Lynn Turner Wants to Break up the Big Four

Ernst & Young. Deloitte. PricewaterhouseCoopers. KPMG.

The Big Four auditing firms.

Lynn Turner
Hemming Morse

Lynn Turner is the former Chief Accountant at the Securities and Exchange Commission (SEC).

He wants to bust them up. Make the Big Four the Big Eight again.

“I think it’s an anti-competitive environment,” Turner told Corporate Crime Reporter in an interview last week. “They should be broken up into eight firms. Breaking up any company is a significant undertaking. It does involve a lot of effort. That would not necessarily be easy, but it is very doable. We have had large public companies that have broken themselves up in the past. We know it’s very doable. But the Justice Department and Federal Trade Commission would need to have the courage to undertake that and do that. That would be advisable. Do I think they will do it? No.”

The European Commission stopped a merger that the FTC and Department refused to stop.

“Yes. Back in around 1989, there were eight of these large audit firms – the Big Eight. Then they started to merge. A company by the name of Arthur Young merged with a company called Ernst & Whinney and formed what is now Ernst & Young.  Deloitte Haskins & Sells merged with Touche Ross to form Deloitte Touche – now Deloitte. The most recent merger between Coopers & Lybrand and Price Waterhouse formed PricewaterhouseCoopers.”

“There were a number of mergers that had occurred by the time we got to 1998.”

“In 1998, Ernst & Young decided to merge with KPMG. They took their proposal to merge to the regulators in the United States as well as in Europe.”

“The U.S. regulators approved that merger. However, the European Commission rejected it. They found it was anti-competitive. The European Commission was spot on target. They were way ahead of their U.S. counterparts. And they made the right decision. Had they not done that, instead of being down to the Big Four, we would be down to the Big Three, which is almost an untenable situation. These firms each have to be independent of the company they are auditing. But these public companies like to look to and buy services from the Big Four other than just the audit.”

Is there a chance the Europeans will break up the Big Four?

“No. These Big Four have phenomenal political power around the globe – with perhaps the exception of China. The Chinese government has made it clear that they are in power and not the auditing firms. But each of these four firms are some of the largest donors to the politicians in Washington, D.C., including to the campaigns of the President and the campaigns of Senators and House members. Through those huge campaign contributions, they are able to wield tremendous power, including over the regulators.”

“For example, back around 2011, the regulators here in the United States talked about requiring these audit firms to having to rotate out of the audits every twenty years. That is, periodically, a company would have to go and get a new auditor so that you wouldn’t have too cozy a relationship between the auditor and management. They have done that in the European Union. The European Union and the Commission is way ahead of us in the United States in that respect.”

“When the regulator started talking about that in the United States, those four firms went up on the hill and got Congress to enact a law that said the regulator could not require the auditors to periodically have to change out on the audits. It just shows the power of these four firms and their ability to actually control what the regulators are able to do.”

“In fact, if you look at the SEC’s Office of the Chief Accountant – the principal regulator of these firms – the top people in that office are former partners at one of these four firms who have rotated into that office and have in the past rotated back to the national offices of these audit firms.”

“We have a serious problem with the revolving door between the audit firms and the regulators who are supposed to be keeping the firms on the straight and narrow path. That in itself is one of the big contributing factors to the Department of Justice having to bring this case against KPMG.”

“The people involved in that case are people who worked at a Big Four audit firm, went to work for the regulator, then left the regulator and went back to the firm. And when they went back to the firm, they illegally obtained information from the regulator that they then used inside the audit firm.”

You have written a paper outlining reforms you think should be made. In the paper, you point out that the country came really close to having a public auditor.

“Yes. After the stock market crash in 1929, Congress under President Roosevelt looked to enact some laws to clean up the public stock trading markets, make them more transparent, and give people a reason to once again want to invest in the stocks of those companies in those capital markets.”

“One of the proposals that Congress considered was to require all companies who sold their stock to the public, have their financial statements and disclosures audited by a set of eyes other than those of management.”

“And Congress considered two options. One option – and how the bill was originally drafted –  was to have government employees perform those audits. And of course, we have that done today with the banks in the United States. The federal banking regulators all have teams of auditors that go out and examine the books, records and practices of the banks around the United States. Congress considered that option.”

“But the auditing firms at the time pushed back and came and testified before Congress. They said –  rather than having these audits done by the government, let us do the audits in the private sector. And by an extremely narrow vote, Congress amended the draft to have the audits done by these so called public auditing firms – although they are all owned by the partners in the firms. That is the decision that Congress made.”

“Ever since 1933 when the Securities Act was past that year into law, there has been a requirement that each company that sells their stock to the public must have an audit by one of these firms and that the firm must have no ties that would cause anyone to question whether or not that firm is independent of the company they are auditing.”

