Our experts describe you as an appallingly dull fellow, unimaginative, timid, lacking in initiative, spineless, easily dominated, no sense of humour, tedious company and irrepressibly drab and awful. And whereas in most professions these would be considerable drawbacks, in chartered accountancy they are a positive boon.
- Monty Python

In an industry of wannabe lion-tamers¹ whose aim is to ensure fair financial reporting and adherence to market regulation, it may well come as a surprise to find that the accountancy world has been dominated by only four companies since 2003. Until very recently, people spoke of them as The Big Five, so who are they, and what happened to number five?

Arthur Andersen

Well, in mid-2002 Andersen's², once the darling of the accountancy world, and reportedly the most selective in its recruitment and clientele, vanished.

Andersen's was implicated in the Enron scandal. The fast-growing Houston-based energy and financial services company admitted in 2001, just moments after its directors had sold their shareholdings, that it had falsified its earnings since 1997. Enron filed for bankruptcy, but equally culpable were the auditors³, Arthur Andersen, especially when they were caught shredding audit papers! Clients started jumping ship, but this was just one of a string of scandals, including the well-publicised collapse of US telecommunications giant Worldcom, who in 2001 hid $3.9 billion in expenses, allowing it to post a net income of $1.38 billion, instead of a loss. Clients tried to distance themselves from Arthur Andersen very rapidly.

Finding themselves subject to scrutiny by three bodies: the Securities and Exchange Commission (SEC), the US equivalent of the Financial Services Authority in the UK, the US Congress and the Institute of Chartered Accountants (ICA), which works to regulate the accountancy industry itself. Arthur Andersen found itself with no clients, and its reputation left in tatters. The remaining large accountancy firms swallowed up its partnerships around the world. This left only the Big Four.

So who are the remaining four?

Listed in descending order of revenue for the global partnerships for years ending 2004. the four remaining big accountancy firms are:

1. PricewaterhouseCoopers (PWC)

2. Ernst & Young (EY)

3. KPMG (Klynveld Peat⁴ Marwick Goerdeler)

4. Deloitte (Deloitte Touche Tohmatsu or DTT⁵)

So what do they do and what makes them the BIG four?

Put simply, the Big Four control the top end of the accountancy market. These are huge multinational partnerships with revenues measured in billions of pounds. The Big Four act as auditors, accountants, tax advisers, business advisers, corporate finance advisers, insolvency practitioners and administrators and consultants to the largest companies in the world. Over 80% of the companies in the FTSE 100, the DOW, the Nikkei, the Hang-Seng, and every other major market in the world will be audited by one of the Big Four. These are the largest accountancy companies, and the company that ranks fifth in size⁶ is considerably smaller. It would be like comparing Spar with Tesco.

Isn't this a bad thing?

That is a rather interesting question. The problem is that to audit a company the size of, say, BP requires vast resources. You need people around the globe working together and in large numbers. You need specialists in banking (BP has its own internal bank), insurance (BP partly insures itself through captive insurance), investments (BP has huge amounts of money in stocks, bonds, buildings and of course oil), not to mention specialists in the petro-chemical industry. The only place you will find all of these skills is in an organisation large enough to support them all. Hence the Big Four emerged through a succession of mergers. Companies could go elsewhere, but investors would think the audit a bit suspicious if they felt the auditors were not up to the job, so most will not move away from the Big Four, resulting in a perpetual circle.

Is this limited market a bad thing? Technically, no; there is a choice, and in addition, shareholders can refuse to appoint the chosen auditor at the Annual General Meeting (AGM). In this case the directors would need to appoint new auditors, and have them approved in an Extraordinary General Meeting (EGM). However, the Big Four also act as advisers and consultants, and some people feel that this creates a conflict of interest, as auditors are supposed to be independent.

