By Don Quijones, of Spain, the UK, and Mexico, and an editor at Wolf Street. Originally published at Wolf Street
Will Carillion collapse create next Arthur Andersen? No, the “Final Four” audit firms are “too big to replace.”
As the rubble from the financial collapse of British infrastructure giant Carillion gradually settles, two powerful parliamentary panels are piling pressure on the world’s biggest audit firms to disclose the full extent of their involvement with the company. The big four auditors — Deloitte, Ernst & Young (EY), KPMG, and PricewaterhouseCoopers (PwC) — have received letters from the Business and Work and Pensions select committees demanding that they reveal all the work they carried out for Carillion since 2008.
The move comes amid growing concern around the world about the power of the so-called Big Four — down from the Big Five after Arthur Andersen imploded in the wake of the Enron scandal — and the potential conflicts of interest that can arise between their myriad roles.
A case in point: when Spanish authorities tried to roll seven failed or failing Spanish saving banks into Bankia in 2011, Deloitte was hired not just as Bankia’s auditor but also the consultant responsible for formulating its accounts, in complete contravention of the basic concept of auditor independence. Deloitte (together with Spain’s market regulators) then confirmed in Bankia’s IPO prospectus that the newly born franken-bank was profitable and in sound financial health. It was a blatant lie. Bankia collapsed within less than a year of its IPO. Shareholders ended up losing billions and were later reimbursed by Spanish taxpayers.
In the case of Carillion, all four of the Big Four provided services of some kind or another to the now defunct company, but it was Dutch-seated KPMG that signed off on its accounts. This it did without fail, even in early 2017 when it was clear that Carillion had wafer-thin profit margins and was dangerously overloaded with debt, including £2.6 billion worth of pension liabilities. Between 2012 and 2016 Carillion ran up debts and sold assets just to continue paying out dividends to shareholders.
Yet in Carillion’s last ever annual report, KPMG approved Carillion’s viability statement, certifying it as strong enough to survive for “at least three more years.” Within less than three months, Carillion’s management was forced to admit it had significantly overestimated revenues, cash and assets, prompting a stunning stock market meltdown from which it would never recover.
A scathing letter to the Financial Times this week called for Carillion’s directors and KPMG to be investigated for the company’s collapse. Martin White, of the UK Shareholders Association, and Natasha Landell-Mills, of Sarasin & Partners, wrote:
“Although fingers are being pointed in all directions, most are missing the real culprit: faulty accounts appear to have allowed Carillion to overstate profits and capital, thereby permitting them to load up on debt while paying out cash dividends and bonuses.”
All of it on KPMG’s watch.
Carillion’s collapse bears a striking resemblance to the dramatic demise of Spanish green energy giant, Abengoa, in 2016. For three years, the auditor, Deloitte again, failed to spot (or at least report) any of the glaring irregularities on Abengoa’s financial statements. By contrast, Pepe Baltá, a 17-year old student in Barcelona who chose Abengoa as the subject of his high school economics project, noticed serious flaws in the company’s accounting — a full year before Deloitte’s auditors finally blew the whistle. “The big surprise was that negative profits were being converted into positives,” Baltá told the Spanish daily El Mundo.
Yet each time a new corporate scandal or collapse exposes the failings, abuses or conflicts of interest of one of the big four accounting firms, a dainty slap on the wrist is the inevitable punishment. When Deloitte was found to have “seriously” infringed Spain’s auditing laws by ignoring at least a dozen glaring errors and irregularities in Bankia’s accounts prior to its IPO, the auditor was fined a paltry €12 million by Spanish authorities.
The problem is that the Big Four are simply too big. Having extended their tentacles into just about every facet of business administration, from accountancy to auditing, to legal and tax consultancy, while wiping out or gobbling up all their smaller rivals, the big four firms have grown horrendously large and conflicted, says British financial journalist Ian Fraser.
In the US, the Big Four audit 497 of the 500 S&P 500 companies. In the UK, the Big Four audit 99 of the FTSE 100 companies. In the vast majority of EU Member States, the combined market share of the Big Four audit firms for listed companies exceeds 90%. In Spain, all IBEX 35 companies are audited by the Big Four. Their global annual revenues have reached $134 billion in 2017.
This perfect oligopoly poses a major problem, not just for companies looking for alternatives but also for governments. “These giant firms are… virtually unassailable and are now called the ‘Final Four’,” says Fraser. “There’s a fear in government that you can’t allow one of these companies to fail because if there’s only three left, there will be even less competition in the sector… and even more of an oligopoly. As such, government is almost being held to ransom around the world by these big four firms.”
