Big Four break-up threat

COULD THE “BIG FOUR” acc­ounting firms be forced to become the Big Ten?

When former City minister Lord Myners suggested last week that the Office of Fair Trading (OFT) may need to investigate the dominance of the Big Four accounting firms, he raised the prospect of Britain’s competition watchdog breaking up the big accounting firms in order to improve competition in the audit market.

The Big Four, who scrutinise all but one of FTSE 100 company accounts, have taken a hammering during a Lords committee inquiry into the audit industry, with peers raising various concerns, including over quality of bank audits before the banking crisis and a lack of competition in the market.

Nevertheless, Myners’ warning that the dominance of the Big Four poses a “systemic risk” and should be diluted, possibly through an investigation by the UK competition watchdog, goes further than most proposed reforms for the audit market.

Myners made the comments when he was giving evidence to the House of Lords economic affairs committee, which is investigating the Big Four’s dominance of the audit market.

His concerns echo those of some leading investors.

Earlier this month, Guy Jubb, head of corporate governance at Standard Life Investments, one of Britain’s largest insurers, told the Lords inquiry into the audit market that eight was a “comfortable number” of competitors from which clients should be able to choose an auditor.

Myners’ comment about “systemic risk” refers to concerns that the collapse of one of the Big Four firms would cause major disruption to financial markets and thousands of large businesses.

The remark also draws a parallel to Britain’s biggest banks, which, according to some experts, have become “too big too fail” and may need to be broken up. This would make them easier to wind down without taxpayer bailouts should they collapse, according to some experts.

Over the weekend, the head of the commission looking at the ways Britain’s banks operate has indicated that major changes are on the way.

Tighter regulation of the UK audit market looks increasingly likely too, potentially challenging the dominance of the Big Four firms.

Later this year, the Lords committee will publish prop­osals to improve competition in the UK audit market, which the government will consider.

Meanwhile, the European Commission (EC) is considering a mandatory rotation of auditors and a cap on advisory fees as part of a review of the audit market. The Financial Reporting Council (FRC) has recently published recommendations to improve the oversight of auditors.

In the spotlight

So is an OFT investigation likely? The OFT has a three-point checklist when deciding whether to launch an investigation. It looks for suspicion of collusion, price fixing or the abuse of dominance, under the Competition Act.

An OFT spokeswoman said that it was awaiting final reports from the Lords audit inquiry and the FRC, before deciding whether to launch an investigation into the Big Four.

When the OFT’s chairman, Philip Collins, appeared before the Lord’s audit inquiry last autumn, he stressed the “international nature” of the Big Four accounting market.

“We have to look in terms of what the solutions might be and what is practical in an international setting,” Collins told peers. “So it is a market in which we have a keen interest but it is not a market in which we felt it appropriate, in the last seven or eight years, to conduct a detailed review because other things had been happening.”


Legal view

If competition regulators decide to investigate the Big Four, legal experts say it would probably be based on suspicion that firms were abusing their dominance in the audit industry.

The most radical option, allowed under or European Common law (article 102 of the Treaty on the Functioning of the European Union) would be for competition regulators to look for evidence that the Big Four firms are collectively abusing their dominant position in the market.

Firms can be fined up to 10% of their annual turnover, if found guilty. In 2004, the EC fined Microsoft €497m (£332m) after ruling that the software giant had abused its dominant market position.

In the UK, the OFT could examine audits of FTSE 250 companies and require the Big Four firms to divest some of their business, with mid-tier firms taking on some of their audit clients, said Edward Craft, partner at Wedlake Bell, a law firm.

“The OFT could say the Big Four firms are too big and [for example] force them to sell half of their clients to the next tier of auditors,” Craft said. “This could create a big ten of accounting firms.”

However, Craft stresses that this is unlikely to happen and is the “nuclear option”.
A less controversial, and more likely option, would be for the OFT to review the audit industry to check for anti-competitive behaviour, using a power under a section of the Enterprise Act.

“The OFT would hope to show anti-competitive behaviour or advise financial regulators to pass new rules for the audit market,” said Andrew Scott, a senior lecturer in law at the London School of Economics.

Big Four reaction

Most of the Big Four firms are keeping their heads down. Deloitte, KPMG and Ernst & Young declined to comment on Myners’ points. However, Richard Sexton, PwC’s UK head of assurance, said the firm disputes Lord Myners’ claim that the concentration of audit services in banking pose a “systemic risk”.

“No audit firm is too big to fail, but the crux of the issue rests on what should be done to avoid such a situation if a firm collapsed and how the audit market would react,” Sexton said.

PwC is working with the FRC to develop contingency plans to deal with the collapse of one of the Big Four firms, even though such a collapse is unlikely, Sexton adds.
In the UK, the government appears reluctant to break-up the Big Four firms. The
first evidence of the government’s thinking on the issue emerged last week in a summary of a letter sent from the department of business to the EC regarding the commission’s audit industry consultation.

In the letter from the office of employment minister Edward Davey, it said that any “forced” break-up of the Big Four to resolve the concentration of the audit market would have to take place on a global scale and could risk “unintended consequences”.However, the use of restrictive clauses by banks forcing clients to use Big Four auditors during credit negotiations, an issue highlighted by Accountancy Age, would be a matter for the competition authorities, the government adds in the letter.

One alternative to breaking up the Big Four would be for the FRC to set up a team of leading institutional investors to review the audit market and encourage large companies to use audit firms outside the Big Four, thereby improving competition. This idea is favoured by Grant Thornton (GT), the UK’s fifth-biggest accounting firm.

Steve Maslin, who chairs GT’s partnership oversight board, said: “Lord Myners is right to talk of failure of one of the largest audit firms and there is clear concern among shareholder groups and regulators that the current excessive level of concentration is unsustainable and could threaten capital markets.”
The Big Four firms are discovering that size can become a liability.

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