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Big Four hobbled by conflict-of-interest issues

Their lucrative advisory arms cause their auditors to hold back on their audits to protect consulting opportunities, and many former accountants have joined regulatory bodies

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Wirecard's meltdown has left the Big Four accounting firms with a major cultural problem that regulators may struggle to fix.

New York

TWO decades of financial disasters from Enron Inc's collapse in 2001 to Wirecard's meltdown have left the Big Four accounting firms facing a major cultural problem that regulators may struggle to resolve.

The 1.9 billion euros (S$2.97 billion) missing from Wirecard's balance sheet brought the chief executive officer's arrest, the German payments firm's insolvency filing and a lot of finger-pointing.

Some have blamed German regulator BaFin for its oversight failures. Wirecard's auditor, Ernst & Young, called it an "elaborate" fraud that even a very rigorous probe may not have discovered.

EY is also on the hot seat. It was added to a class-action style lawsuit against Wirecard on Tuesday, and stands accused of failing in its most fundamental duty.

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It is a systemic problem facing not just EY, but also the other members of the Big Four: KPMG, Deloitte and PriceWaterhouseCoopers, said Atul Shah, an accounting and finance professor at City University of London. "After the 2008 crash, hardly any auditor was fined or went to jail over their failure to warn society," he said. "After that, it got worse - the common factor is the cultural problem."

The Big Four have each developed lucrative advisory arms to compete with McKinsey & Co and other firms to provide the opportunity for revenue growth and brand-building that accounting does not.

Regulators say this creates an inherent conflict of interest and encourages auditors to be restrained in their audits to protect consulting opportunities.

Now EY's role as Wirecard's accountant has prompted German politicians to blast their country's regulators and to join their British counterparts in calling for the Big Four to be broken up.

EY is "committed to a multi-disciplinary model" because it provides the "technical skills and industry expertise necessary to deliver high-quality audits", as well as the resources to invest in technology, the firm said in a statement. "Quality audits depend on a broad team with diverse skills, delivered with a culture based on shared values," it said.

Deloitte has been "consistent in its support for reform", said the firm's deputy chief executive, Stephen Griggs. "We remain committed to playing our role in delivering change that embraces audit quality, improves choice and restores trust."

KPMG and PwC did not comment.

BaFin has already come under fire for taking more than a year to report Wirecard for suspected market manipulation, following a tip-off about irregularities at the payments company.

BaFin chief Felix Hufeld issued an apology, saying that it shared responsibility for the "complete disaster" at Wirecard because it didn't do a good-enough job as a regulator".

At least one German lawmaker has called for a "comprehensive reassessment" of BaFin's role.

Sven Giegold, a German member of the European Parliament, has called for the legislative body to open an investigation into Wirecard, asked the European Commission to review its rules on auditing, and called for audit firms to be fully separated from advisory business.

Even if the Wirecard scandal has shaken Germany's financial sector, critics in the UK, where the Big Four have a big presence, have been calling for reform for nearly a decade to little effect. That may be because the companies' influence with regulators is too strong to allow a breakup.

Karthik Ramanna, a professor of public policy at the University of Oxford, pointing to former Big Four accountants who take roles with the regulatory bodies, said: "The audit regulatory landscape has few neutral voices. Alumni abound."

A number of former partners at the Big Four firms sit on committees at the Financial Reporting Council (FRC), the UK's industry watchdog. Anne Whitaker, former head of audit and risk partner for EY's UK financial services practice, chairs the FRC's Audit Quality Review committee.

The FRC said it has strict rules about members or former members of the profession sitting on its committees and is transparent on such matters. The law requires that no accountant or auditor can sit on a regulatory board within three years of leaving the profession, it said.

Michael-John Albert, who works on the delivery of audits at EY, and Veronica Poole, a senior partner at Deloitte, are members of the FRC's corporate reporting council, an advisory panel without decision-making power. Councils include current professionals to give up-to-date insights, and are subject to the same conflict-of-interest rules, the FRC said.

Still, the influence of industry members is a force, experts say. "They have become very big political operators and have captured the regulatory process," City University's Prof Shah said.

All of the firms have dealt with scandals in the last decade, many still under probe. Last month, the FRC reprimanded KPMG after the firm admitted shortcomings in its work for a client, which had to restate its distributable reserves twice. Last year, Deloitte was fined £4.3 million (S$7.4 million) for failing to properly audit the accounts of a Serco Group unit.

Last week, the FRC said its plans to force a split in the Big Four's accounting and advisory units - on hold because of the pandemic - will now proceed and be implemented next year.

Accounting experts are sceptical. Michael Willis, director of the University of Cambridge's master of accounting degree programme, said: "A few months ago the threat of seismic government action seemed more credible, but Covid has put a pause to that for now. I don't think we'll see a lot of regulatory change in the short run because of the Covid volatility." BLOOMBERG

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