When we use the term ‘big four’, we’re not referencing EE, O2, Three, and Vodafone, although they are audited by the other big four, namely Deloitte, Ernst & Young (EY), KPMG, and PwC. Each of the big four is an international network of like-minded accountancy firms operating under the same corporate banner. They are the result of mergers and acquisitions dating back two centuries. For most of the twentieth century, we had the big eight before more merges whittled it down to five. Since the collapse of Arthur Andersen in 2002 (more on that shortly), we’ve been left with four.
Deloitte, EY, KPMG, and PwC provide both Auditing (inspection of financial records) and Consultancy (expert advice, including tax planning). Having one of the big four onboard adds instant credibility to any business, charity, or government body. At any one time, they service around 90% of Britain’s biggest businesses and are accounting for what Microsoft and Apple are to computing – trusted halo brands leading the field.
As the industry’s Illuminati, the big four have a legitimate monopoly, although some call it a cartel!
Unlike computing, where ownership of IP and patents are heavily protected, auditing starts off with the same basic principles for anyone to build on. Could a smaller firm do the same job? In theory, the answer is yes, but in practice, the resource required for such large audits is rarely found anywhere else. The big four bank on their reputation for employing the crème de la crème of talent, making it easier to overlook smaller alternatives. Whilst all firms are obliged to keep auditing and consultancy free from bias, the lines inevitably do blur.
The Downfall of Andersen and Enron
It’s early 2001, and in response to an investigation launched by the Securities and Exchange Commission (SEC), Andersen is busy shredding two tonnes of documents which prove Enron has been hiding losses and inflating profits through Special Purpose Entities and unconventional accounting policies. To the outside world, at least, Enron was a successful $100bn conglomerate, shielded from debt collectors. Hidden from view and hushed was any employee who dared question the balance sheet. The SEC would later conclude Andersen and Enron colluded with each other to mask the latter’s real financial position and ‘game the system’. Andersen had reaped the financial rewards of this wealthy client for many years and had little reason to stop the charade. In the wake of Enron’s dramatic bankruptcy, Andersen was found guilty of obstructing justice which served only to accelerate the exodus of clients tarnished by association. Enron highlighted the dangers of a single firm providing both auditing and consultancy, which effectively allowed them to mark their own work. Less than two years after the shredders first worked overtime, Andersen filed for bankruptcy. And then there were four.
Irrespective of how untouchable the big-name brands of a given industry appear, they like everyone else are vulnerable to life’s big three – Death, Taxes, and Debt Collectors!
Humbling the Big 4
The case of Andersen Enron was not the first time our accounting Illuminati had hit their own wicket, and it certainly isn’t the last. No matter how high the pedestal, firms are run by human beings who ultimately fall short from time to time, as we’ll touch upon now.
Humbling EY: the 2020 collapse of Munich-based payment provider Wirecard saw their longstanding auditors EY on the receiving end of fines and sanctions. Amongst the accounting irregularities was a missing €1.9bn and the apparent use of fake bank statements. A few years later, in 2022, EY was found to have fallen short again; this time by the SEC, who found fifty staff had shared answers to the ethics section in the CPA exam.
Humbling PwC: for its part in the 2016 collapse of British Home Stores (BHS), PwC was fined £6.5m. Unearthed was a £571m pension deficit and going concern accounts filed days before BHS was sold for just £1. In 2023 PwC’s government consultancy business in Australia was jettisoned for AUD$1 following the leak of draft corporate tax avoidance laws between 2014 and 2017. To date, nine partners have been accused, and more than sixty recipients have been identified.
Humbling KPMG: in the wake of Carillion’s collapse in 2016, KPMG were fined £14.4m for hiding the true extent of its financial woes and amending documents when subject to an Audit Quality Review (AQR). In 2021 eight people including some KPMG staff were charged with 47 counts of fraud and money laundering in respect of the now defunct Johannesburg-based VBS Mutual Bank.
Humbling Deloitte: for their part in not detecting fraud at Taylor Bean & Whitaker, leading to the mortgage lender’s demise in 2009, Deloitte agreed to pay the FRC $145.5m. A year after Hewlett-Packard bought Autonomy for $10.3bn, the tech giant wrote down $8.8bn, launching a lawsuit against Deloitte for inflating Autonomy’s value. Deloitte later agreed to pay $45m in settlement.
EY’s Project Everest
Like the other big firms, EY is the product of mergers and acquisitions. When two become one, there are inevitably challenges in blending two different corporate cultures. It was culture, costs and client opposition which saw EY’s merger with KPMG aborted in 1998. Corporate culture is fundamental to the success or failure of a firm; in the decades since, corporate identity has strengthened to the point where the big four firms are probably beyond the point of compatibility.
In May 2022, EY announced plans to demerge by splitting its core business into two divisions. Those long calling for the big four to be broken upheld their breath. EY planned to use an initial public offering (IPO) to float the more profitable consultancy business and keep the auditing business in private ownership. Known internally as Project Everest, the split proved controversial, exacerbated by a weak IPO market. The partners struggled to agree on how the cards should be restacked. A year and $600m of costs later, the US arm of EY withdrew support, and Project Everest was abandoned. A demerger may still be on the cards, but in the form of two privately owned companies. Insiders suggest an EY split is the right idea, but an IPO was the wrong chariot to do it in. Even if EY does split, its auditing business would still be large enough to take its place amongst the big four.
As Enron and the more recent humbling prove, it is still possible to act on bias when the same firm provides auditing and consultancy. Despite tight regulations, a conflict of interest still exists, and that champions the call to break up the big four. AQR inspections are periodic and, for obvious reasons, cannot validate every audit, past and present. We saw this in Carillion, where an AQR inspection uncovered retrospective discrepancies, and by then, it was too late to correct course.
A forced break up of the big four would cost a phenomenal amount, requiring a government or trade body to bankroll it. EY’s first voluntary break-up attempt showed how not to do it for $600m. A successful second attempt would lay the ground for the others to follow. Perhaps the answer is a similar principle to PwC Australia, where the consultancy business was simply sold, albeit after a humbling. Another solution would be regulation preventing the same firm from filling both auditor and consultant roles. One firm may not be keen on having another see their workings, but the advantage gets neutralised because they can both see each other’s. The door may then open for smaller firms to work with the upper echelons of enterprise, and the big four become ten, twenty, a hundred! Accountancy is all about presenting a true and fair view, and although it largely achieves this through regulation, when it falls short, Captain Hindsight and Déjà vu Dave are waiting!