Thank you very much for the opportunity to address the Board on this topic of firm culture and governance. We see the International Ethics Standards Board for Accountants (IESBA) as playing a critical and much-needed role around the standard of firm governance and culture: this is increasingly an international issue as the largest firms become international firms, and IESBA is one of the few organisations with an international remit.
In Australia, we have seen the impact, and we're living through the consequences, that can occur when culture and governance breaks down within a significant firm. We have had a busy year on that front in 2023 with multiple parliamentary inquiries, investigations and law reform, and significant public interest, and this has continued into 2024.
We are a revenue collector: we do not have a direct role in regulating the accounting profession. In Australia, the professional bodies play the traditional supervisory and educational role in relation to tax professionals, whether legal or accounting. We also have an organisation called the Taxation Practitioners Board which specifically regulates some, but not all, tax advisors. Notwithstanding the lack of a direct, formal role of the Australian Taxation Office (ATO) in regulating the profession, how firms operate, and large firms in particular, is very important to the tax performance of large corporates in Australia, and so the ATO has played a significant role in trying to positively influence ethical and professional standards in the big firms.
We see the big firms primarily through the lens of the behaviour of their tax divisions, including how they operate internationally. We also see interactions of the firms with government: both in consultation on new law and service offerings, and as a provider of services to government agencies. Ethics of the big professional firms have been at the forefront of public debate in Australia over the last year, so we have had to spend a lot of time thinking about that.
Our goal today is to raise areas for consideration by IESBA (but not answers!) where we have seen tensions and challenges that arise for firms in being the ethical firms they seek to be, including:
• conflicts between tax and audit functions
• conflicts that arise when a firm advises government on policy matters
• cultural perspectives and challenges in international firms
• tensions of consulting businesses
• challenges with incentive structures
• challenges in firms weighting increasingly away from the “traditional” businesses
• ensuring effective consequences and accountability.
As a starting point, it is important to point out that I think all the big firms are striving to be ethical firms and have many excellent people in them striving to be ethical. It is however beneficial to draw out some of the areas where we have seen pressure on those firms achieving those aspirations.
I have some areas to touch on, but I first wanted to mention this concept that we have of a systemically important firm. Once a firm gets to a particular size, it fundamentally changes how it should think about itself and indeed how society will think about it. Our concept of ‘systemically important’ is a firm that has industry or economy wide effects in a local jurisdiction. Naturally, we say that once you get to that size, public interest is much more important because you can change how things work in your society. Being systemically important brings a greater demand for transparency and public accountability and when I look at the big firms in Australia, we see them as systemically important across four distinct markets: financial statements audits, large market tax advice, private sector consulting and government consulting. This of course may not be the case in all jurisdictions.
You often hear the phrase an organisation is ‘too big to fail’, but can a firm get to a size where it's too big to manage its conflicts effectively? I’d like to touch on a few of the areas where we have seen tensions arise.
Looking at the tax function as it operates in its own right, we have introduced in Australia the Large Market Tax Advisor Principles which are a credible standard for governance frameworks over the tax functions of a large firm. The Australian arms of all four of the big firms have signed up to these principles and we are now looking at how they might be adapted for large law or mid-tier accounting firms. There is no reason why these principles could not be adopted in other jurisdictions, perhaps with minor modifications.
We have previously spoken with IESBA around conflict between tax and audit services: audit independence is generally critical, but our perspective is that it’s particularly critical in relation to tax services. In many cases, the in-house finance function will not have been involved or conflicted in terms of the events which give rise to an accounting issue: however, this is unlikely to be the case in relation to tax matters. If the finance function has been involved in a tax position, it really needs a truly and robustly independent view, and this means that companies (and the audit firms) should be very careful in what tax services are provided by the auditor.
