Big Four must split consulting and accounting profits in UK

The UK’s audit industry regulator has announced plans to force top accounting and advisory firms to separate profits relating to their different lines of work. The move will see profit distributions to partners who run audits only receive profits made through audit work, something the Financial Reporting Council hopes will prevent the conflicts of interest allegedly at the heart of a number of major accounting scandals.

Despite announcements more than 18 months ago that the UK’s accounting watchdog would be transformed into with a more robust, statutory regulator, the transition from the Financial Reporting Council (FRC) to the Audit, Reporting and Governance Authority still seems a distant prospect. In the meantime, the FRC is still tasked with bringing the UK’s largest auditing and advisory firms to heel in the wake of a number of monumental scandals which have caused the collapse of several major UK companies.

The so-called Big Four, consisting of the professional services industry’s four largest operators Deloitte, PwC, EY and KPMG, have been at the heart of a number of accounting misdemeanours in recent years, making them the focal point of calls for change in Britain’s auditing market. Following the 2018 collapse of Carillion – which all four of the firms were later accused by UK Parliament of “feasting on” via their accounting and advisory wings – the FRC has ramped up its efforts to punish the quartet – regularly issuing record-breaking seven-digit fines in the process.

In spite of this, and a later report from fellow watchdog the Competition and Markets Authority – which issued a new market cap to try and encourage clients to hire mid-tier firms for their auditing needs – calls for a break-up between the Big Four’s auditing and advisory wings have persisted. Critics, including the UK’s Business Select Committee, cite the possibility of clients purchasing both consulting and book-keeping work from the same Big Four firms as a potential conflict of interest, suggesting that it is impossible for staff in the businesses' audit arms to offer truly independent oversight of a client's accounts in such a scenario.

Now, in the latest bid to address such concerns, the FRC has ordered the Big Four to put their UK auditing and consulting practices in separate business units by 2024. The division will see profits between the auditing and consulting wings of professional services firms be separated, meaning profit distributions to partners who run audits come only from profits made through audit work – a move the FRC will hope removes the potential for conflicts of interest.

Sir Jon Thompson, CEO of the FRC, said of the news, “Operational separation of audit practices is one element of the FRC’s strategy to improve the quality and effectiveness of corporate reporting and audit in the United Kingdom following the Kingman, CMA and Brydon reviews. The FRC has delivered a major step in the reform of the audit sector by setting principles for operational separation of audit practices from the rest of the firm. The FRC remains fully committed to the broad suite of reform measures on corporate reporting and audit reform, and will introduce further aspects of the reform package over time.”

March 2020 saw the FRC initially notify UK firms of its intent to compel changes. Following the confirmation of the new rules, which are described by the FRC as “principles for operational separation,” professional services firms must detail their plans for complying with the regulations by the autumn.

However, the changes still stop short of the chief change sought by many critics of the current system, which would force the likes of the Big Four to entirely disentangle themselves at the corporate level – an idea briefly flirted with in the US in the wake of the Enron scandal. As it is, professional services may keep both accounting and consulting wings within the same parent companies, something which will likely leave those seeking more stringent change unsatisfied, and wary that there may still be loop-holes which firms can exploit to work around the latest changes.