By Don Quijones, of Spain, the UK, and Mexico, and an editor at Wolf Street. Originally published at
Will Carillion collapse create next Arthur Andersen? No, the “Final Four” audit firms are “too big to replace.”
As the rubble from the financial 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) — 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 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, :
“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, 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, British financial journalist Ian Fraser.
In the US, the Big Four 497 of the 500 S&P 500 companies. In the UK, the Big Four 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 $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’,” 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…