Moving to services beyond tax, I think one of the things we've seen in Australia is that there are different conflicts that can arise when a firm advises government. Some consulting engagements, for example advising how an agency can be more efficient, or how to implement an IT system, will give rise to “normal” conflict considerations. However, it's qualitatively different when you are advising a government how to change the rules (and that's whether you're paid or unpaid). If you are participating in one of these processes, public interest should be your absolute driving force but it's potentially unreconcilable with duties to normal clients in the affected industries. I think we saw that play out in Australia over the past year. The other issue which has arisen in Australia in a different context is that when you’re providing services to government, simply delivering an engagement to the satisfaction of the procuring officer or the head of the agency may not be sufficient. this is because the “true” client may not be the procuring officer and it may not even be the head of the procuring agency, but may instead be the broader government (or the broader citizenry) and so this can itself bring conflicts which need to be considered and carefully managed.
I would also note that at the very heart of consulting is a tension between relevant experience and expertise (which a prospective client is hiring the consultant for) and client specific information (which the previous client does not want shared with others). Managing this tension is at the heart of running a successful and ethical consulting business. There is also an onus on clients to understand the potential conflicts of their consultant, and to critically judge the consultant’s output in full understanding of the potential strengths and weaknesses of that advice.
The second aspect I wish to draw out is that there are different cultural perspectives and challenges in an international firm. It’s so important that IESBA contributes to this space, as this is a real challenge for the firms. The first question that arises is: are you truly an international firm or are you just a network of firms? And secondly: are you saying one thing to your clients (we are a single multinational firm) and another thing to regulators when things go wrong (we are just a local partnership)?
Now what this leads to I think is lowest common denominator issues and/or perhaps conflict of norms issues. This is very important in understanding what happens in a multinational firm in an international engagement where there are different norms or standards in different jurisdictions or even just different attitudes, and we see that quite often in tax: the different countries and societies have different norms in relation to tax compliance. There's really an interesting question which arises: which public interest and whose standards should prevail? I would put that if you're truly an international firm it should be the highest standards but if you operate as a network of firms, you may have a challenge that you slip to the lower standards, or there are irreconcilable differences in standards. A particular practical challenge for a local managing partner is what happens if the local arm of a firm is not satisfied with the ethical position of another member firm but is forced to deal with them.
To make this more tangible, in one jurisdiction, the accepted norm may be that tax is an important social contribution, that large companies should only take positions on a “should” or “strong should” basis, and that contentious positions should be taken to the tax authority. In this jurisdiction, a firm may view it as unethical to take an aggressive or barely plausible position to their client. In another jurisdiction, tax is instead seen more as an exaction of private wealth, and the norm is that large companies are obliged to take plausible positions for the benefit of their shareholders (and hence firms should take even aggressive schemes to their client if they are to do their ethical duty to their client). You can readily see that there might be an irreconcilable difference between the positions taken by different member firms even in the one firm.
Next, there are absolute challenges withincentives driving inappropriate behaviour, and our perspective would be that incentives really matter: both financial and internal recognition. It is hard in practice to have a ‘balanced scorecard’ type incentive system. The real (as distinct from “paper”) incentive structures often seem to us to be very revenue based, not even profit based – let alone risk-adjusted profit based – in terms of hire and fire decisions (even if on paper they are meant to balance the “how” with the “what”). Perhaps more importantly, and I'll touch on this later, revenue “success” seems to be very important for promotion into management roles which brings its own governance problems down the track.
The next point is around firm weighting between “traditional” and “non-traditional” businesses. In Australia the big four firms have a relatively (very) high weighting to non-traditional businesses. They have historically had very big consulting arms compared to their audit and tax arms. One question that comes to my mind is: are their audit practices at their heart or only at their start? In other words, does a critical mass of lateral hire partners, particularly in the non-traditional businesses (who are seen as very successful because they're bringing lots of money), change the mindset of the partner and indeed the firm? Does the self-concept of ‘partner’ and ‘partnership’ move from being a steward for the next generation to being a highly paid executive? This has flow on implications for how a firm thinks about ethics. And I think there is a risk that even in a firm which takes ethics very seriously, you run the risk of an audit or traditional business which is highly focused on compliance and ethics but then is isolated and almost ringfenced within the broader firm, and a consulting business which may have a shorter-term focus.