In recent years, many UK watchdogs, calling for greater diversity, have asked the Government to do two things. The first is to put in place a time limit on which any one accountancy firm can be the auditor of a Public Limited Company, i.e. a company that is floated on one of the various stock exchanges. However, understanding the complexities of a large business such as the aforementioned BP takes a lot of work, and this can make changing auditors a troublesome and expensive business. The second thing being pushed for is to ensure more of the large companies use Second Tier auditors - those outside the Big Four. The issue is how to achieve this without affecting the reputations and hence the share prices of the Big Four. It would be difficult to force companies to choose a Second Tier auditor, as they would first need to be clearly defined. In addition, as the audit of privately owned companies is specifically for the benefit of the shareholders rather than the other stakeholders, such as the public, the Government, and the company's suppliers and customers, it is not really for the Government to choose who the auditors should be.

Another issue is the influence these companies have on the regulation of the accountancy world itself. These four firms are able to ignore certain directions that come from the accountancy institutes on, for example, working practices, due to their collective size and the lack of choice to their customers. They also have huge influence on audit guidelines for large companies, as they are the only companies with experience of auditing large companies. The undue influence is hard to avoid, and is another cause for concern. In the UK, this is mitigated by the fact that the Financial Services Authority does have the ability to make practices issued by the Institutes legally binding.

Are the Big Four Classified as Limited Companies?

Strictly speaking, no. The Accountancy Firms historically have all been partnerships. This meant that they were not limited companies, but private businesses owned completely by the partners. In the event of bankruptcy or losing court cases, etc, the partners themselves had unlimited liability, and could lose their home and all their assets, unlike a limited company where only the company's assets are at stake. However in 2001, the UK Government passed an act allowing the creation of a new legal entity, the Limited Liability Partnership (LLP), the first of which was Ernst & Young. This finally gave the partners limited liability without having to issue share capital or declare that the company is an independent legal entity. The downside for them is that for the first time these partnerships have had to issue audited accounts.

So what for the Future?

In 2004 an event occurred which may have brought about the demise of one of the Big Four, leaving us with the Big Three. After losing a major court case in the House of Lords, Equitable Life, one of the world's oldest and biggest mutual companies, found itself unable to meet all of its liabilities and was put into run-off - it was forced to pay off its existing policies and close. It very quickly decided to sue all of its former directors and its auditor for damages caused by incompetence. Ernst & Young, the second largest accountancy firm was hit with a multi-billion pound lawsuit. If it lost, its malpractice insurance would not have covered all the liability, and would in all likelihood have wiped out the firm and the partners. As the work was done prior to becoming an LLP the partners would still be held fully liable. However, in 2005, without any settlement from EY, Equitable dropped its case. The accountancy industry had dodged a major bullet.

In the event that Ernst & Young had disappeared in the same way as Andersen's, then governments and regulators around the world would have had little option but to intervene in the accountancy world. Leaving only three companies available worldwide to audit large multinationals in everything from petro-chemical companies to grocery companies to banks and insurers would have left these companies in the position to create a near monopoly. The most radical solution would be a forced demerger of the current accountancy firms to ensure diversity of choice and to bring these companies down to the same levels as the Second Tier firms.

And Finally - the Sarbanes-Oxley Act

In 2002, in the wake of the SEC's investigation into the Enron fraud, the US Government passed a radical new piece of legislation to protect investors by imposing strict controls on the accounting of public companies. Named after its sponsors, Senator Paul Sarbanes and Representative Michael Oxley, the Sarbanes-Oxley Act, also known as SarbOx or SOX, applies an extensive set of mandatory control procedures to all US-registered public companies. As virtually all global companies trade in the US, the impact has been felt worldwide. Companies and auditors who fail to comply can expect to find themselves liable to criminal investigation.

A full description of the requirements of this complex piece of legislation is beyond the scope of this entry⁷ but its major provisions include the following:

• Chief Executive Officers (CEO's) and Chief Financial Officers (CFO's) are now personally responsible for financial reporting, and the entire decision-making process behind it. They must also report the effectiveness of their internal controls.

• Auditors must be entirely independent, with much non-audit consultancy work for the same company banned under the laws.

• There are strict controls over insider trading.

• The civil and criminal penalties for violations have been increased.

• There is protection of company whistleblowers who might report violations.