Public audit – to mutual, or not to mutual?

THE AUDIT COMMISSION’S death knell has sounded, and interested parties are buzzing with ideas for its successor. One popular option is the founding of a mutual, and stakeholders are endowing the idea with all their dreams for the future of public audit.

Mutuals are formed when employees assume ownership of a company, and each has a say in its operation. There are many models and varying degrees of stakeholder engagement, but one of the best known examples is John Lewis, which has 76,500 partners who share the profits and running of the business.

Mutualisation of the Audit Commission has become entangled in the competition debate, and many parties have seized upon the concept as a counterweight to the domination of the Big Four.

The House of Lords audit inquiry committee threw its weight behind the proposition, and proponents eagerly point out that the commission’s work currently accounts for 10% of the total audit market. Members of the public body also back the idea, and Gareth Davies, managing director of audit practice, said almost 90% of staff support mutualisation.

But the creation of a mutual ushers in a number questions, not least, the issue of cost, implications for employees, and whether the fairytale firm can really compete with private sector peers when it sets sail in the big bad world of audit.

Mark Johnson, managing director of mutualisation specialist TPP Law, said the challenges are myriad but the benefits could be great. He pointed to the commission’s excellent client base that, if maintained, could give the player a significant shunt towards to the top of the market.

If mutualisation goes ahead, the first challenge would be spinning out, whereby members buy the audit part of the commission from government, turning it into a distinct company or public liability partnership. The price of the business unit would have to be ascertained, as well as the value of goodwill and established client relationships.

Johnson said this process could take a year to 18 months, and the clock is ticking. While the benefits of creating a body with a clear public service mission seem evident, in these austere times a sale to private firms would be a temptingly fast solution with the added bonus of cash in hand for the government.

Were employees to push ahead with the purchase, funding would be an obvious obstacle. Employee cash would almost certainly go into the pot, alongside substantial funds borrowed from a commercial lender. Johnson thought it unlikely the government would ‘be soft’ on a new mutual – either by offering a good price or a lenient payment timetable – ruled as it is by overriding austerity considerations.

If the deal were to go through, the structure of the mutual and allocation of its ownership would be the next big question mark. Audit Commission employees are calling for a system whereby senior members directly own shares in the company, while junior members would have an interest in a trust holding shares on their behalf.

But who would qualify for the premium membership package, and how would remuneration be shaped? This brings us to one of the fundamental questions of mutualisation – what is in it for members?

The Baxi Partnership is a consultancy that grew out of the successful employee takeover of a boiler manufacturing company, which now offers advice to organisations making the jump. Its list of reasons to go mutual are extensive, many would argue that giving staff a stake makes them happier, more motivated and loyal.

Johnson says mutual members also have the possibility for financial gain if the business takes off, and this could motivate some to back the transformation. A potential problem with the shared ownership system arises when staff want to leave; they cannot take their stake with them, so an internal market for shares must exist.

Another factor to consider is the conditions of members’ employment. Under the TUPE regulations set out in 1981, staff terms and conditions are protected throughout mutualisation, meaning the new outfit assumes the responsibilities of the old public entity. This includes paying for benefits like pensions; these can be large in the public sector, and might be a heavy financial burden for a fledgling firm. Of course, such generous packages need not be extended to new members of the mutual, but this risks creating a two-tier structure.

Employee questions aside, the survival of the new mutual is predicated on Audit Commission clients – from local authorities to drainage boards – bringing their business to its door. If it is to survive in a free market – as the government is advocating for public audit – it must be competitive.

To do this, it would have to run more commercially, and take a long, hard look at its cost base. Mutualisation fans say there are a number of ways the firm could keep fees low. Olivier Roth, researcher at think tank the New Local Government Network, said having no external shareholders would keep costs down. Other proponents have counted the pennies saved by disposing of the Audit Commission’s wider responsibilities, and say this adds up to savings for clients.

The final issue to consider is the possibility of failure. This is likely to be uppermost in the minds of would-be members, who stand to lose their job and their investment in one crushing blow.

Three principle safeguards should protect against this risk. Firstly, a regulator would oversee operations and solvency, and should catch any problems before they brought the mutual to its knees. The Department for Communities and Local Government wants to extend the FRC’s remit to cover public audit, and it would then fall to the regulator to watch over the fledgling mutual.

Secondly, a sound business plan at the point of departure should put the organisation on the path to success. This is an additional time pressure on the authors of the mutual plan, as traditionally the wider workforce would be consulted, and the process could prove lengthy.

Finally, and perhaps most importantly, a government promise to step in if the group collapses would provide crucial assurance to members and clients alike. Such a mechanism would normally be worked into the terms of sale, and it could be the deciding factor for mutualistion.

There is no doubt that the Audit Commission’s days in its current guise are numbered. The future of public audit is much less certain, but the concept of forming a mutual is riding high on a mix of popular approval and fears over increasing concentration in the market. Whether the details can be hammered out in time remains to be seen, but it will be an important test case in Cameron’s Big Society, where government is looking for new ways to organise public services, and the new benchmark for success is protecting the public purse.