In other words, the Big Four, the self-anointed guardians of fiduciary responsibility and probity at the world’s biggest companies and banks, are not just woefully compromised and conflicted; they have grown too big to replace. And doling out petty fines for bad behavior each time they’re caught out is not going to change that.
At “the company that runs Britain,” profits were privatized, costs will be socialized. Read… Collapse of Construction Giant with 43,000 Employees Globally Sparks Fear and Mayhem
27 comments
Comments are closed.
“There’s a fear in government that you can’t allow one of these companies to fail because if there’s only three left, there will be even less competition in the sector”
Well, it’s not like that is working out for us as shown here by the collapse of Carillion after being given a clean bill of health. I think that what is needed is an Glass–Steagall act but for accountancy. Split them up into those company parts that do pure accountancy and all those lucrative consultancy contracts can get spun off into other companies. The only way to help stop this is to remove the temptation of cross-interest. I have read of corporations demanding clean bill of health or else that accounting company would not receive any of the other contracts on offer. With smaller pure accountancy companies, there would not be the same blackmail possible and that might open up the path to other newer companies getting into the field. But they would have to be watched. Closely!
Nationalize audit by as assigning the duties to thrive in the US and Inland Revenue in the UK for public companies.
Obvious solution is have all 4 fail at the same time. Maybe Carillion will pull the rug out from under them all.
As founding partner and current CEO of a small consultancy boutique, I see the Big Four eating up consultancy projects every day leveraging their audit role. And please do not mention the hilarious “conflict of interest” policies where auditors cannot take consulting roles: typical solution is that Big Four 1 acts as an auditor for three-six years, and does not perform consultancy (or it does, provided they ” do not collide with the audit role”) then the audit job goes to Big Four 2 (or 3, or 4) and new consultancy assignments move from the newly appointed auditor to the old one…).
I see only a very strict Glass-Steagal like (if you are an auditor you only act as such, auditing companies must be “pure auditing players” fully owned by audit partners, no cross ownership with other companies, no additional services sold). I know it sound draconian (and partial) but auditing is really a service to “economy” as a whole not to the single company and should be treated as such. Currently the service auditor “apparently” or “often” seem to provide is to certify books and figures so that you can raise funds. In my (admittedly dreaming) mind, their service is to provide certainty TO THE MARKET AND EXTERNAL STAKEHOLDERS (who cannot have access and visibility) about a company’s books and figures.
… And they are eating a lot of junk food too!
I personally know of one person (there are more) who is a serial entrepreneur. His business is to boot up a consultancy business around a core of high quality staff with high wages and good perks then, as business picks up through competitive offers, they rapidly pad the staff numbers with whoever is in “the market”, to getting “growth” numbers.
The big 4-5 here will soon notice the upstart and buy it to recalibrate the competition back to whatever their models are calibrated with, after that, the core will leave and go to the next startup, which just happens to be started by the same guy “investing his money”.
Basically, the same machinery happens with Chinese restaurants. When the staff suddenly changes on a really good Chinese restaurant, just let it go and find a new favourite one. You will regret eating there again!
Difference is that the Chinese restaurant is liable when there is an outbreak of food poisoning. Liability for fraud that the accountancy firm basically signed off on by approving the accounts would be a good place to start.
An auditor sign-off is an equivalent of a potato-stamp on the financials, and anyone who treats it with more, after the very clearly published examples to the contrary, deserves what they get.
There has been so many at best incompetent, at worst fraudulent accounts, that basically the legal requirement for audit is at best no value, at worst misleading and should be dropped. The intention of hte law was good, but it is now dead.
The only (workable, status quo is of course an alternative but not really workable) alternative is that auditors take liability, which is not going to fly ever, as they know only too well it would kill them pretty quick.
Maybe don’t ask them, then? Just do!
Other professions, like Engineers are liable. We don’t see that many transformer stations suddenly blowing up here in the 1’st world and it is not the case that having this liability makes it very difficult or super-expensive to get a substation or wind-mill designed. The liability insurance for an up to 1 mio EUR liability cover for an electrical engineer is about 600 EUR per year, peanuts. Because they get it right most of the time.