What is the state of that independence?

“We are seeing more and more cases in which the regulators are finding that the auditors are violating the independence rules. Some of them are quite outrageous. We have found cases of the audit firms spending large amounts of money to cozy favorable relationships with the companies they are auditing. We have found that the companies have provided legal indemnification to the auditors even if their work is subpar and doesn’t meet professional standards. There is no way to hold the auditor accountable in those situations for poor work because the company has agreed to indemnify the auditor. Those are pretty outrageous and by the way they are prohibited by the laws and regulations in this country.”

“As an auditing professor in college, you teach every new auditor those independence rules. And they fully understand them. Yet, for some reason when people get into these firms, these firms do have a culture where they very strongly believe they are entitled to the annuities they get from each company they audit. And no one should be able to disrupt that annuity. It almost creates a culture that is anything but independent. And as I mentioned, the regulators are finding more and more instances of violations of the independence rules.”

“I now understand that the Big Four firms have submitted a white paper to the Public Company Accounting Oversight Board. They are asking the board to allow them, when they have broken these laws, to get a waiver so that they don’t have to give up their contract with the company they are auditing.”

“If the PCAOB were to allow that, it would be the end of independent audits here in the United States and investors would be put at extreme risk.”

The recent prosecution of  KPMG executives also raises the question of the revolving door between the PCAOB and the Big Four.

“And it’s not a slow revolving door. This door is spinning at a very fast pace with the very people who inspect the audits from the regulator — the PCAOB. The PCAOB is getting many of the people they use to inspect the audits from those Big Four firms. After doing the inspections for a number of years, and after those people have figured out how these inspections are done, then all too often, they go right back to the Big Four auditing firms with all the information of how the inspections are done. They are now back in the auditing firms with inside information. That’s why some of the charges were brought against some of the auditors at KPMG. They illegally obtained information that they were not supposed to have and they used that information to try and thwart the efforts of the PCAOB to inspect their audits.”

Given all of that, why not embed within the SEC a unit that does public audits – similar to the bank examiners?

“You could. There was nothing wrong with that with one important thing to think about. We have had some serious financial crises in this country since the Federal Reserve was formed in 1913. And the Federal Reserve has had all of these bank examiners. And yet having all of these government bank examiners, time and time again, we have found that they have failed the country. They have failed the country by not controlling and regulating properly the savings and loans, which failed in the late 1980s. All of those had been examined by government banking examiners.”

But are those failures inherent in public auditing? Or can we have excellence in public auditing?

“We can have excellence in public auditing. We can have excellence regardless of whether the auditor is working for the government or working for one of these private auditing firms. In either case, we have not established accountability for auditors who don’t serve the public interest and who serve their own interests instead.”

In your proposal, you come down strongly in favor of private auditing over public auditing, even though we could have excellence in either. Why is that the case? And you go so far as to propose removing the current requirement for public companies to have an independent auditor.

“I don’t eliminate the requirement. I say we have to establish a direct line of responsibility and accountability between this auditor who is checking the books and the people that auditing is supposed to be serving – the investing public.”

“Rather than having the government mandate that there be an audit, and create this federal utility, which doesn’t work in either the private or public sector, I propose that we have the investors — the owners of that company —  decide whether or not they want this external audit. And 99.9 percent of the time, I believe those investors will vote to have the independent audit.”

“But then, rather than working as the result of a government mandate, the auditors are not working for management, but they are actually working for, and can be removed by that vote of the shareholders. And they are the ones then that the auditors will be accountable to.”

“Today, it is management of the company that puts the numbers together and puts out the financial reports. And they are the ones writing the check for the auditors. Thus the big audit firms think they work for management and they put the interests of management high above the interest of the investing public.”

“Time and time again in public courts in this country, the auditors have gone in and said they have no obligation to the investing public. That’s outrageous. That’s what we need to change. We need to make sure these auditors know who it is they work for. It’s not management. It’s for the shareholders who must have those audited financial statements to get credible information so they can make smart investment decisions. That is what I would turn around and change.”

“And when I change that, I would also change who writes that check. Today, the PCAOB collects a fee from every single public company in the United States. They have the right to do that. It would be easy enough for them to turn around and say — we are also going to collect enough in that fee to pay for the audits. And so when the audits are done, the PCAOB would use that money they collect from the companies to pay directly to the audit firms.”

“I also say that if the PCAOB finds in doing their inspections, as they often do, that the audits weren’t done right, they would then have the right to go in and replace the auditor and have the company get a new auditor who could get the job done right. That’s the type of system where you have transparency and accountability that can work.”

(For the complete q/a format Interview with Lynn Turner, see 32 Corporate Crime Reporter 7(11), Monday February 12, 2018, print edition only)


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