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April 30, 2008

Mixed feelings as mid-tier reacts to findings of EU Oxera report

By Nicholas Moody

Mixed feelings as mid-tier reacts to findings of EU Oxera report

Two audit firms using alternative practice structures say allowing external capital investment into European audit firms would be a good move, although a mid-tier firm says removing invisible barriers would do more to increase audit choice.

The comments are in light of a 240-page report from consultancy Oxera, which was published by the EC last month. It examined ownership rules applying to audit firms, their corporate structures, access to capital and the consequences such access might have on audit market concentration. Information was drawn from 56 surveys of companies, ranging from finance to food, as well as 44 interviews, including 29 with audit firms. The report found that relaxing ownership rules in European audit firms could create new investment and entry opportunities into the international audit market.

‘Encouraging’ outcome The potential of alternative ownership structures within audit firms has been highlighted by the experience of UK firm Tenon Group and US firm McGladrey & Pullen. Andy Raynor, chief executive of Tenon, says the idea that there can be external involvement or investments in audit practices is an “encouraging” outcome of the report.

“If the objective of opening up investment into audit practices is to make sure there is greater choice in the market, my view would be it can’t do anything except help,” Raynor told IAB. “I think if you’re going to have businesses that are chasing the major international corporations that are, at the moment, almost exclusively the province of the Big Four, they are going to [require] deep pockets to do so. That is because those businesses, the Grant Thorntons or the BDOs of this world, are actually going away from their natural client base.”

Tenon, a Morison International member firm, is an Alternative Investment Market-listed accounting and business advisory company. If Tenon acquires a new business with an audit arm, the audit practice is separated out and held in Tenon Audit Limited. Audit makes up around 10 percent of Tenon’s business, generating turnover of around £13 million ($27 million) to £14 million.

Although this forms a small proportion of its overall fee income, Raynor says the discipline of having an external investor is an advantage. “I think actually that the corporate structure and the discipline of having an external investor, whether it is external shareholders or an individual external shareholder in private equity, adds structure and there is a discipline which I think actually improves the business,” he said.

McGladrey & Pullen, a US member firm of RSM International, runs a separate audit practice to RSM McGladrey’s corporate tax and consulting business, which is a subsidiary of the publicly listed tax consultants H&R Block. Prior to creating its alternative practice structure with RSM McGladrey in 1999, McGladrey & Pullen’s revenue was approximately $300 million. The current combined annual revenue for McGladrey & Pullen and RSM McGladrey has since grown to approximately $1.4 billion.

Dave Scudder, managing partner at McGladrey & Pullen, says access to capital helped the firm grow its business serving the middle market since 2002. “I’m not sure we would have been able to capture the market share from the changes in the US audit market were it not for that additional capital and resources [available through the alternative structure with RSM McGladrey],” he says.

Not all in agreement However, not all partners speaking with IAB agree that liberalising access to capital is the best way to improve choice in the audit market. Grant Thornton’s head of external professional affairs, Steve Maslin, said removing invisible barriers to entry would do more to increase choice.

“It was almost as if the commission had decided that the best way to increase auditor choice was to liberalise the ownership rules but there’s no point dealing with the ownership laws until all the perception issues and invisible barriers to entry are dealt with first,” he said. “If the commission was successful in overcoming some of these invisible barriers of entry to the audit market – then in that scenario, we can see that it possibly would be a worthwhile exercise to liberalise the ownership laws at that point.”.

Maslin explained that some of those invisible barriers include removing the historical ties between intermediaries, such as investment banks and the Big Four firms, giving shareholders more involvement in the choice of auditors and improving the transparency of audit reports.

Nicholas Moody

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