Liability might even move the accountancies over on “our side” in getting clearer, simpler, more transparent accounting rules and higher quality accounting because fewer mistakes lowers their insurance costs and we get the worst examples kicked out of the profession and/or put in jail; It should mean something when the accountants won’t sign the accounts in full as it were. It doesn’t really today, we can’t even legally exclude companies with remarks on their accounts from public procurement on that basis, which is double useless.
Unfortunately, the auditors have a massive lobbying power, and their clients (who have quite a bit of iit too) have no interest in auditors being liable, because it would mean proper audits.
“All auditors deserve it. They have such narrow thinking.
We want them to do statutory audit. Public (we) also expect them to do “business audit”. How can they not have a more robust logic test !!!
If they don’t try to detect fraud, how the @#$% can they confirm the reasonableness of the numbers?”…
A direct quote from a dear friend who also happens to be a liquidator (name redacted). Who is now an NC fan after I forwarded a couple articles to him.
Forbearance on the part of regulators always leads to greater losses. Until there is a response to break the Big 4 oligopoly. This will continue.
And thank you Yves for keeping us up on all this.
Thank you to J-LS for posting and to commentators, especially FA Jensen Vlade for bringing up liability. On that note, how about personal liability, too? That will concentrate the mind.
A big thank you also to NC for giving this story airtime and providing for insight ATL and BTL.
It’s interesting how much resource was thrown by the FT at the Dorchester event in comparison to their coverage of Carillion. The same can be said about the rest of the MSM.
I know some journalists at the pink paper. The suggestion is that Dorchester was a bit of a favour for the PTB, a distraction from Carillion, Brexit, the NHS etc. The event at the Dorchester has been going on for over thirty years. There are similar still going on. The difference is that the FT and the rest of the MSM would not dare expose the others as much bigger fish attend them, the type who sign off adverts in the FT, hire hacks for PR purposes etc.
Wow, your closing comment is amazing but I should not be surprised. Strip clubs are the norm for Wall Street entertainment, yet are in some ways tame compared to what happened at the Dorchester (in NYC, men are absolutely not allowed to touch the strippers, they get thrown out by bouncers if they do. I’m sure it’s different in other cities, but strippers in NYC are not prostitutes, and again the bouncers help enforce that by putting them in cabs at the end of the evening.) However, my sense is that in the US, they keep this sort of thing away from charities and limit it to client parties with “models” since most rich men recognize the blackmail potential (Mike Milken was famous for having “models” at his Predators’ Ball and none of his clients would touch them).
The biggest corporate fraud (when the brooms came out to attempt sweeping it under the carpet they called it “accounting irregularities”) to ever hit South Africa is currently unfolding. Steinhoff International, a giant SA retailer which owns, among others, Mattress Firm in the US, Harveys Furniture in the UK and Conforama in France, is embroiled in a corporate scandal that has left a trail of destruction engulfing everyone from fund managers to ordinary government employees (the state pension fund administrator is the second largest shareholder and had a billion dollars worth of value wiped out by this), and guess who’s been complicit in all this, KPMG. Alas, another big four firm, PWC, has been appointed to “investigate” the corporate shenanigans leading up to this house of cards tumbling down. How earnest the whole process will be is anybody’s guess really, but i get the sense that holding one’s breath for an objective, dispassionate investigation might be tantamount to self deception.
The painful reality is that the big four lease out space in their global network of closets to hide corporate skeletons that, if exposed, would see open revolution in the streets of cities around the world from the great unwashed masses.
Thank you, Thuto.
Steinhoff’s demise is not a surprise. They were big clients of HSBC, where I worked, in the mid-noughties. Staff based in London, e.g. me, and colleagues based in Jo’burg were often at loggerheads over the credit risk management for them, but not only them, and how SA colleagues, but not only them, gamed the system when using the London balance sheet for their pets.
Thank You Colonel Smithers. The only thing one can say is that every journalist and their dog couldn’t stop lavishing adulation upon “SA’s greatest business export” and its charismatic, larger than life, CEO whose rags to riches ascension to the top imbued upon him a charisma that disarmed even the most diligent, “switched-on” investors of their critical thinking faculties. Now, after the fact and with the benefit of hindsight, his groupies have dropped him like the proverbial hot potato, claiming they suspected all along that something with the numbers was amiss.
Thank you, Thuto.
