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Who audits the auditors?

“The Big Four” of the auditing companies – Deloitte, PwC, EY and KPMG, is in the heart of the modern financial system, but surprisingly few things are known about them. This is an apparent paradox: the accountability of global capitalism depends on organisations, which are not quite transparent about their own activity

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There have been significant debates about the offshore zones and tax havens in the last years, encouraged by the media leaks such as The Panama Papers. They uncovered the scale of tax evasion and of the illegal financial flows of rich people, including those related to famous political figures and large corporations. Questions have been raised about how the regulations that prevent tax evasion and money laundering could be improved, so that the transparency is increased with regard to the places and the organisations that let and encourage those activities.

Some of the most important actors in modern financial system are the accounting and auditing firms. Their market is dominated almost completely by four organisations – Deloitte, PricewaterhouseCoopers (or PwC), EY (known until recently as Ernest & Young) and KPMG. In the beginning of June 2017 the report “The Big Four: A Study of Opacity” was published. It sheds light on the secrecy of those companies.

The research’s authors are Richard Murphy and Saila Naomi Stausholm. It is commissioned and financed by members of the European Parliament from the United European Left and the Northern Green Left (GUE/NGL), who participate in the European Parliament’s commission that investigates the Panama Papers’ uncovering.

The report points out that “The Big Four” are an important player in the ecosystem for tax avoidance, but in spite of that they are allowed to operate in secrecy. There are not measures undertaken that deal with the apparent conflicts of interest between they are main functions of audit and tax services. The four companies also escape from their responsibilities in different countries, posing as networks of independent firms, while in reality they operate under the common control.

“The reality is that the Big Four firms are central to the operation of global capitalism. This form of capitalism is dependent upon the logic of shareholder capital being accountably used by management, which is distinct and separate from those who own the enterprise, and whose actions are reviewed by independent auditors. This system could not function without the audit services that the Big Four firms provide. These firms are, then, quasi-regulators at the heart of the global financial system and yet we know remarkably little about them. This presents a clear paradox: the accountability of global capitalism is dependent upon firms that enjoy significant opacity about their own operations”, the report notes.

The authors of the investigations urge the European Union to undertake measures such as imposing a division between the auditing activity and the tax services, and also such as the rejection of the fictive structure of “The Big Four” as a network of independent companies. According to the researchers they have to be treated as single corporations which operate in the EU with a single license. Also, the researchers recommend that the firms be forced to publish reports about their global activity country by country.

How big is “The Big Four”?

The companies from “The Big Four” are usually considered as accounting firms, but in reality they generate a large part of their income through a wide spectrum of services, including auditing, consulting services and tax-related activities. Deloitte has the greatest volume of operations, followed by PwC, EY and KPMG. The four companies dominate the auditing market for international corporations. All but two out of the hundred largest companies who are listed at the stock exchange in one of the largest global financial centers – London, use the services of “The Big Four”. Only 10 of the companies in the wider index of the London Stock Exchange FTSE 350 are not clients of “The Big Four”.

The auditing firms are large economical players. Their combined sells are 120 billion euro in 2017. 43 billion euro of that sum are auditing income, almost 28 billion euro are tax services and 49 billion euro and consulting services. None of these firms gives exact data about the scale of its operations. But using different information sources and research tools, the authors of the report have found out that these companies have been active in 186 jurisdictions, and their overall number of employees reaches 887 695. In comparison, the next two largest international firms in the sector – BDO and Grant Thornton, have respectively a turnover of 7,6 billion and 4,8 billion dollars for the last year, while the number of their employees is respectively 67 731 and 42 000.

Operations in tax havens

Auditing firms play a significant role in our economy through the trust placed in them to report on the truth and fairness of the financial statements of firms to regulators and investors. The fact that they play an important role in tax havens, or secrecy jurisdictions as we prefer to call them, just adds to curiosity about the activities of these firms”, add the authors of the research.

According to different estimations assets worth between 7 and 21 trillion dollars are being kept in tax havens and offshore zones. “This is only possible because the apparent depositories for this illicit wealth can secure the local tax and audit services of the Big Four firms in the secrecy jurisdictions where these funds are reported to be located, then it follows that the operations of the Big Four firms are at the heart of the tax-haven world. The scale of their operations in these places needs to be known and properly regulated”, the report points out.

