UK watchdog orders ring-fencing of Big Four audit business

London (Reuters): Britain’s “Big Four” accounting firms must ring-fence auditing from their consultancy work, the country’s competition watchdog said on Thursday in a response to book-keeping failures such as at construction company Carillion and retailer BHS.

“Auditors should focus exclusively on producing the most challenging and objective audits, rather than being influenced by their much larger consultancy businesses,” the Competition and Markets Authority (CMA) said.

Exemplifying the issue, regulators found PwC’s lead auditor of BHS spent two hours on its 2014 audit and 31 hours on more lucrative non-audit work, leaving the bulk of auditing work to juniors. PwC was fined a record 6.5 million pounds ($9 million) for its shortcomings.

Britain’s business minister Greg Clark has said he would introduce legislation to implement the CMA’s recommendations, which constitute the most radical reform of auditing yet after previous attempts by Britain and the EU to loosen the Big Four’s grip on the market have failed.

Yet operational separation of audit and consultancy at PwC, EY, Deloitte and KPMG would fall short of the full break-up that British lawmakers called for this month.

The CMA noted “difficulties with an immediate global structural split”, given the Big Four are international and Britain can only intervene in the UK.

The operational split should be reviewed by regulators after five years to see if tougher measures were needed, the CMA said.

Audit quality

The audit practices of the Big Four should have their own management, accounts, pay policies, chief executive and board. Profit-sharing between audit and consultancy should be banned, and promotions and bonuses should be based on the quality of audits, the CMA said.

The Big Four, who audit nearly all of Britain’s blue chip companies, say ring-fencing would do little to improve competition and standards, and proposed caps on how many companies they could audit to give smaller rivals a leg up.

But the CMA has not included this in its final recommendations.

The CMA confirmed its initial recommendation that the top 350 listed companies must hire two auditors, with one from outside the Big Four - a step some companies are leery about because of the extra cost. Both would be liable for the audit.

Regulators could allow “initial limited exceptions” to the joint audit rule for the biggest, most complex listed companies, the CMA said in a nod to a suggestion from lawmakers.

Grant Thornton and BDO, the nearest rivals to the Big Four in Britain, are far smaller and would find it hard to audit a major international company.

The CMA said a company which hired only a non-Big Four auditor would be exempt from the joint audit rule, but all exempt audits should face closer regulatory scrutiny.

Joint audits would remain until regulators decide choice and competition have improved enough to address the sector’s vulnerability to a Big Four firm going bust, the CMA said.