THE HOUSE OF Lords audit report delivered its scathing summation last week, and the over-arching conclusion was that the Office of Fair Trading must investigate. Calling on the OFT at every turn seems a convenient bandage for the many ills of audit, but it raises two serious questions. Firstly, is the OFT the right forum to address the myriad problems? And secondly, what will happen if the body does take up the mantle?
When it comes to an OFT study, commentators agree on just one thing – that restrictive banking covenants warrant investigation. Hereafter, opinions differ wildly, with some saying there are alternative ways to deal with the issues, while others claim competition is not the problem.
Big Four firms were the first to hit back at accusations, insisting that the top of the market – though concentrated – is a fiercely competitive arena. At least one second-tier firm has backed this claim, arguing the problems do not stem from lack of competition.
Tom McMorrow, director of policy at Baker Tilly, said the fact that the EU green paper on audit policy did not highlight a competition problem proves that it does not exist.
Stella Fearnley, professor of accounting at the University of Bournemouth, has similar views. She said that although restricted choice and market concentration are behind Big Four dominance, there is little evidence of a lack of competition.
Among those who welcome an OFT investigation, there was fierce debate about its focus. An investigation into covenants is universally popular, but when it comes to other problems, commentators are full of alternatives.
Steve Maslin, head of external professional affairs at Grant Thorton, said institutional investors are central to the solution. He advocated commissioning a panel to take a top-down look at the market, saying this would convince executive boards that a less concentrated audit market is good for business.
ACCA’s head of policy Ian Welch said limiting liability would encourage smaller auditors to tender for larger contracts, but admitted it is hard to convince companies. He argued the solution here is for a corporate group to set collective liability caps, saying the OFT will have little power in this area.
McMorrow agreed that liability is a primary area of concern, saying it falls outside the OFT’s remit. He says the Lords should put their weight behind alternative tools like the government’s Professional and Business Services Group, set up to establish key priorities for competitiveness and growth.
PwC’s head of policy Pauline Wallace has said another of the Lords’ findings, and proposes a different solution. She highlighted one of the main fears – that the Big Four might shrink to three – would be better tackled through contingency plans and rigorous quality checks than an OFT investigation.
Opinion is divided as to whether the OFT should be called in and what issues they must address, but what happens if the body does get involved? This is by no means a foregone conclusion, and will be decided in a board meeting later this month.
If they decide to go ahead, the first stage would be a market study lasting around six months, allowing the body to meet with stakeholders and request information. This would act as a preliminary inquiry to see whether a further investigation is required.
From here, the OFT can go down one of three roads. Firstly, it can try to fix the problems using relatively gentle means – persuading auditors to find a mutually agreeable solution.
If it finds the problems have a structural base or require permanent change, the issue might be referred to legislators. This is arguably the strongest tool in the OFT’s arsenal, but a senior legal practitioner warned the process could be lengthy and the outcomes uncertain.
This brings them to the third option, which has already found favour with the House of Lords. The OFT, can, if it has reasonable grounds to suspect conduct or structural issues are acting as a brake, refer the problem to the Competition Commission. The threshold for referral is relatively low, and the source said a combination of Big Four domination plus pressure from lenders and reputational issues may be enough to warrant a referral.
This decision could throw light on auditors’ attitudes to change; if the OFT does call in the commission, firms will have a chance to respond to concerns, potentially opening up a negotiation that could preclude the commission taking the issue further.
Angus Johnston, law lecturer at Oxford University, explained the referral will take the form of a detailed report presented to auditors and the commission. Firms could then try to address the concerns in a bid to head off commission involvement. This might be advisable, as the commission would conduct an in-depth investigation lasting two years. It has considerably more powers than the OFT, and can make statutory changes without ministerial approval. Johnston gave the example of BAA, which was found guilty of contravening fair trading standards and is being forced to sell two Scottish and one London airport. Auditors may take this as a healthy warning to heed the OFT’s concerns, should the process get this far.
Johnston said auditors’ likely response to a commission referral would depend very much on the plausibility of the report. If firms concede there are problems and are prepared to entertain solutions, they could enter into negotiations with the OFT. If not, the commission would conduct a full-blown investigation resulting in a range of remedies, which, at their most extreme, might force the break up of the Big Four.
With so many unknowns, it is hard to predict the fall-out of the Lords’ invitation to the OFT. Commentators think it unlikely the body will ignore the request, but the parameters of its investigation – and the resulting recommendations – remain a much-debated mystery.
In our view
Pre-packs have a serious image problem. And by association, so do the insolvency practitioners that propose them.
An unfair, opaque process that cuts creditors out of the loop and often places the company directors back in charge, free of a big tranche of the old company’s debt, is the complaint.
The combination of a lack of creditor influence, plus the same old directors in place on many occasions – the term phoenix company is the term often used with all its negative connotations.
But for the government to propose that three days’ grace must be given to creditors where an insolvent business is sold back to connected parties makes little sense, and renders the process defunct.
For big businesses, staff and associated business parties could well up and leave. And most pre-packs sold back to directors occur in smaller companies, where a three-day hiatus will just rack up administration costs.
Different forms of pre-packs are being trialled, but without a definitive replacement.
Opening up the administrators’ pre-pack report to the public, known as SIP16s, is at least progress. It feels like playing the same old record, but insolvency is a much better process when as transparent as possible.
Unless the insolvency profession can really hammer home the importance and value of the pre-pack process, then its demise will lead to more liquidations, and creditors will lose out to an even greater extent.
And who will be blamed? Insolvency practitioners of course.
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