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April 30, 2008

Mid-tier warns ownership reform and joint audits not the answer

By Nicholas Moody

Relaxing the ownership structure of audit firms and encouraging the use of joint audits will have little effect on increasing choice in the audit market for large UK public companies, according to several mid-tier firms.

The UK Financial Reporting Council (FRC) recently published a discussion paper on the possible effects of changes to audit firm ownership rules and has begun a consultation on the use of multiple audit firms to conduct single engagements.

lThese initiatives are part of a progress report from the Market Participants Group, which was established in October 2006 to provide advice on improving choice in the UK audit market. The discussion paper considered audit ownership issues, including the impact of outside capital and a possible decline of audit quality from conflicts of interest.

The update also published figures showing no dilution of auditor concentration in the FTSE 100, but a slight increase in non-Big Four firms carrying out audits for FTSE 250 and small cap companies.

Smith & Williamson national head of assurance and business services Giles Murphy said the market’s perception about which firms had the critical mass, strength and brand to compete with the Big Four was more of an issue than a lack of funding. He suggested that increasing audit transparency by publishing audit transparency statements or introducing better self-regulation of the profession, would be more effective.

Tenon Audit technical director Patrick Wright said that “throwing money” into mid-sized audit firms was not going to change the market’s perception about the capability of mid-sized firms to perform large public audits. Tenon Audit currently operates as a separate legal entity from Tenon Group, an AIM-listed member of Morison International, and is already able to access outside capital because of this alternative practice structure.

“While I don’t see changing ownership rules would be detrimental in any way to the development of our auditing practice, I don’t think its going to create any surge of business. It would be nice to have the greater flexibility in the legal ownership structure to allow the development to take place but it is by no means a panacea for the concentration in the hands of the Big Four,” he said.

Breaking down barriers

Grant Thornton UK said if regulators were serious about changing the composition of the audit market of large listed companies they needed to focus more on barriers on the demand side, as that was the key to getting more competition and choice in the market.

Chief executive Michael Cleary said the overall composition of the UK audit market had not changed significantly and regulators would have to make “bold” steps to foster choice.

“While the management of financial institutions at the highest level understand and support the need for greater choice, in practice there is often resistance to appointing a firm outside the Big Four,” he explained.

Deloitte UK, Nexia International member Smith & Williamson and Tenon Audit believe joint audits would increase inefficiency and they did not see great market demand for their use.

Martyn Jones, national audit technical partner at Deloitte, urged regulators to inform stakeholders rather than impose artificial regulatory requirements. Jones said there were market concerns about problems arising from having too many auditors involved in giving the same opinion on group and joint audits.

“I worry that somehow something may slip through the middle between different auditors, so that’s what I call an audit quality concern which needs to be overcome. As regards to joint audits, they may operate in other parts of the world, but there doesn’t seem to be a significant demand for joint audits in the UK,” he said.

Nicholas Moody

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