid-January according to his Twitter feed (@BrydonDonald).
• The uncertainty under a Brexit effect of legislation to implement the recommendations of Sir John Kingman to supplant what he called the “ramshackle” FRC with a new Audit, Reporting and Governance Authority.
• And the prospects for action on the advocacy of the Competition & Markets Authority and the BEIS committee headed by Labour MP Rachel Reeves for joint audits of the FTSE 350 with mandatory challenger participation, or other forms of coerced audit market reduction of the Big Four’s dominant share.

Years of experience and hindsight will likely be needed, to determine whether RSM’s undertaking of an engagement shunned by all of the Big Four and other challengers will prove either very brave or very foolish.

On that, the constant business press visibility of Mike Ashley’s swashbuckling adventures suggests that RSM’s risk managers must be devoting sleepless nights to the acute recognition of the hazards of their mission – considering that, as put in the firm’s 2019 Transparency Report (p. 41) “in general (the firm) is not active in high audit risk environments.”

Perfectly understandable -- because any proceedings by investors or law enforcement arising out of Sports Direct’s accounting and public reporting would likely have a one-and-done impact on RSM’s very stability. Its audited 2018 financial information, the latest available, includes only £ 13,000 in “provisions,” none identified as litigation; it references only unspecified but “appropriate professional liability insurance;” and it indicates no financial commitment or support from the RSM network’s global structure – confirming, as put in the same Transparency Report, that the each firm in the RSM international network is “a separate and independent legal entity” and that “no single member is responsible for the services or actions of another.”

The relative size of the Sports Direct engagement matters. It is to be RSM’s only FTSE 350 engagement. With a market cap of £ 1.7 billion, it is multiples the size of RSM’s handful of AIM-listed companies. And for an extra risk factor, the company’s NASDAQ listing of its ADRs (SDISY) brings the attendant challenges of compliance with the American securities and auditor regulation regimes and exposure to the hazards of US litigation.

Returning to the broader audit market share issues – the extent of business media attention to the single event of RSM’s hiring should be a check on the CMA’s advocacy that challenger firms should take on 20% or more of the FTSE 350 work over something like a ten-year span.

That is, the CMA’s proposal would mean the migration to new auditors of some 70 companies or the equivalent in joint audit participation. If allocated to the challengers according to their 2018 audit revenues[2] -- having added one, RSM would be looking at nine more; Crowe and Mazars as the two smallest might take up ten between themselves; BDO and Grant Thornton as the two largest would look to add a couple dozen apiece.

Yet to date, neither the politicians, the regulators nor the strident critics of the profession have advanced anything like strategic plans by which those firms would succeed in developing or delivering the personnel, expertise, geographic coverage, financial resources or risk appetite upon which to scale up from RSM’s one-off.

Should Mike Ashley have been left to stew in the consequences of his own attitude? The authority of the UK business secretary to appoint an auditor only addresses a board’s failure to act, not an enforced appointment in the absence of a willing candidate – nor would an attempt at governmental conscription align with the profession’s requirements to rely upon and have a mutually trusting relationship with a client.

Put another way, and by no means impugning either the ambitions of RSM and its challenger brethren or the enthusiasm of the critics, reality intrudes. However enthusiastically a “Nirvana fallacy” may be urged, the frequency of its repetition neither adds legitimacy nor rebuts the folly of unachievability.

 

 [1] As a parenthetical, for those interested in the vexing question whether the investing public actually does value the audit function: Sports Direct’s share price on the LSE actually rose by five pence both on July 29, the day Grant Thornton announced its resignation, and September 11, the day of the annual meeting when it was conceded that no successor was engaged, and then fell by six pence on the day RSM was announced.

[2] Updating from the prior year’s figures in my recent book, “DOA: Can Big Audit Survive the UK Regulators?” (Amazon May 2019).

 

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What’s Hot in Big Audit? October 4th at the ICAEW in London

A major up-dating is set for October 4 at the London home of the Institute of Chartered Accountants in England and Wales – its 2019 Audit Conference, “Reflect, Reform, Refocus.” Proceedings will be reported in the next issue of its magazine Audit & Beyond – but live attendance on Friday will be worth it.

The context is volatile and challenging. Relevant current events include:

• The September 23 collapse of venerable travel operator Thomas Cook, this time with a gloss on the expected query -- “Where was EY?” -- that features the absence of a “going concern” qualification in its 2017 and 2018 opinions.
• The on-going noncompliance of Mike Ashley’s Sports Direct with the requirement, unfulfilled since its September 8 Annual General Meeting, that the company find an auditor willing to succeed Grant Thornton.
• And the persistent silence of the Competition & Markets Authority, following its April 18 report, which proposed that most of the FTSE 350 should be obliged to engage a second audit firm, selected from among the so-called “challengers.”

These items of immediate attention are piled on those of recent months, in addition to the CMA’s report – the report by Sir John Kingman on December 18, 2018, which set up the on-going process of rehabilitating the Financial Reporting Council into a new Audit, Reporting and Governance Authority, and the April 2, 2019, report of the Business, Energy and Industrial Strategy committee of Parliament with its calls for yet more aggressive steps to force a reduction in the near-total large company audit dominance of the Big Four, break up the Big Four, or hobble the scope and skills of their audit practices.

The morning keynote speaker at the ICAEW conference will be Sir Donald Brydon, expected to bring the world up-to-date – albeit with sensitivity and due regard for protocols and discretion – on the state of his mission, launched in December 2018 by the Business Secretary, to inquire and report on “the Quality and Effectiveness of Audit.”

