08 December 2012

The Economist: Two controversies ensnare the Big Four

The Big Four claim that their global scale and multidisciplinary scope are good things. But the events of the past few weeks show there are perils, too, in trying to have the best of all worlds.

Buying Autonomy, a British software company, once seemed like a good idea to Hewlett Packard. Western investors were once eager to buy into Chinese companies that had secured listings on American exchanges. Both these changes in sentiment raise awkward questions for the Big Four accounting firms.

The computer giant, Hewlett-Packard (HP), announced last month that it was writing down the value of Autonomy by $8.8 billion, in part because of “accounting improprieties, misrepresentations and disclosure failures”. (Mike Lynch, Autonomy’s former boss, denies the charges and has set up a website demanding that HP detail its accusations.) With so few global auditors to choose from, a saga like this ends up sucking them all in. Deloitte was Autonomy’s auditor; Ernst & Young is Hewlett-Packard’s. KPMG provided advice on the deal. PwC has been hired by HP to sort through the mess.

If HP’s claims are true, Deloitte, Autonomy’s auditor, will be the one in the cross-hairs. If they are false, Ernst & Young, which will sign off HP’s huge write-down of Autonomy, will have a lot of explaining to do. HP says the third of the Big Four, KPMG, “audited” the deal; KPMG says it provided only a “limited set of non-audit-related services”.

Deloitte has most reason to be nervous. As well as auditing Autonomy, it provided $6.7 million in non-audit services over seven years, prompting critics to raise familiar questions about conflicts between accountants’ auditing duties and their consulting work. Deloitte advised Autonomy on executive pay, for example, something that would be forbidden under America’s Sarbanes-Oxley law, but was permitted in Britain. Moreover, Deloitte Luxembourg last year announced a close partnership with Autonomy to roll out a piece of Autonomy software.

America’s SEC charged the Big Four and BDO for refusing to share documents related to audits of troubled Chinese firms listed on American exchanges. Chinese divisions of the Big Four have audited several Chinese firms that listed abroad and then tanked. Prominent among these are Longtop Financial, a technology firm that has since been delisted in America, and Sino Forest, which Canadian authorities are investigating for allegedly faking its own forestry assets.

American regulators, including the SEC and the PCAOB, have been demanding the work papers for the controversial audits from the Chinese affiliates. That puts the auditors in a bind. American regulators must ensure that the foreign auditors of firms listed in America are doing their job properly. But Chinese laws forbid the sharing of those documents, on the grounds that vaguely defined “state secrets” might surface.

For a while, Sino-American negotiations seemed to be making some progress on a compromise. A few months ago officials from PCAOB were allowed to observe their Chinese counterparts during a “trust-building” exercise. But a meeting between the two sides in November appears to have ended frostily, and the SEC hardened its position this week by declaring that “firms that conduct audits knowing they cannot comply with laws requiring access to these work papers face serious sanctions". The PCAOB is expected to declare by year’s end that if a foreign auditor has not been inspected properly by American authorities, it will be deregistered.

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© The Economist