London: The world’s top four audit firms will have to split up and rename themselves under a draft European Union law to crack down on conflicts of interest and shortcomings highlighted by the financial crisis.
“Investor confidence in audit has been shaken by the crisis and I believe changes in this sector are necessary,” Internal Market commissioner Michel Barnier said on Wednesday.
Policymakers have questioned why auditors gave a clean bill of health to many banks which shortly afterwards needed rescuing by taxpayers as the financial crisis began unfolding.
Barnier said recent apparent audit failures at AngloIrish and Lehman Brothers banks, BAE Systems and Olympus “would strongly suggest that audit is not working as it should”.
More robust supervision is needed and “more diversity in what is an overly concentrated market, especially at the top end”, he said.
Just four audit firms — Ernst & Young, Deloitte, KPMG, and PwC — check the books of most blue-chip companies in the world, a situation the Commission said was “in essence an oligopoly”.
Under Barnier’s plan big audit firms — the four top ones — will have to separate audit activities from non-audit activities, such as tax and other advisory services — “to avoid all risks of conflict of interest”.
Claire Bury, one of Barnier’s top officials, said the plans, if approved by EU states and the European Parliament, would have an impact on the business models of the Big Four.
The audit and non-auditing operations of the big firms, defined as having a revenues of more than €1.5 billion in the EU, would have to have separate legal ownership structures.
“The will have to change names as well. I suppose we will have branding issues at the end of the day,” Bury told a press briefing.
Public tendering of audit work by listed companies would be compulsory and include consideration of second-tier auditors.
Commission officials indicated that as the measure dealt with major structural reform of the market, the industry would need time to adapt but they hoped the new rules would be in place within 3-5 years.
“It’s not something that can be rushed through,” Barnier’s spokeswoman said.
EU states and the European parliament will have the final say on Barnier’s draft law, a process that involves haggling and likely changes.
Barnier, under pressure from some fellow commissioners, dropped at the last minute a key element of his plans — mandating “joint audits” of listed companies as a way to improve audit quality and help smaller auditors have experience of checking the books of big companies.
Instead, he has tried to introduce incentives to encourage joint audits by finessing another part of the measure -- the mandatory switching or rotation of auditors.
A sole auditor would only be allowed to audit the same firm for up to eight years but, if a joint audit was being done, this mandate could be extended up to 12 years.
An audit firm would not be allowed to offer non-auditing services, such as tax and other consultancy services, to a company it is auditing.
The EU plan also bans so-called loan covenants whereby banks lend money to companies on condition they are audited by one of the Big Four.
Officials from the big audit firms have warned that audit costs will increase and quality could suffer but their smaller rivals welcome Barnier’s plans, which would open the door to new business for them.
The UK Competition Commission is already probing the sector and regulators in the United States are looking at audit firm rotation as well.