Views on the broad range of concerns will be offered by speakers from practitioners, the standard-setters, and the regulators – see its programme.

I will be there, with a few words to offer. No spoiler alerts are needed – the grounds and reasons for my skepticism about the mooted “reforms” are laid out in my book of this May, short but detailed -- “DOA: Can Big Audit Survive the UK Regulators?”

For those unable to be in Chartered Accountants’ Hall on the 4^th, my perspectives on the issues derive in good part from this single graphic, showing the global accounting networks with 2018 revenue greater than $ 500 million.

Anyone paying attention to the implications of this array, and still clinging to the belief that either joint audits or forced market share re-allocation can be achieved, is invited to bring forth the arguments. Presentation space will be offered here, free and in full – fairly warned that the section will be labeled “Fiction and Fantasy.”

 

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A Taxman Cometh – The United Kingdom Gets a New Audit Regulator

London continues the center of political and regulatory threats to the Big Audit model – there being no way to tell the difference between Washington’s summer torpor and the chronic somnolence at the SEC and the PCAOB:

 “Cometh the hour, cometh the man”? Perhaps – although not clear.

Whitehall’s July 18 announcement is that career civil servant Sir Jonathan Michael Thompson – “Jon” yclept – will leave his post as chief executive of HM Revenue and Customs, succeeding Steven Haddrill, the lame-duck chief executive of the Financial Reporting Council.

He will arrive in interesting times. The FRC – “toothless and passive” as described by Labour MP Rachel Reeves, and in City grandee Sir John Kingman’s December 18, 2018, report (¶ 4) “a rather ramshackle house … built on weak foundations” – is to mutate into a newly configured Audit Reporting and Governance Authority.

Or not. Housekeeping adjustments at the FRC began with uptake of the Kingman report by Greg Clarke, cabinet secretary for Business, Energy and Industrial Strategy. More serious changes require legislation, although whether any law-making energy survives the Keystone Kops environment of Brexit will abide – as will, indeed, any policy initiatives that may outlive the dubious tenure of a Tory government predicted to be led by Boris Johnson.

To fulfill ARGA’s charge, described in the July 18 Financial Times as “restoring confidence in the quality of the audit work in the UK after scandals at companies such as Carillion, the outsourcing group,” Thompson steps into fraught conditions.

First, as addressed in detail in my new book – “DOA: Can Big Audit Survive the UK Regulators?” – he will find his regulatory cookbook lacking achievable recipes:

• The headline recommendation in the April report of the Competition and Markets Authority was that all but the largest of the FTSE 350 companies should engage two audit firms. The problem is that if enacted, a requirement that second auditors be selected from the ranks of the “challengers” would suffer irredeemable impracticality based on those firms’ limited scale, capacity, financial resources and risk tolerance.
• The CMA’s other proposals -- that there be “organizational separation” of the Big Four’s audit practices, and that they should foreswear all ancillary services to audit clients -- were already either fait accompli or well capable of adoption, yet are of dubious and unproven impact on the quality of auditor performance.

Second, the more aggressive actions urged by press and academic critics as well as the April 2019 report of the Reeves committee -- such as enforced reduction of the Big Four’s market dominance, actual break-up, or shrinkage of the large firms to “audit only” -- have failed to acquire traction.

Third, presuming the best of regulatory intentions at the new ARGA, reality will intrude to impose practical limits on the scope of any enforcement penalties -- the head-on hazard that the failure of another Big Four firm, in a reprise of the 2002 litigation-driven collapse of Arthur Andersen, would disintegrate the entire model.

Last and most important, ARGA will inherit two of the FRC’s structural handicaps – that by the nature of its auditor oversight remit it is distant by two removes from the machinations of corporate malefactors; and that, like any enforcer, it will be under-resourced, politically stressed, and consistently late to arrive on the scene of the next and inevitable outbreak of scandal.    

In this less-than-optimistic setting, Sir Jon brings to his new task a CV in government accounting and finance and a career-long string of civil service postings – none relating to the profession of public accounting or, in particular, the national and global complexities of the Big Four networks’ provision of audits for the world’s large public companies.

Rather, as the FT observed, his tenure at HMRC included “controversy over staff bullying” and “an independent review (that) found that abrasive behavior was prevalent.”

Context affects the prospects for success. “Horses for courses,” as the English put it. Or in the tactics manual of the American mob, “don’t bring a knife to a gun fight.”

Is a bare-knuckled bureaucrat well suited to the UK’s multi-party bun-fight over its audit model? Critical public reaction to the evidence given in last January’s committee hearings by non-auditor representatives of the large accounting firms suggests the importance for credibility’s sake of detailed experience and communication capability.

Credit Sir Jon with the energy and skill set of an experienced civil servant –- whether or not transferable to a radically different context, where both enthusiasm and ideology may well be sucked into the vortex of Big Audit’s technical, professional and business structure and culture – enough to smother the best of intentions.

One risk is clear: his initiatives will be hostage to the Dunning-Kruger effect – the prospect that inexperienced decision-makers will suffer all-too-human over-confidence and fail to recognize the limits of their capabilities in a complex field.

As the current occupant of the White House in Washington has been fond of saying since 2016, about his own ad lib initiatives that so often dissolve into thin air or inaction, “We’ll see.”

 

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