UK: Peers Call On OFT To Investigate Domination Of Big Four In Audit Market

Last Updated: 14 April 2011
Article by SJ Berwin's EU & Competition Team

The House of Lords Select Committee on Economic Affairs has called on the Office of Fair Trading ('OFT') to investigate the UK audit market.  Their specific concern relates to the domination of the audit market for large companies by the four biggest players, namely Deloitte, Ernst & Young, KPMG and PwC (the 'Big Four').

The report states that the 'clear oligopoly' of the Big Four creates issues regarding competition and choice in the audit market.  Of the FTSE 100 companies only one is not audited by the Big Four and, on average, an auditor remains in place at one of these companies for 48 years.   Furthermore, of the FTSE 250 companies, 240 are audited by one of the Big Four.

The report was particularly critical of the situation regarding bank auditing, as Ernst & Young does not participate in this area of the market.  The Select Committee raised concern about the prospect for competition if one of the Big Four were to withdraw or collapse, as happened in 2002 with Arthur Anderson, auditor of Enron.  The report states that the 'disconcertingly complacent' attitude of bank auditors had been a 'significant contributory factor' in the banking crises, specifically highlighting PwC's role as auditor of Northern Rock. 

The OFT gave evidence to the Select Committee and identified aspects of the audit market which it considered tended to restrict competition.  These factors included the lack of incentive to switch auditors as there was little apparent difference in offerings and difficulty in discerning audit quality.  This is reinforced by the costs on switching auditor, requiring management time, a tender process and familiarisation of the auditor with the business.  In addition, the Big Four have the technical and international capabilities necessary to service the largest companies, which may restrict access for second tier firms.

Potential methods for increasing competition include the outlawing of restrictive bank loan clauses which require the borrower to be audited by a Big Four firm and introducing a requirement to re-tender audit contracts every five years.

The OFT has said it is currently considering whether to conduct a market study into the audit market, although it may limit this to looking specifically at the effect of bank covenants.  Such a market study could result in a referral to the Competition Commission and, subsequently, recommendations to government for changes in laws and regulations and/or potentially far reaching remedies.

CAT cuts penalty fines in construction recruitment cartel

The fines imposed by the OFT in cartel cases have again come under scrutiny by the Competition Appeal Tribunal ('CAT'), this time in relation to the OFT's construction recruitment cartel.  In 2009 the OFT imposed penalty fines on Eden Brown, CDI and Hays, along with three other recruitment agencies, for price fixing and engaging in a collective boycott of a new entrant.  As in the recent construction bid rigging CAT judgments, the OFT's methodology for setting fines has been criticised for being too mechanistic.

In particular, the CAT found that the calculation of relevant turnover was inappropriate in the context of the market. It found that the OFT erred in using the gross turnover of the companies, rather than after deduction of the wages paid to temporary workers.  Since a substantial proportion of the business of each of the agencies comprised the placing of temporary workers, the use of gross fees increased the computation of relevant turnover by over four times.  The CAT highlighted that relevant turnover is used to reflect the effective scale of activity of each undertaking and that the OFT cannot simply take the turnover figure from a company's accounts if there is a more appropriate figure which can be used. 

In addition, as in the earlier construction bid-rigging cases, the OFT erred in using the relevant turnover from the year before the decision, rather than the year prior to the infringement (which was held to be more appropriate as it better reflects the impact of the infringement).

Similarly, as in previous cases, the CAT also found that the application by the OFT of the Minimum Deterrence Threshold was inappropriately mechanistic.

However, the CAT held that the OFT was entitled to use 9% of relevant turnover (i.e. just 1% below the maximum starting % set out in the OFT's penalty guidance) to reflect the seriousness of the infringement in this case, given that price fixing and collective boycott are among the most serious kind of infringements.  Further, the CAT agreed that it was reasonable for the OFT to apply a modest 5% reduction in fine to take account of the fact certain of the parties had introduced a compliance programme.

As a result, the CAT has substantially reduced the fines imposed on the three companies, from around £39 million to £7.9 million - Eden Brown from £1.07m to £477,750, CDI from £7.6m to £1.5m and Hays from £30.3m to £5.8m.

Supreme Court declines to hear appeal in Safeway v Twigger case 

The UK's Supreme Court has declined to hear a further appeal by Safeway against a Court of Appeal ruling that the supermarket could not recoup antitrust fines from certain former members of staff who, it claimed, were behind the anti-competitive pricing practices.

Last December, the Court of Appeal ruled that an OFT fine could not be recouped from the former Safeway directors and executives, because the sanction had been imposed on the company alone (see Community Week issue 503).  The Court of Appeal further held there was a public policy interest in not allowing companies to shift their liability onto individuals and insurers.

Even though the Court of Appeal refused Safeway (which was acquired by Morrisons in 2004) permission to appeal its judgment, Safeway applied directly to the Supreme Court arguing that an important principle of law was at stake.

The Supreme Court, the UK's highest court, is understood to have now rejected that application.

The dispute goes back to an OFT antitrust investigation into alleged collusion between supermarkets and dairy processors in relation to the retail prices of certain dairy products.  In 2007 Safeway agreed to enter into an 'early resolution' agreement with the OFT which involved admitting its involvement in the infringement in return for a reduction in fine.  Safeway then took steps before the courts to recover the fine and certain costs from its staff, arguing that they were behind the price-fixing practices and should therefore be liable.

The Supreme Court's decision means that there can be no further judicial scrutiny in the UK.  As such, it is clear that the financial consequences of infringing the Chapter I infringement fall solely on the undertaking found to be in breach. It also means that policy initiatives by the OFT to encourage employees to blow the whistle will not be distorted by potential private actions by their employer.

To view Community Week Issue 516, 8 April 2011 in full click here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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