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Commission proposes splitting accountants' auditing and consultancy work to prevent conflicts of interest

Out-Law News | 02 Dec 2011 | 10:19 am | 2 min. read

The UK's 'big four' accountancy firms could be forced to separate their auditing services from their consultancy work under proposals unveiled by the European Commission.

Auditing firms will also have to stop acting for companies every six years and take a break of four years before the same company can rehire them.

The proposals are intended to restore the credibility of European auditing firms after "considerable failures" around the 2008 financial crisis.

"Audits of some large financial institutions just before, during and since the crisis resulted in 'clean' audit reports despite the serious intrinsic weaknesses in the financial health of the institutions concerned," the Commission said in a statement.

EU Commissioner for the Internal Market Michel Barnier dropped previous proposals that would have required banks and large firms to appoint two auditors.

The Commission has raised concern about the lack of competition and conflicts of interest in the auditing profession as the market is dominated by the 'big four' firms Deloitte, Ernst and Young, KPMG and PricewaterhouseCoopers. These four firms audit over 85% of listed companies in the vast majority of member states, the Commission said. In the UK, the Big Four audit 99% of the FTSE 100 largest companies.

"Investor confidence in audit has been shaken by the crisis and I believe changes in this sector are necessary: we need to restore confidence in the financial statements of companies. Today's proposals address the current weaknesses in the EU audit market by eliminating conflicts of interest, ensuring independence and robust supervision and by facilitating more diversity in what is an overly concentrated market, especially at the top end," Barnier said in a statement.

Under the proposals, audit firms will be prohibited from providing non-audit services to their audit clients. Firms which collect more than a third of their audit fees from big clients or which collect more than €1.5 billion a year in audit fees from clients within the EU will also have to separate audit activities from non-audit activities in order to avoid all risk of conflicts of interest.

Firms will be required to rotate after a maximum engagement period of six years, unless the firm appoints more than one company to carry out 'joint' audits in which case this period can be extended to nine years. The client will have to 'cool off' for four years before it can re-engage the same firm. "Joint audits are not made obligatory but are thus encouraged," the Commission said.

In addition, the Commission plans to create a 'single market' for statutory audits which will allow firms to provide auditing services anywhere in the EU once they are registered within one member state. Firms will also have to comply with international auditing standards, with supervision activities overseen by the European Markets and Securities Authority (EMSA).

The draft proposals will now go before the European Parliament for approval.

Accountancy firms expressed concern that being forced to separate their auditing functions from the rest of the business would affect their ability to provide a "quality service". Rolf Nonnenmacher, head of KPMG's activities in Europe said that firms needed to be able to rely on their expertise in other disciplines.

"The capability of firms to provide quality audits will be diminished if auditors are separated from wide-ranging advisory expertise including, crucially, risk management in the financial sector," he said.

He added that the Commission's mandatory rotation proposals would cause "serious disruption" to large companies, while having no positive effect on audit quality.

Roger Barker, head of corporate governance at the Institute of Directors, agreed that the proposals would "undermine the ability of audit committees to respond to the specific circumstances of individual companies". They would also increase auditing costs, he said.

"In any case, these are issues which should be addressed through national corporate governance codes, not European legislation. Such Europe-wide regulation is a blow to the UK's corporate governance framework based on 'comply or explain'," he said.

In October, the Office of Fair Trading (OFT) referred the Big Four auditors to the Competition Commission following similar concerns over the lack of choice in the statutory audit market in the UK. The OFT said it had been "concerned for some time" about the "highly concentrated" audit market, citing low levels of switching and substantial barriers to entry.