The FRC’s New Boss Takes Aim at the Audit Oligopoly

The subject of auditors, their regulators, and the conflict of interest that occurs when those auditors provide consultancy services has been well covered here in Financial Regulation Matters. We have examined the issues within the Financial Reporting Council (the UK’s main regulator of audit services) that have seen the regulator’s internal structures change recently. We have also examined a number of issues affecting the audit sector, including the presence and effect of an oligopolistic model, the so-called ‘expectation gap’ that exists between how the auditors perceive their role to how the market and society perceives their role, and also how some auditors have started to take voluntary steps to divest or spin-off their consultancy arms. With regards to the last point, we spoke about how either allowing auditors to voluntarily divest, or forcing them to divest with no long-term strategy was a mistake, so the recent comments of the new head of the FRC are worth examining.

Simon Dingemans, the former finance chief for GlaxoSmithKline and long-time Goldman Sachs employee (where he ran its European mergers practice), took over the FRC last month. Immediately he has gone on the offensive and stated that ‘this is a rare opportunity to reform something so wholeheartedly’. However, the way he is approaching the massive task is interesting. Instead of making the common regulatory mistake of championing competition within an oligopolistic sector that actively kills competition, he has argued that ‘you’re not going to be able to create another firm of that global scale. The real question is how do you create better quality audits at the Big Four, how do you make those firms more sustainable and at less risk of collapse?’. He has already rejected a proposal to enforce mandatory joint auditing – arguing that the plan leads to duplications and extra costs – but instead wants to focus on separating the firms’ audit and consultancy services and introducing ‘transfer pricing’. Transfer pricing relates to a concept whereby there are inter-company pricing arrangements, and Dingemans argues that ‘it would mean we could make sure those audit firms were robust and properly funded, and that they’re charging clients and paying partners properly’. In essence, he is attempting to bring about a scenario where audits are not loss-leaders for these firms and that they are both adequately funded and representative both in terms of profitability and incentive. Yet, there are issues in the new Head’s approach. He is arguing that new legislation that would kill the FRC and replace it with the Sir John Kingman-inspired Audit, Reporting and Governance Authority is not required because he has already started implementing the report’s recommendations – these recommendations range from changing the hiring policy of the regulator to increasing the severity of its sanctions. Dingemans defended the FRC and said that, under its previous management, the FRC ‘was dealing with a fairly unmanageable brief and no powers or money to actually deal with them’ and that, now he is in and since the number of crises that have affected the FRC and its authority (Carillion, Patisserie Valerie etc.), things will be different: ‘if they can see I’m going to have the teeth, then I can do a lot by waving the threat’.

The new focus on the oligopoly and its dynamics is to be welcomed. Too much regulatory capacity has been wasted on mis-regulating financial oligopolies (the same issues have affected oligopolies such as the banking and credit rating oligopolies). However, there is no mention, yet, of any long-term regulatory strategy to guard against mechanisms which have, traditionally, caused more harm than good. How will the regulator guard against a delayed amnesia whereby, in say 5 years time, the auditors reinstall their consultancy arms and continue transgressing? This happened after the last waves of regulation against the sector at the turn of the millennium, and is a real concern. Also, how does the regulator enforce the concept that auditors are supposed to be spotting fraud and have a social duty to do so? Finally, is a ‘threat’ enough? On one side of the argument he is only a month into his role, so there needs to be time afforded to achieving the reforms required. However, time is of the essence. The language is not really encouraging when taken as a whole. ‘Threats’ do not work against multi-billion pound organisations protected by an oligopolistic model. Companies within those environments create their own cultures, they are very rarely enforced. This is the crux of the matter; Dingemans has been tasked with regulated one of the oldest, most well-resourced, oligopolistic, and socially important financial sectors that exists – it is quite the job.

Keywords – audit, business, oligopoly, @finregmatters