The world’s top four audit firms will have to split up and rename themselves under a far-reaching 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,” the European Commission’s internal market commissioner Michel Barnier said on Wednesday.
The big auditors said the plans would bump up costs and would not improve audit quality, while smaller rivals accused Mr. Barnier of softening his original stand in the face of lobbying.
Policy makers have questioned why auditors gave a clean bill of health to many banks which shortly afterward needed rescuing by taxpayers when the financial crisis unfolded.
Mr. Barnier said recent apparent audit failures at AngloIrish and Lehman Brothers banks, BAE Systems and Olympus Corp. “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.
EU states and the European Parliament have the final say on Mr. Barnier’s draft law, a process that involves haggling over the next 12 to 18 months, which often changes elements.
“There could be significant unintended consequences if we legislate more than absolutely necessary,” said Syed Kamall, a centre-right EU lawmaker from Britain, who will sponsor the measure in parliament.
Four audit firms – Ernst & Young, Deloitte & Touche, KPMG International and PricewaterhouseCoopers LLP – check the books of 85 per cent of blue-chip companies in most EU states, a situation the commission said was “in essence an oligopoly.”
U.K. data shows the four’s profit margins are 50 per cent higher than the next four audit firms, the commission said.
Under Mr. Barnier’s plan, they will have to separate EU-based audit activities from non-audit activities, such as tax and other advisory services – “to avoid all risks of conflict of interest.”
There would have to be legal separation of audit and non-audit services if more than a third of revenues from auditing comes from large listed companies and the network’s total annual audit revenues are more than €1.5-billion ($2-billion) in the EU.
Industry sources said it was unclear whether employees would have to give up being partners in one side of the business.
The news drew criticism from all four firms.
“The capability of firms to provide quality audits will be diminished if auditors are separated from wide-ranging advisory expertise, including, crucially, risk management in the financial sector,” said KPMG’s European head Rolf Nonnenmacher.
PricewaterhouseCoopers’ U.K. chairman agreed. Mr. Barnier has not provided “any concrete evidence for any positive impact of these proposals on audit quality or properly assessed the additional cost burdens for business,” Ian Powell said.
Deloitte said the plans would create an audit regime in Europe inconsistent with those in other markets, and Ernst & Young said they would have minimal impact in preventing future financial crises.
Public tendering of audit work by listed companies would be compulsory and include consideration of second-tier auditors. Commission officials hope the new rules would be in place within three to five years.
“It’s not something that can be rushed through,” Mr. Barnier’s spokeswoman said.
Mr. 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, 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.
As the big audit firms denounced Mr. Barnier’s plan, other companies said it wasn’t tough enough. BDO, one of the next-tier audit firms, criticized the commission for ditching mandatory joint audits following “lobbying and extensive influence of the largest firms.”
“The remaining proposals appear to be worse for the market than no proposals at all,” senior BDO audit partner James Roberts said.
U.K. accounting body ACCA said Mr. Barnier’s plan will be hard to implement and could prove counterproductive.
The EU plan bans so-called loan covenants whereby banks lend money to companies on condition the Big Four audit them.