A draft European Union law unveiled on Wednesday has the world's biggest audit firms bracing for a major shakeup in their biggest market.
The proposals would go much further than corporate auditor restrictions in the United States, their second-largest market, where they have had some success fighting reform plans.
In one of the biggest crackdowns yet on the audit profession, the European Union's Internal Market Commissioner Michel Barnier proposed forcing the largest audit firms to separate their consulting businesses and either share audit work with smaller rivals through joint audits, or rotate clients every six years.
The proposal must be approved by the European Parliament, but lawmakers have shown a strong appetite for tough regulations and had already called on Barnier to make such proposals.
The draft law and the mandated legal separation of audit and non-audit services could strike at the heart of the business model of the Big Four, which have branded themselves as full-service, global professional services firms.
"These sets of proposals would be a game changer," said Robert Hodgkinson, executive director of the Institute of Chartered Accountants in England and Wales, an accounting body based in Britain. "They have hugely complex effects. What is eventually enacted we don't know."
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Potentially the most far-reaching change is a requirement that the largest audit firms split off their consulting arms into separate and renamed legal entities.
That move could undermine branding efforts of the Big Four audit firms -- Ernst & Young, Deloitte, KPMG, and PwC -- and hurt their ability to seamlessly serve big multinational companies.
The moves are the harshest response yet from authorities to conflicts of interest and the role of audit firms during the global financial crisis, when auditors failed to warn of problems at major banks that collapsed or required massive government bailouts.
EUROPE A $39 BLN MARKET
"Firms in Big Four networks work very closely on multinational clients, and if you have such major structural reforms as these it must surely have an effect on how they operate globally," said Arvind Hickman, editor of the International Accounting Bulletin.
Europe accounted for about $39 billion of the Big Four's $95 billion in total revenues in fiscal year 2010, while $31 billion was earned in the United States and $25 billion in the rest of the world, according to data from the International Accounting Bulletin.
The Big Four auditors said the proposals would increase audit costs.
PwC's UK Chairman Ian Powell said Barnier has not provided "any concrete evidence for any positive impact of these proposals on audit quality."
KPMG's European head Rolf Nonnenmacher said the ability of firms to provide quality audits "will be diminished if auditors are separated from wide-ranging advisory expertise."
Deloitte said the plans would make Europe's audit regime inconsistent with those in other markets while Ernst & Young said they would do little to prevent financial crises.
The changes are meant to increase auditor independence and address criticisms that auditors have turned a blind eye to questionable accounting for the sake of holding on to lucrative consulting fees.
Consulting has been the fastest-growing business for big audit firms and makes up about 25 to 35 percent of their global revenues, according to the International Accounting Bulletin.
Audit makes up about 45 to 50 percent of Big Four revenues, though growth is slower in that area.
Details of the EU's draft law remain sketchy, and parts of it are sure to change before it becomes law. Britain is expected to try to soften the draft, but it has often been outvoted on other rules. The final law would be binding on all EU states.
CLIENT-PAY MODEL STILL AN ISSUE
The EU's proposals go further than 2002's U.S. Sarbanes-Oxley auditor reform act, which limited the types of consulting services that audit firms could provide to their audit clients, but left them free to sell consulting services to non-audit clients.
Because Congress has already addressed consulting conflicts, it is unlikely to revisit the issue, said Lynn Turner, former chief accountant for the Securities and Exchange Commission.
"I don't think Congress will give what Barnier's proposing a second thought," Turner said.
The main U.S. auditor watchdog, the Public Company Accounting Oversight Board, is considering mandatory auditor rotation, though the proposal's fate is uncertain.
After a major lobbying effort, the Big Four were successful in beating back some of the harshest measures considered by the U.S. Congress in response to the Enron and WorldCom accounting scandals a decade ago.
For example, Congress had considered auditor rotation but that was not part of the final Sarbanes-Oxley Act.
(Reporting by Dena Aubin in New York; additional reporting by Huw Jones in London and Nanette Byrnes in New York. Editing by Howard Goller and Kevin Drawbaugh)