We have had the same in the UK (the Maxwell family in the early 1990s and the Green family in the past couple of years) and Mauritius (the Rawat family’s British American Insurance in the past couple of years). Whenever I hear of rags to riches rises, or “ascension fulgurante” in French, I pay attention as it’s very difficult and, especially with modern finance, hard to access long-term investment. Having worked in private and then wholesale banking, such performance is rare and increasingly rare. Most rich people are rentiers, rarely innovators.
I also have one per cent cousins, the Dalais and Leclezio families in Mauritius. The former were partners of the Kerzner family / Sun group. It has taken both families over two centuries to achieve that kind of status. My branches were cast out as male ancestors married outside.
The Australian government is in thrall to the big four, particular for ‘independent advice’. Whenever that term is used in the government’s media onslaughts one can only read it to mean that the reported outcome aligns with the government’s desired position. According to the ABC, Australia’s public broadcaster, the big four ‘have won close to half-a-billion dollars in consultancy work over four years’. They are now habitually used to provide advice that the public service, as the traditional provider of advice to the government, would find unconscionable. Is your cat a dog? Of course of is.
The former head of KPMG, the firm which audited the Royal Bank of Scotland and HBOS, heads the UK’s conduct risk regulator, the Financial Conduct Authority. Sir John Griffith-Jones should have been fired years ago or not appointed in the first place, but he knows where the bodies are buried and how to bury them – and when to do the dirty work for politicians, e.g. firing Martin Wheatley for George Osborne.
The P in KPMG stands for Peat, from the former Peat Marwick MacLintock. Two members of the Peat family, including Sir Michael earlier this century, have headed financial control for the royal family, the post called Keeper of the Privy Purse. Other toffs have worked for KPMG, so they have the connections.
Thanks for this.
In the vernacular, I think it’s called milking a dead cow.
and then I read elsewhere of the expanding practice of using attorneys by the big four which then gives the whole thing attorney-client privilege…
Avoiding accountability is the ne plus ultra of the neoliberal nobility. So many aspire to it, so few achieve it.
As we are focusing on KPMG, let me recount a story from this lunchtime. Kweku Adoboli was just addressing a City audience. A former partner from KPMG and a former head of compliance at Icap took issue with Adoboli’s contention that the system was as culpable as he is. As these fora are adult, the pair were laughed at / out of court for their temerity in absolving the firms, including their auditors, of guilt.
One attendee pointed out just how significant arbitrage, in all its forms, is a contributor to the UK economy.
Things certainly appear to have changed since the late seventies, when as a young trainee manager for the minerals division of British Industrial Sand, I experienced two internal audits. They were a thing of terror & reminiscent of those films in which the FBI moves in & effectively shuts everything down. We did not exist for the audit staff, except as minions to be summoned & interrogated in relation to some apparent error which judging by their demeanour, was worthy of capital punishment.
As this was before computer systems everything had to be checked by calculator, which in my case was the equivalent of playing chopsticks – the rather menacing auditor who was checking my stock figures was in contrast a Martha Algerich on her much grander version, who made it obvious that my couple of errors over a twelve month period, rendered me as unfit to play in any orchestra.
I left soon afterwards, although the above played no part in that decision, taken unknowingly on the cusp of computeristation & Neoliberalism.
At this point, the big four should be broken up into smaller pieces.
I agree with the earlier comments that auditors should be audit only. Then tax services would also be tax only. Likewise, the consulting and other business should be totally separate. Otherwise you will get musical chairs among the big four companies.
There should also be more stringent restrictions on what partners can do as well in terms of where they go after they audit to prevent a conflict of interest there.
From a conversation this weekend related to this very topic:
Accounting nowadays is just another tool of senior management. The result of the rise of the mega Corporation and professional boards and layer upon layer of passive investors.
The Executive wheeler dealers see Auditors as acting on their behalf to reach their favourite (always non cash-flow) targets – in order to justify pocketing more of the real cash flow from investors.
It is ironic.
With the seal of approval of accounting standards, management deliver ‘high level’ non-cash business performance numbers as promised, pat themselves on the back, and quickly go about writing themelves a cheque.
How many times has a large impairment followed an exec’s departure? Or receivables which didn’t end up being so receivable after management bonuses were paid?
Even more ironic; how are you supposed to have “efficient markets” when financial reporting moves further and further away from measuring business performance based on cash flow? EMH is supposed to be based on available information re. current and future cash flow.
Yet another success story of neoliberalism. at the same time as they’ve made their capital markets “free” to boost productivity, the information which supposedly underpins the investment decisions has become less and less trustworthy demonstrated by more and more cases of accounting fraud..