Firm governance is also something being examined very closely in the Australian context. If you start off with the position that partnership, with joint and several liability, is ostensibly a very high form of mutual self-regulation, the partners have a great interest in ensuring that the other partners behave well. The questions that have been considered in Australia are: does this break down when a firm gets to a certain size (especially if liability limitation schemes are in place), and does the discipline of joint and several liability fall away?
In practice we see this in a movement to more corporate style models of governance, we see CEOs, governance boards and the like but indeed, how does this “stick” when a board or a CEO ultimately relies on the votes of the partners that they are meant to manage? And are there problems with the CEO being able to deal with problems from high earning, well connected partners within the partnership? Can a powerful partner bloc effectively be immune from this form of governance? Going back to what I said earlier, I think there are also specific and critical governance risks where promotion to management is based on a revenue base. What you end up with – and I think we've seen this both in Australia and in other jurisdictions too – is when problems emerge, it may well be the people who were originally responsible for those problems who are now in the very management positions that are meant to resolve those problems.
Part of an ethical framework is to ensure that there are effective consequencesand internal and perhaps external signalling of those consequences. What we have seen is that the firms attempt to manage these matters in house, which brings challenges with transparency – certainly very limited transparency externally but often no transparency even internally – as the partner is allowed to leave with dignity, perhaps even celebrated on their exit. Now obviously there is a challenge there to balance fairness to the individual, but I think it's fair to say often there is little signalling to others that there are consequences for breaches of ethics.
And finally, there is a tendency for big firms to become rules-based only focusing on the rules and law breaches and lose sight of the ethical overlay, which allows firms (and partners within those firms) to effectively shape themselves around the lower standard. This is obviously a challenge for the firms, but also a challenge for a standard setter such as IESBA: how do you ensure that the firms do not just become rules based but remain principle based as well?
Was the recent experience in Australia a case of ‘a few bad apples’?
In short, no. I spent the first half of my career in a big firm, and I've spent the last ten years in government and my reflection would be the private sector has a tendency to blame problems on an individual or a small group of individuals, and the public sector has a tendency to blame things on systems and processes. As in all things, the truth is somewhere in the middle. My perspective is that when things go badly wrong, it probably requires a few individuals or groups of individuals to do the wrong thing but fundamentally they are operating within an incentive structure, which shapes accepted behaviours.
My perspective of the recent events in Australia is that there were very strong incentive structures (the “rover” model and the partnership income outcomes supporting that) and very weak disincentive structures for the sort of behaviour that we saw. To me, it was not a few bad apples – it was a bad incentive structure which overemphasised revenue and winning new clients, it required people to respond to those incentive structures which they did. This was essentially a senior management decision. Some people responded to that incentive structure and made some bad choices, but I also think it was a failure of the management structure to foresee problems, let alone respond when the problem started becoming apparent.
Part of that failure of the management structure to deal seriously with it was that problem that I spoke about before, which is there's a real problem when people get promoted off the back of being successful or ostensibly successful when their position is attributable to the thing that they now have to manage. So I would say, this is not just a problem of a couple of rogue partners, this is fundamentally a problem of bad incentive structures – or unbalanced or unconstrained incentive structures – which actively rewarded a sort of certain behaviour without proper safeguards. The “line” partners made bad choices, but were responding to the incentive structures in place – that is, they did what they were meant to do – and then management failed to respond when the problem started emerging.
Conclusion
I hope these reflections have provided a useful insight into the ATO’s experience in working with the big four firms in Australia. There is absolutely a role for global standards around ethics, governance, and transparency of the accounting profession, particularly for the largest firms who set the tone for the smaller players, and we hope that by raising some of the tension points that have arisen in Australia, we are helping contribute to a framework which addresses practical, real-world challenges.
We look forward to continuing to work with IESBA and the Accounting Professional & Ethical Standards Board here in Australia and appreciate the opportunity to raise these perspectives for your consideration.
