Thinktank says ‘it’s time to break up the big four’

In its submission to Treasury’s inquiry into the regulation of accounting, auditing, and consulting firms in Australia, The Australian Institute recommended that the regulatory framework should mandate structural separation of non-audit and consulting components from auditing functions at the accounting firms by splitting the firms into two separate entities.

This would decrease the size of the businesses and reduce the prevalence of conflicts of interests and the volume of confidential information within each business, the submission said. It also said this should eliminate the sharing of confidential information between the audit and consulting arms of these firms.

“While the current regulatory framework was intended to manage conflicts of interest, there is a significant record of misconduct, as the appendix to this submission demonstrates,” the submission said.

“For reforms to resolve such deep-rooted, structural issues, they too must be structural in nature. More modest reforms around ethical guidelines, licensing requirements, or caps on the number of partners will not be sufficient to meet the challenge on their own. Full structural separation is the most likely to prevent future misconduct and scandals, protecting the integrity of audit work and protecting clients from the misuse of their confidential information.”

The parliamentary hearings into the alleged KPMG audit misconduct revealed breach of confidentiality by partners like former KPMG Australia chief operating officer Eileen Hoggett, who admitted to writing a “pivotal” email about confidential documents in her locker to her personal assistant relating to the Lendlease audit.

Furthermore, former partner, audit and assurance, Kim Lawry was grilled over a media report that said she took a screenshot of confidential papers on her phone. Lawry claimed during the hearing that she did not recall being aware that the documents were confidential.

The Australian Institute reasoned that structural separation would prevent the culture in non-audit arms from “infecting” the operation of audit work. It would also eradicate the incentive for improper use of confidential information by removing any financial link between audit and non-audit work, it said.

Alongside this, the submission continued, it could protect audit firms from non-audit scandals, thereby preventing consultancy work from “tainting” the reputation of a critical element of the Australian economy.

While Treasury also identified achieving operational separation within existing structures as an option to prevent audit misconduct where they would still remain part of the same overarching business, the submission argued that this would rely on the effectiveness of internal safeguards and regulatory oversight to avert future misconduct.

“As it stands, internal safeguards have been demonstrably insufficient, and these firms currently operate in a “regulatory black hole” that has frustrated attempts at oversight,” the submission said.

Another proposal in Treasury’s option paper is to reduce the size of the big four accounting firms by capping the number of partners at 400. However, the submission contended that this would not be effective in combating structural conflicts of interest that exist in these large firms.

Similarly, the firms could sidestep partner caps by creating comparable senior roles with different remuneration structures and continue to grow. This would not ensure that the overall size of accounting firms would shrink, the submission said.

However, structural separation should form a part of a suite of complementary measures, including requiring major audit and accounting firms to incorporate in order to bring them under the Corporations Act so that they are governed by the same standard as corporations, the thinktank recommended.

“If mandatory incorporation is not possible, major audit and accounting firms could be regulated in a similar way to corporations under the Corporations Act,” the Australian Institute recommended.

The submission noted that the act contains some legal rights and whistleblower protections for employees and former employees who raise misconduct issues to either senior employees of the company, the regulator, or in some cases, journalists and parliamentarians.

“Whistleblowers within a partnership, such as the KPMG whistleblower whose allegations were shared under parliamentary privilege by Labor senator Deborah O’Neil, are not afforded those protections,” it said.

“Though accounting firms are not completely excluded from other whistleblower protections, there are significant gaps in the protections that do apply, including uncertainty over whether partners are able to be eligible whistleblowers who can receive legal protections.”

Commenting on its submission, The Australian Institute director of corporate regulation Josh Bornstein said: “Conflicts of interest are baked into the big four by virtue of their structure, engendering an exploitative and unethical culture.

“A structural problem demands a structural solution. Breaking up the big four will dramatically reduce the incidence of conflicts of interest and misconduct. The big consulting firms look and act like companies, albeit badly behaved companies. It’s time to tax and regulate them like companies.”