In the researchers’ view the auditing firms don’t publish reports for their organizations as a whole, because they claim that there is no such global organization as theirs. The activity reports of the connected firms are published only in the jurisdictions where there are requirements for that. “What all of this means is that these firms enjoy levels of opacity denied to many of their multinational corporation clients… Such is their ability to create opacity that they have been very successful at preventing further information about their operations being made available for anyone to easily appraise”, claims the report.

In order to establish the real scale of firms’ operations, the researchers have used the available information at their sites and their reports at global and local level, as well as a number of alternative methods. In order to determine the number of their employees in the different jurisdictions for example, they had to use secondary sources such as the pages of these companies in the social network for professionals LinkedIn, documents for hiring of personnel, articles in local media and others.

The researchers have focused upon four basic criteria:

  • Which are the jurisdictions where the firms from “The Big Four” operate
  • How many offices they have in every jurisdiction
  • How many employees they have in every jurisdiction
  • What information about the ownership of the local operations has been disclosed

The research has shown that none of the firms shows completely correct data for its operations, with EY having the highest level of opacity. According the researchers’ calculations, the four companies operate in 186 jurisdictions, with 43 of them being tax havens – or 81% of all jurisdictions of secrecy in the world. The overall number of The Big Four’s employees, which the report has identified to work in offices in jurisdictions of secrecy is 9,9%.

The firm with greatest presence in tax havens is KPMG, which has offices in 40 such jurisdictions. Each of the companies declares operations in less jurisdictions than its real presence, and numbers offer vary even in the official sources of the companies.

For example, KMPG has pointed 152 locations in its official lists, but the research has established that the firm operates in 161 jurisdictions. The company is active in places such as Afghanistan, Greenland and Cuba, which has not been announced in the official databases. At the same time Gabon is present in these lists, but there is no indication that the company is present there. In some cases there are offices which are announced in annual reports for the given firm’s activity, but they are not present in the global list with offices (such as Antigua and Barbuda), while in other cases it is exactly the opposite – such as Syria.

The conclusions of the report show that “The Big Four” firms are overpresented in jurisdictions which are tax havens and offshore zones. The greatest number of offices, as expected, is in the countries of the G-7, led by the USA, and in the markets of the OECD and BRICS. The medium number of offices in proportion to the number of population however places in leading position jurisdictions such as the Caribbean island of Bonaire, the British Virgin Islands, Gibraltar, Monaco and the Cayman Islands. The Scandinavian countries are an exception in this ranking, because there exists a greater number of offices than the medium, as in these countries the firms make services for the whole local business and not only for the big corporations.

If the number of offices in proportion of the countries’ GDP is used for a ranking, the top 25 are again almost completely jurisdictions of secrecy, starting with Bonaire and ending with Cyprus. The same situation can be applied for the medium number of employees, which is almost twice greater in the offices in tax havens.

Firm Medium number of employees per office Medium number of employees in non-secrecy jurisdictions Medium number of employees in secrecy jurisdictions Medium number of offices in non-secrecy jurisdictions Medium number of offices in secrecy jurisdictions
Deloitte 276,2 260,5 323,2 5,37 2,14
PwC 375 322 557,2 5,33 2,24
EY 326,7 292,5 444,7 5,11 2,25
KPMG 284,3 265,6 339,1 5,44 2

This proportion remains in force also if only small countries with population of less than 3 million people are taken into consideration. For example, Deloitte has medium 199,8 employees in offices in such offshore zones, in comparison with 89,3 in other small countries, which doesn’t offer tax refuge. A surprising exception is Bolivia, where Deloitte apparently has over 2000 employees.

This overrepresentation can be explained neither with the size of the countries’ market, nor with the local business’ activity. For example, on the main Cayman island Deloitte, PwC and KPMG have altogether 579 employees (there is no available information about EY), which represents around 2% of the working local population. The secrecy which such jurisdictions provide seems to be the basic stimulus for “The Big Four” to have such a strong presence there.

Fictive decentralization – the KPMG case

The research’s authors point out that the topic about the structure of “The Big Four” is surprisingly insufficiently researched. The report presents an in-depth analysis only for the KPMG’s structure due to the lack of the necessary time and resources for the making of such comprehensive look at all the four firms.

All the four firms use approximately the same model for their corporate structure. Each has a central organizational unit, which seems to be responsible for the intellectual ownership, for the license of the firms in the entity and for imposing of common standards. In the case of three of these firms – Deloitte, PwC and EY, this unit is based in London – respectively Deloitte ToucheTohmatsu Limited, PricewaterhouseCoopers International Limited and Ernst & Young Global Limited.

