May 16, 2018

Two parliamentary committees suggest accounting reforms after Carillion liquidation

U.K. regulators should consider breaking up the Big Four accounting firms, two parliamentary committees said Wednesday, contending a construction company’s collapse shows U.K. audit firms have become a “cosy club” incapable of questioning companies’ finances as needed.

In a joint report, the House of Commons’ Work and Pensions Committee and its Business, Energy and Industrial Strategy Committee, which have been investigating Carillion PLC’s January collapse into liquidation, said auditors played a big role in widespread failures of oversight that had allowed Carillion to become a “giant and unsustainable corporate time bomb.”

In particular, the committees said, KPMG, Carillion’s outside auditor for 19 years, was “complicit” in questionable accounting practices at the company, complacently signing off on its directors’ “increasingly fantastical figures.”

That has led to the danger of a crisis of confidence in the audit profession, the report said. “KPMG’s audits of Carillion were not isolated failures, but symptomatic of a market which works for the Big Four firms but fails the wider economy. There are conflicts of interest at every turn.”

A KPMG spokesman said the firm believes “we conducted our audit appropriately,” and that “there are clear benefits” to having auditing and consulting under the same roof. But “we also recognise the growing challenges that this structure presents and the importance of managing these to ensure public trust.”

The report didn’t spare the other Big Four firms. Deloitte, which acted as Carillion’s internal auditor, was either “unable or unwilling” or “too readily ignored” failings in Carillion’s risk management and financial controls, the committees said. Ernst & Young provided “six months of failed turnaround advice” to Carillion, the committees said, and PricewaterhouseCoopers, which is managing Carillion’s liquidation, could name its price to do so as the only remaining Big Four firm not already working for the company.

As a result, the committees said, the government should refer the matter to the U.K. Competition and Markets Authority, to explore whether the Big Four should be broken up into smaller audit firms, as well as whether their audit operations should be split off from non-audit functions like consulting.

The move comes after a similar suggestion in March by Stephen Haddrill, chief executive of the U.K.’s Financial Reporting Council, to break up the Big Four in the U.K. to create “audit-only” firms. The Big Four now get more of their revenue globally from consulting and other advisory work than from auditing, and many of the industry’s critics believe that creates the dangers of conflicts of interest and loss of focus on their core auditing work. They think breaking up the firms would spur more competition.

A Deloitte spokesman said audit-only firms “would reduce audit quality and be detrimental to investors and the capital markets.” EY said the current model “provides the structure, breadth and depth of technical skills and industry expertise necessary to deliver high-quality professional services, including quality audits.”

PwC said that while competition is “fierce” in the market for auditing large companies, “we would welcome more players to boost choice.”

In addition to the auditors, the committees’ report also blasted Carillion’s directors, which it said presided over a “rotten corporate culture,” and U.K. regulators, including the Financial Reporting Council.

[The Wall Street Journal]