The “big four” auditing firms – Deloitte LLP, Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP, or PwC – again grabbed the headlines; the seemingly endless regulatory inquiry flow in the audits shows no signs of slowing down. The most recent to be announced is the UK Financial Reporting Council’s (FRC) investigation into PwC regarding its audits of Galliford Try and Kier, two of the UK’s largest construction contractors. PwC audited Galliford Try for 20 years until 2019 when it was replaced by BDO under rotation rules, and has audited Kier, the government’s largest construction contractor, since 2014.
These are just the latest in a now swollen list of investigations into the Big Four’s historic audit work; there are currently seven ongoing regulatory investigations into PwC’s audits. These include its audits of British Telecom and carrier Eddie Stobart Logistics. Further away, the FRC announced in January that he was also investigating PwC’s audits of defense firm Babcock International Group, which spanned a four-year period.
Since 2020, the FRC has opened new investigations into PwC’s audits of a collapsed mini-bond company, London Capital and Finance, and Wyelands Bank, which was owned by steel billionaire Sanjeev Gupta. Additionally, PwC was fined 10 million pounds ($13.3 million) in 2018 for its audit of retailer BHS, which later collapsed.
PwC is in good company. As is well known, KPMG is currently being sued over its audits of struggling contractor Carillion: the UK’s official receiver is taking unprecedented action as part of its effort to maximize returns for creditors of the collapsed business.
In August 2021, the FRC KPMG fined £13m and ordered him to pay over £2.75 million in costs due to his role in Silentnight’s insolvency in 2011.
Meanwhile, in Germany’s biggest post-war accounting scandal, Ernst & Young continues to deal with the fallout from the collapse of payment processing company Wirecard, which it audited for a decade before its subsequent insolvency.
After Lookers announced the discovery of potentially fraudulent transactions at one of its units, Deloitte is also being questioned by the FRC over its audits of the car dealership. After overseeing Lookers accounts for 14 years, Deloitte stepped down as auditor in 2020.
As well as being investigated over its audit of Essar Oil UK, Deloitte was also fined a record £15million for gross misconduct in its ‘reckless’ audits between 2009 and 2011 of Cambridge-based software giant Autonomy, for which he was severely reprimanded. .
Unless audit failure leads to insolvency, where the UK tax authority HM Revenue & Customs (HMRC) is invariably strapped for cash, in tax matters the usual pathology where holes audit or accounting blackouts are discovered is that the profit (net income) is overstated (which has the effect of inflating retained earnings and owner’s equity), and therefore a higher tax liability is (presumably ) incurred, so that there is no revenue fraud.
In generic terms, construction contracts often present difficulties in recognizing revenues and costs over the life of multi-year contracts. The Galliford Try and Kier surveys may still serve as good examples to illustrate this point. As a result, errors in accounts (whether fraudulent or negligent), where tax is understated or tax liability is misrepresented, will generally attract the interest of HMRC and interest and penalties are likely to arise. In cases of tax evasion, HMRC investigators can look back on accounts for up to 20 years.
Audit reform—current state of play
Given last year’s FRC audit quality inspection results and the amount of regulatory intervention currently, the evidence that the existing UK audit regime is in dire need of overhaul is overwhelming. It should be noted that the so-called “challenger” firms are not faring much better than the Big Four, with Grant Thornton and Mazars currently in the regulator’s crosshairs.
One would think that the reforms envisaged could not come quickly enough. However, it has now been nearly three years since the reform recommendations were presented for the first time and 12 months have passed since the government officially announced its revision of the British audit regime. This included proposals to break Big Four dominance, increase competition from small business challengers and introduce new reporting requirements for directors.
There have been recent media reports that the proposals are now in the hands of ministries for final (yes, final) approval. However, there is no guarantee that they will be included in the government’s next legislative programme, although they are expected to feature in the Queen’s Speech in May 2022. They may well not become law until 2024.
Main features of the reforms
Regarding some key features of the reforms, the Department of Business, Energy and Industrial Strategy (BEIS) is recorded as indicating“It is not healthy for audit quality that the UK audit market is so concentrated, with 97% of FTSE 350 audits carried out by just four audit firms. This concentration is not facilitated by the fact that these companies also compete to provide a wide range of other commercial services to larger companies.
Announcing the report, Business Secretary Kwasi Kwarteng suggested that major further reforms to the audit regime would “restore business confidence” following major corporate collapses and accounting scandals such as Thomas Cook, Carillion and BHS. Part of the long-awaited plan is to replace the UK’s audit watchdog, the FRC, with a new regulator, the Audit, Reporting and Governance Authority (ARGA).
The introduction of ‘managed shared audits’ is planned, which will require companies in the FTSE 350 that are currently audited by one of the Big Four to be partly handed over to smaller ‘challenger’ companies to improve competition . He also expects the definition of “public interest entities” to be expanded, imposing additional governance requirements on more companies.
Commenting further on the reforms, there has been much optimistic discussion from the Big Four themselves about the opportunity the reforms present to build a stronger business by improving standards of corporate governance, reporting and audit ecosystem to ensure the UK’s future competitiveness.
Other commentators have argued that they can create long-term value, improve confidence and resilience, and ultimately lower the cost of capital; they further suggest that the value created would far exceed the cost of additional regulation.
Much of this seems self-evident, as it is indeed vital that the government maintain momentum in implementing audit industry reform. But the question is whether the strength of purpose behind the rhetoric and the ability to implement widespread reform will be sufficient to fully achieve the level of change needed.
While the government seems determined to tighten regulatory oversight of the audit profession, in the area of financial services at least, the direction of travel looks very different. Under new plans presented last November by Chancellor Rishi Sunak, UK financial services regulation post-Brexit will be more laissez-faire. According to the Treasury, there will be a “once in a generation” opportunity to reform the way financial services are supervised and controlled. The government said in January 2022 that it wanted repeal an important part of EU law on financial services as one of its main ‘Brexit benefits’. It seems that this could well include measures to prevent future financial crises.
Having endured a recent global financial crisis, many commentators fear any regulatory relaxation in this context and wonder: will the existing regulatory gap in audit oversight simply be shifted to financial services oversight after Brexit? in a “regular robbery” from Peter to pay Paul?
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.
Paul Brehony is a partner at Signature Litigation LLP.
The author can be contacted at: email@example.com