This kind of British companies with limited responsibility in practice are mutual structures, which are often used by charity organization, non-commercial clubs, societies and so on. They usually don’t have shareholders and capital, but members who act as guarants; the change of the members is simplified and doesn’t lead to tax complications. Such organisations can also claim that they don’t make commercial activity, but act on behalf of their members, who are not an object of taxation. The requirements for reports on such companies in the United Kingdom are also minimal. This structure is very convenient for the auditing companies, which use the logistical and the legal base in Great Britain, and the favourable tax conditions, without disclosing significant amounts of information.

KPMG doesn’t use such kind of firm. In its case the coordination legal entity is the Swiss-based KPMG International Cooperative. Each firm in the KPMG network mentions this Swiss company at its site. It is present also in the transparency reports, which some of the firm publish. The researches give as an example such a report of KPMG in Luxembourg, which they claim to be typical for all those similar documents.

The aforementioned KPMG report says that KPMG International “carries on business activities for the overall benefit of the KPMG network of member firms but does not provide professional services to clients…The structure is designed to support consistency of service quality and adherence to agreed values wherever in the world the member firms operate…For example, KPMG International establishes and facilitates the implementation and maintenance of uniform policies and standards of work and conduct by member firms and protects and enhances the use of the KPMG name and brand”.

The message is clear – there is unity in this structure, but also there is a important level of division. This division might not be as significant as the legal framework states it, say the authors of the report. This is especially noticeable in the presence of positions such as “Global Head of Audit” and “Global Head of Advisory”, which hint at a level of coordination, which does not correspond to what is characteristic for diversely controlled firms.

There is also other evidence for difference between the substance and the form of the firm. For example, the real operative structure of KPMG seems to be more complex than the officially stated, because the functional international control of the group is in Netherlands and not in Switzerland. According to the regulatory reports of the British branch of the firm, the address of KPMG International is in Netherlands. This contact address however hasn’t been listed in the annual global review of activity for 2016.

The already mentioned KPMG Luxembourg report says the firms from the network have agreements with KPMG International that oblige them to apply the quality standards. There are sanctions listed, which KPMG International can enforce upon firms from the network. The authors of the research say that this is an obvious paradox: KPMG presents itself as a structure of separated firms, but each one of them has to operate according to strictly applied common standards. The firms also have common financial interests – for example, they have a common insurance operation for professional responsibility.

The separate firms also seem not to be equal. KPMG International has a few basic governing bodies – Global Council, Global Board and Global Management Team. The Global Council includes 58 firms that are members of the organization in accordance with the Swiss law. They represent other firms, whom they have issues sublicenses. This shows that KPMG’s operations at many places could be under the form of a sublicense from other jurisdictions, but the researchers haven’t managed to achieve more clarity about the structure. This two-level model probably plays an important role in KPMG’s operations in tax havens, which are not represented directly in the governing structure.

The authors of the report have found out that the sites of 106 local firms from the network list an entity, which is presented as a member of KPMG International. In some cases the local operations are governed by a firm in another jurisdiction – for example KPMG in Azerbaijan is governed by the British offshore zone Guernsey. The offices of the firms on the Balkans (including in Bulgaria) are conducted by local firms, who are however branches of the Cyprus-based KPMG CEE Limited. However, in 55 cases at the sites of the firms is listed no firm that represents KPMG in the respective jurisdiction of the office, even if there are links towards sites of KPMG International. The greatest number of offices, whose ownership is not clear, is in Brazil.

“The fact that KPMG does not disclose who all of its member firms are means that large parts of the KPMG network appear to be publicly unaccountable, which is unacceptable for an organisation of its global significance”, continues the report. The authors of the research add that the support of such structures is expensive and complicated, but gives the auditing giants considerable advantages – lower the regulatory and legal expenditures and risks, prevents their clients from investigations and guarantees covering for the real scale of their operations and profits.

Market’s failure

“Auditors are in the most extraordinary and unique position of being both regulators and simultaneously providers of commercial advice on the abuse of legal systems in the current system of global capitalism. Like all systems global capitalism cannot survive without regulation. The absence of regulation in capitalism does not create ‘free markets’. Market failures create opportunities for abuse that denies free access to markets, permits excess profit, misallocates capital, encourages monopolies, permits undetected fraud and denies consumers choice. None of these outcomes are socially or economically beneficial”, the report states.

“The Big Four are key to the operation of global capitalism but fail that responsibility. The recommendations this report makes would change this so that they account for their actions in every location in which they operate”, say the authors of the report in their conclusion.

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