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  • When investors decide to put money into a company, chances are they've looked at

  • its financial statements, which contain audited reports of the organization's accounts,

  • giving them the confidence to part with their money.

  • For a majority of large, publicly traded companies, these audits are conducted by one of the Big

  • Four accounting firms: KPMG, PWC, EY and Deloitte.

  • But their dominance is under threat from regulators.

  • Following the collapse of some high-profile companies, scrutiny is on the conflict of

  • interest between the accounting industry's audit and non-audit services.

  • It's led to calls from the public, politicians and regulators for the break-up of the Big

  • Four and a shakeup of the accounting industry.

  • In 2001, energy company Enron collapsed amid accusations of accounting fraud, which was

  • at the time, the largest corporate bankruptcy in U.S. history.

  • The demise of a publicly listed company that was worth over $60 billion left many asking

  • how the firm's auditors, Arthur Andersen, could have signed off on accounting books

  • that overstated the energy giant's profitability.

  • Arthur Andersen ended up being another casualty of the scandal, convicted of obstructing justice

  • and losing the right to file accounts.

  • Less than a year after its conviction, the fate of America's oldest accounting firm

  • was effectively sealed, even though the Supreme Court later overturned the ruling.

  • Andersen's firms around the world were then sold off to members of what became the Big Four.

  • But before the emergence of the Big Four, the market for audit services was dominated

  • by eight companies that were created through alliances across the Atlantic and beyond.

  • Along with Arthur Andersen, the eight included Arthur Young, Coopers & Lybrand, Deloitte

  • Haskins & Sells, Ernst & Whinney, Peat Marwick Mitchell, Price Waterhouse, and Touche Ross.

  • The Big Eight, as they were known, grew rapidly amid a wider consolidation within the industry,

  • including smaller firms like KMG which merged with Peat Marwick to eventually become KPMG.

  • Marketed as modern, global business networks, competition between the eight intensified

  • as they expanded internationally.

  • By 1989, the Big Eight started to whittle down further when Arthur Young combined with

  • Ernst & Whinney while Deloitte Haskins & Sells merged with Touche Ross to form Deloitte & Touche,

  • usually referred to as Deloitte.

  • The Big Six became the Big Five in 1998 when Price Waterhouse merged with Coopers & Lybrand

  • to form PricewaterhouseCoopers, now known as PwC.

  • And when Arthur Andersen collapsed, the Big Five became the Big Four.

  • Their dominance of the industry has grown ever since.

  • In 2019, the Big Four had more than 75% of the global accounting market share, nearly

  • a 10 percentage point increase from the year before, while their revenues during that financial

  • year exceeded $154 billion.

  • The group also has a lock on the world'slargest public companies.

  • In 2019, just five of the 500 companies in the S&P stock market index were audited by

  • a non-Big Four firm.

  • In the U.K., all companies that make up the FTSE 100, the country's blue-chip index,

  • were audited by one of the Big Four in 2018.

  • This collective dominance is one reason why regulators are attempting to prise the audit

  • market open to tougher scrutiny and fresh competition.

  • Critics of the Big Four also point out that despite all their resources, including over

  • a million employees, there have been several high-profile failures to uncover massive frauds.

  • A few months after Enron filed for bankruptcy, a bigger accounting scandal involving U.S.

  • telecommunications company WorldCom erupted, this time ensnaring KPMG, who took over the

  • accounting books from the embattled Arthur Anderson.

  • While the Big Four managed to emerge relatively unscathed, more accounting scandals continued

  • to rock investor confidence in the years ahead.

  • I wouldn't hire you, to do an audit of the contents of my fridge.

  • These include the demise of Lehman Brothers in 2008, which was audited by Ernst & Young,

  • now known as EY,

  • Lehman has lostyou can see right there – 36% of its value.

  • The insolvent construction giant Carillion, which counted Deloitte and KPMG as its auditors,

  • We were a customer of Carillion, not the manager of Carillion.

  • Tour operator Thomas Cook, whose accounts were signed off by PwC and EY, and the 1MDB

  • scandal, which tainted three of the Big Four firms.

  • In 2020, German regulators examined EY for approving the accounts of online payments

  • company Wirecard, for more than ten years, before it filed for insolvency.

  • Critics believe they avoid properly scrutinizing their clients' accounts because this could

  • threaten their consultancy work.

  • Along with auditing, the Big Four offer other services such as management consulting, taxation,

  • market research and legal advisory services.

  • In fact, these non-audit services provide the lion's share of the Big Four's income.

  • In the U.K., only a fifth of the Big Four's total revenue is generated from auditing.

  • In the case of Enron, Arthur Andersen was earning more from the consulting services

  • it provided to the energy firm than it did from its auditing activities.

  • Critics also claim that the strong growth of the non-audit business, which resulted

  • from changes in the business environment for accounting firms in the 1970s, has impaired

  • the robustness and objectivity of audits.

  • While the standardized approach to audits ensures that financial statements are fairly

  • stated without material discrepancies, and that appropriate internal controls are in

  • place, this has led to a mismatch in the expectations and limitations of audits.

  • In fact, a study of nearly 2,700 cases of workplace fraud in 125 countries found that

  • a majority are uncovered through tip-offsshowing the importance of whistleblowing

  • hotlinesas opposed to internal or external audits.

  • The Big Four insist, however, that regulations restricting consultancy work are sufficient

  • to protect the independence of their auditing services.

  • These include the SarbanesOxley Act of 2002 in the U.S., and Japan's Financial

  • Instruments and Exchange Act.

  • In the U.K. and EU, auditors are not allowed to provide consulting advice to businesses

  • one year leading up to and during the term of an audit contract.

  • Companies included in the FTSE 350 Index, the 350 Biggest companies in the U.K., must

  • also put their audit out for tender every 10 years and must change auditors every 20 years.

  • However, these restrictions, according to regulators, aren't fool proof.

  • When an auditing contract ends, the firm can immediately begin doing consultancy work for

  • the same company, making it less likely for existing auditors to challenge a client if

  • it jeopardizes future contracts for lucrative non-audit work.

  • Some politicians also argue that these regulations are overly complex and hinder competitiveness.

  • Even with more regulatory paperwork and longer annual reports, these accounting scandals

  • have not abated.

  • There are signs, though, that the Big Four realize that the status quo cannot continue forever.

  • Deloitte has set up an audit governance board, which it claims willfocus on the policies

  • and procedures for improving audit quality.”

  • And EY, in the wake of the Wirecard scandal, has told its clients that auditors should

  • play a bigger role in detecting fraud.

  • The U.K.'s accounting regulator, the Financial Reporting Council, has also set a 2024 deadline

  • for the Big Four to separate their audit units from their other services, although the watchdog

  • stopped short of demanding a full, structural break-up of the firms.

  • The Big Four, in response to queries from CNBC, said that they have taken steps to enhance

  • audit governance, including engaging with the Financial Reporting Council on the principles

  • of operational separation.

  • Audits serve a crucial role in instilling public confidence in financial markets.

  • Yet, the same costly errors that resulted in the demise of Arthur Andersen nearly twenty

  • years ago are still happening today.

  • Unless the industry can restore confidence that their audits are independent, objective

  • and uncompromised, the pressure will build on regulators to act before the financial

  • world is engulfed in yet another accounting scandal.

  • Hi guys, thanks for watching our video. I briefly mentioned Wirecard in this story.

  • We made another explainer on that scandal specifically so do check that out

  • and we'll see you next time.

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The accounting oligopoly: What’s next for the Big Four? | CNBC Explains

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