Big four are playing with fire in auditing multinationals, says PwC

A joint report by the UK partnerships of the big four accounting firms – Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers (PwC) – concludes they are “betting the firms” by auditing the financial statements of multinationals. PwC noted that the risks involved in auditing are “uninsurable, unquantifiable, unmanageable and could at any time destroy our firm, or any of our competitors.”

The collapse of accounting giant Andersen as a result of the Enron scandal and massive litigation claims, such as Equitable Life’s £2.6bn action against Ernst & Young, clearly highlight the vulnerabilities of the major firms. So while the world may want multinationals, the ability to provide credible audits for them is now in doubt.

And this is not the only prime underpinning of the global financial system that is coming into question. Besides audits, financial markets are relying increasingly heavily on credit ratings from the three main international agencies – Fitch, Moody’s and Standard & Poor’s. But while markets need ratings, do the agencies necessarily need the increasing headaches stemming from producing ratings? Analysts suggest that providing credit ratings is becoming less profitable and, like auditing, is subject to growing complexity, higher costs and vulnerability to litigation.

Rating agencies, like auditors, are businesses that are there to make a profit, but because of their unique nature and role, this aspect is often forgotten. Some might say that if the above seven firms cannot make a go of it then market forces will produce ready replacements, a pure example of survival of the fittest. This may be so, but the auditing and rating agency operations are so critical to the proper functioning of global markets it is difficult to see how markets could function without these key players or their replacements. The question then is, what risks are these firms expected to take and what profits can they be expected to make?

PwC has told the UK government that accounting firms could be destroyed without protection and suggested that the firms have a Ł75m liability cap for audits. In financial circles the prospect of government intervention or protection often tends to smack of moral hazard, but while solutions in this area are not easy, a better balance between risk and reward for auditors and agencies needs to be struck. The prospect of multinationals without auditors or ratings is definitely not healthy.