Ed. note: Today we welcome back Adrienne Gonzalez a contributor to Going Concern. She is the founder of GoFraudMe, a GoFundMe watchdog site. You can follow her on Twitter and the hiking trails of Richmond, VA (but keep your distance, stalkers).
Way back in 2008, a small hiccup in the United States financial system brought upon by an even smaller hiccup in the U.S. housing market led to the mild threat of the collapse of the world economy. No worries, all that was avoided thanks to the quick thinking of the Federal Reserve, U.S. Treasury, lawmakers, and other assorted wonks working overtime in New York City bunkers to save the planet from total financial ruin. The implications of such unprecedented action were to be worked out later by other assorted wonks, and here we are all these years later having practically forgotten about the whole thing. Thanks, wonks.
If you haven’t put the experience of nearly being downgraded to Second World status out of your mind, you’ll remember the buzzphrase du jour of those dark times in late 2008: Too Big to Fail. The long and short of TBTF is that big banks, given free reign by regulators to grow bigger and more (buzzphrase alert) systemically important to the global financial system years before, had grown so large that letting them fail despite the fact that they were the reason everything was failing would flush us all down the toilet.
With all that drama behind us, professional pedant (and sometimes GC contributor) Jim Peterson and aspiring PhD William Kring batted around a crazy idea in American Banker the other day: when regulators consider Systemically Important Financial Institutions (hereby referred to as SIFI), they should turn their attention to the "Big Four" auditors.
“But why?” I hear you asking. Of the 6,835 total public companies in the US, 3,067 are audited by Big 4 firms. Their
dominant stranglehold on capital markets percent of market share is even more significant when you consider that 90.9% of Large Accelerated Filers are audited by Big 4 firms.
The biggest problem with this, say Peterson and Kring, is that were — God forbid — a Big 4 firm to fail, it’s unlikely the other three could legally pick up the slack:
[S]ystemic-risk concerns with the Big Four extend to how they audit already-designated SIFIs. Should just one of the Big Four collapse, the whole audit model for the SIFIs would collapse too, due to conflicts of interest and scope-of-practice limitations.
A SIFI is required be audited by a firm that does not already provide ancillary services to the company, such as tax advocacy, valuation, M&A advice or systems consulting. Because of consolidation in the accounting industry, a SIFI likely has connections to all of the Big Four. Should one of the big accountants fail, a SIFI would have no auditor replacement options among the resulting Big Three.
So why couldn’t the remaining six Big Ten auditors step up to the plate? The answer should be pretty clear but let’s go over it for the audience in the back anyway. “Middle-tier accounting firms would be unable to fill the void left by the collapse of one of the Big Four, because of the demands of scale, geographic coverage and depth of sector expertise required of a realistic alternative,” say Peterson and Kring. Additionally, there’s no way a Marcum or RSM would voluntarily sign up for potential legacy lawsuit liability in the wake of a sudden Big 4 firm collapse because that would just be stupid. It’s one thing for PwC to settle billion dollar lawsuits, it’s quite another to expect Anton & Chia to do it. Might as well expect H&R Block to figure out GE’s tax liability while we’re at it.
But wait, there’s more! As Francine McKenna points out, categorizing Big 4 firms as systemically important could mean that the rest of us get to systemically dig into their financial data.
— Francine McKenna (@retheauditors) January 9, 2017
No doubt Big 4 is adamantly opposed to the mere thought of a financial colonoscopy in the event they are deemed critical to the function of already categorized SIFIs. Opening up that can of worms means going from self-reporting revenues to — gasp — a more thorough outside analysis of their financial well-being. Were it to come down to taking down the global financial system or revealing the skeletons in their respective closets, it’s not like Big 4 would have a choice.
Lucky for them, wonks like Jim Peterson are pundits, not politicians.