The benefits of incorporation

When I was elected as UK senior partner in 1994 I was conscious of the ever increasing pressures on accountancy firms. Pressures of litigation, recruitment, greater disclosure of information and pressures for more open styles of management, all compounded by the severest competition that any of us had ever known. It was never an option just to hope these pressures would go away, or hoping that they would lessen. That would have been the reaction of the dinosaur. I wanted KPMG not only to react, but to lead.

I set in train an internal exercise to look at all the options that we had in order to respond to the pressures described and create a KPMG fit for the next century. After considerable debate and discussion, the concept of KPMG Audit plc became a reality. A way within UK law of incorporating our listed and regulated business. A significant step as KPMG audits over 25 per cent of the FT 500. A step that was only taken after consultation with clients, regulators, government and other interested parties, as well as all of our partners across the UK. A step that also ensures that the quality of audit opinion is not impoverished. It was probably the most extensive consultative exercise that any professional services firm has ever undertaken.

Support was overwhelming. We could incorporate within the UK and we did.

We did consider every other possible option including going offshore, but clients and our own partners did have reservations about KPMG moving offshore. KPMG saw no reason to become an offshore auditor. Our incorporation route involved a financial cost, but it was one that we were happy to pay on the basis of a wide consensus that it was the best balanced solution for KPMG.

KPMG argued strongly and it was widely accepted that there were important reasons why our clients would not be materially affected by incorporating the listed and regulated business audit. Insurance should cover all but the truly exceptional claim, recourse to partners’ assets is likely to make a practical difference only once, and businesses do not operate on the premise that they are likely to make mega-claims after a mega-fraud.

Nor does incorporation help hide a negligent partner. So in my view, and in the view of KPMG, incorporation can make no difference to the overwhelming majority of clients and investors.

It is not just the UK which offers auditors the structures to limit liability, it is an increasing international trend. In the United States virtually no auditor of a large corporation carries unlimited liability. In 1994 each of the bigger firms became a limited liability partnership. Across Europe in France, Germany, Italy, Switzerland and the Netherlands audit work is undertaken by limited liability entities.

This trend is in the public interest. The public interest as many have realised would be harmed if audits continue to carry collective unlimited liability. The Likierman Report in 1988 and the Financial Reporting Council in 1992 both in different ways made the same point.

In 1993 Sir Ron Dearing, the chairman of the FRC said in their annual review ‘the danger that to protect themselves auditors will be obliged either to accept as audit clients only those whose audits can be undertaken with minimal risk or to increase substantially the scope of their audit with the corresponding increase of cost to the industry’.

In my view it cannot be in the public interest for recruitment to suffer if audit continued to carry unlimited collective liability. That was happening.

Quality people were not choosing accountancy because they saw when they became a partner, they could lose their savings and even their pension because of events of which they knew nothing. Unlimited collective liability raised the spectre of less quality audits because of less quality people, with all the risks that runs for the corporate health of Britain. Indeed because of the breadth of work carried out by firms like KPMG advising at board level, it was clearly an issue of extreme concern to us and our clients.

I have outlined several reasons why I think clients and the wider public interest is served by our incorporation. In our case there is an additional reason why this is true of incorporation. A business may reasonably expect to have a well informed understanding of the position of any major supplier; incorporation has given directors and shareholders a much clearer view of the financial position of KPMG.

At the end of January this year KPMG published a full annual report with profits, partners’ remuneration and capital for all our business, not just that part that we incorporated. We put more financial information into the public domain than any firm of our type had previously done.

This is part of being open, as our advertising says. The result? The sky did not fall in, rather clients, politicians, the market, our staff, potential new recruits all welcomed what we had done. Over 25,000 copies of the report are in circulation and next year we will do the same again. As our business is accounting, how can we, KPMG, not be fully accountable in 1996?

Colin Sharman is UK senior partner of KPMG.