When the story of the next global financial crisis is written, few would imagine grey-suited accountants in the role of villain.
But the stereotype of accounting being boring belies how important the profession has become to everyday life.
Much of the modern economy relies on the work of auditors: the accountants who independently verify a company’s financial records.
This work is crucial in providing accurate reports to shareholders and, ultimately, for safeguarding the economy at large.
Recent scandals and financial crises have shown that accounting failure can easily lead to thousands of job losses and billions of dollars in bail-outs, says author and award-winning journalist Richard Brooks.
“We’re all affected by auditing,” he said.
The current system now relies nearly entirely on the so-called “big four” accounting firms — KPMG, Ernst and Young, Deloitte and PwC — whose market share means they are often the only institutions big enough to audit multinational corporations.
So it should be of concern to us all, according to Brooks, that in recent years the big four have “lost sight of their core purpose”, with only a third of their revenue coming from auditing and the rest earned from “consultancy services”.
“It’s not really any longer an accountancy profession,” Brooks said.
“It’s more a consultancy profession, or it would call itself professional services, with auditing just one of its business lines, and a minority one at that.”
Brooks argues this has created a conflict of interest, as the firms are now selling billions of dollars worth of business advice to the same companies they are supposed to independently audit.
“We’re in a situation where we need really good, strong, effective auditing more than ever,” Brooks said.
“But at exactly that time, the auditors have stopped being so interested in it, and have become much more interested in making money for selling consultancy services.”
Bean counters ‘broke capitalism’
In his book Bean Counters: The Triumph of the Accountants and How They Broke Capitalism, Brooks lays out his argument for what is fundamentally wrong with the system.
For one thing, he says, the big four firms have huge market power — KPMG, the smallest of the group in the UK, earns more than the next five smaller firms put together.
Meanwhile, Brooks — who was a tax inspector for 16 years before becoming a journalist — argues the requirement for all companies to submit to auditing has effectively created a “state-guaranteed cartel” for accounting services.
“If you’re a big multinational company you have to go to the big four,” he said.
These “guaranteed cash flows”, Brooks says, have enabled the big four to venture into new business areas, with recent examples including offering cyber security services and buying up smaller consultancy firms.
He said the ties between the accounting profession and the banking industry in the lead-up to the global financial crisis was a particularly striking example of the conflicts.
The big four “dramatically” increased their income from financial services and helped design some of the financial products that polluted bank balance sheets, Brooks says.
“They [the big four] really didn’t have any interest in saying to Lehmann Brothers or RBS … ‘Look, your balance sheets are really looking not that great’ because they were full of products that they had helped create.”
Advisors to the government
It’s not only the corporate sector that relies on the advice and professional clout of the big four.
Brooks says they have become a kind of consigliere for government — selling their services to politicians and bureaucrat who want support rather than an independent appraisal.
It has created a different kind of conflict of interest, where governments have increasingly come to rely on these reports and analysis to back up their policy decisions.
“There’s no major policy change without the big four involved,” Brooks said.
“Major infrastructure investment, transport policy, nuclear policy — almost everything you can think of is being driven by advice from the big four accountancy firms.
“That advice is always ‘oh this’ll be a great idea’ because it then provides years of consultancy work for them [the big four], so they’re heavily conflicted.
“And they also tend to give governments what they want to hear.”
Breaking up the big four
Proposals to limit these conflicts of interest have aimed at separating the auditing and consulting arms of firms, in effect changing the big four into a big eight, or a big 16.
This would, partly, reverse some of the consolidation of accounting firms that lead to the creation of the big four over the past 150 years.
Earlier this year, the chief executive of the UK’s Financial Reporting Council, Stephen Haddrill, proposed a similar idea and also called for another inquiry into the sector.
A previous inquiry in 2013 by the UK Competition Commission resulted in tougher rules for the industry, yet the market share of the big four continued to increase.
Mr Brooks said another option would be to have publicly-funded auditing of major institutions, so that the profit motive was removed from accounting services.
But any change would be met with resistance.
“I think the big four are already mounting some kind of defence,” Brooks said.
“They are bracing themselves for change — they recognise something has to happen but they want the agenda to suit them.”
First published at The ABC. Thursday 12 July 2018.