One obvious change would be to take audit contract decisions away from management and make it an explicit non delegated responsibility of the audit committe on the board. And put accounting regulation under public control dropping the ‘independent agency’ charade. – en fin
Shareholder value et al anyone.
Ahhh, KPMG, (Peat Marwick, etcetera).
At the top of my class, grade wise (though not at all realizing bootstraps older graduates were not at all wanted), I Did a tax season (stupidly thinking I had been permanently employed) at KMG Main Hurdman, of San Francisco. At that time it had been noted as the ninth largest of the Multinational Public Accounting Firms when there were the BIG EIGHT (in no particular order of criminality): Price Waterhouse; Coopers & Lybrand; Peat Marwick Mitchell; Ernst & Whinney; Arthur Young; Deloitte Haskins and Sells; Touché Ross; Arthur Andersen (which, to the best of my recollect, can all be ultimately traced back to London Inc.).
Made the mistake of informing superiors that the 401k deduction calculation being used was incorrect? Made the mistake in believing in a truly progressive tax system ? Made the mistake of not knowing that the largest accounting firms sweat shopped their tax staff only to dump the majority of them on April 16th. Made the mistake of being hired by a firm whose Audit Department aided Technical Equities™ (very big deal in Silicon Valley at that time, side note: in those years when Churning was a SEC term meaning a**hole stock brokers Churning (mostly Widows) bond investments which were meant to be long term[1]) in cooking the books?
Peat Marwick was gifted with Main Hurdman when Main Hurdman was threatened with losing it’s license over that Technical Equities™ cesspool, and became Peat Marwick Main (must read between the lines):
for a few ‘minutes’ before it became KPMG™. Heh, can’t let a good launderer of elite money go to waste now, can we?
[1] My Churning™ anecdote, which I’ve actually never recovered from: The good side of that anecdote is that when I then took a job in a tiny public accounting firm, I recovered $500,000 from the IRS and California’s Franchise Tax Board, for a widow whose bond accounts had been churned by a Silicon Valley Broker (who was a ‘best friend’ of her Attorney husband, who (her husband) actually seemed like a pretty decent person who provided free legal advice for those who couldn’t afford it). That same ‘best friend of her husband,’ Silicon Valley Stock Broker, introduced her (a s a widow of his ‘best friend’) to a Siliicon Valley Muckedy of KPMG for her tax return preparation, for which they charged her a minimum of $5,000 ‘a pop’ for. I went over, and amended, her tax returns of three years, and found $500,000 dollars worth of utter negligence from the company which layed me off, which she finally received. She offered to hire me, as her personal accountant, but I did not have the resources to serve her properly so I could not.
so many recollects, and so many decades of fear of being punished for the recollects by those clearly ‘above’ the Law™.
Imo the trend in every industry for twenty years at least has been amalgamate, merge, acquire whatever you chose to call it. The name of the game has been consolidation because that way impunity lies.
It may have been born in the Savings and Loan imbroglio, at least that was my first hint of it, but, whenever it started, it very soon became Directors’ Choice. Commerce and Industry, formerly competitive fields of endeavor, became hierarchical whether expressed as banking, insurance, broking or any of the subsidiary fields like the scorers in this article.
Adam Smith would laugh at the games we play to maximize profit by avoiding competition.
Will Carillion collapse create next Arthur Andersen? No, the “Final Four” audit firms are “too big to replace.”
Actually, the whole Andersen story (Arthur Andersen and Andersen Consulting) still seems utterly unresolved to me, yeah yeah yeah, Separate Entities ! [Arm’s Length Transactions!™]
Protivity (Wiki™ it and witness the auto reroute™) was sucked up by Max Mesmer’s Robert Half International™:
I just can’t get over that acquisition of former employees of Arthur Andersen sentence, how does one acquire another human being?. Anywho, Robert Half (Temps) was founded in 1948. they generally take 50% of the invoice a qualified accountants price who does not want to sign off as the CFO, and walks away with no reference after they find the snake pit they knew they would, and tell management: I’m not interested in abetting your crime, I am willing to let you know what your liability might be if there were actually a U.S. Justice System. (Who knows how many times the CIA used Robert Half temps for front companies, as those temps – no matter how qualified – are generally not allowed to sit in on the most important management meetings)
Then there’s Accenture™, what a freaking cesspool.
Andersen™, is still alive and Thriving™, believe that.