Trying to Tamp Down Major Auditors' Market Dominance

In letter to Labor Party leader, the three major regulators of Israel's capital markets address IMF criticism of relationship between major auditors and financial industry clients.

Israel's market regulators are considering how to overcome the paucity of auditors for finance-sector companies, they wrote in a letter to the leader of the opposition yesterday.

One possibility is regular rotation of auditors. Another is to clap a limit on how much of a specific industry one auditing firm may cover. A third is to establish a supervisory body for auditors of publicly-held companies.

These alternatives are discussed in the letter jointly written and signed by the chairman of the Israel Securities Authority, Shmuel Hauser, supervisor of banks David Zaken and the commissioner of capital markets, insurance and savings at the Finance Ministry, Oded Sarig.

The letter, to Labor Party Chairwoman Shelly Yacimovich, was drafted in response to her request for input after the International Monetary Fund published its survey of the Israeli financial system in April.

The IMF's report was scathing when it comes to the fact the fewer than a handful of auditors control the services provided to Israel's major financial institutions.

The issue of concentration among auditors is especially prevalent among banks: exactly one company, KPMG Somekh Chaikin, audits the financial reports of four of the country's five biggest banks.

"We understand the concern raised in your letter regarding the potential negative consequences of business concentration among bank auditors and auditors of other financial sector companies," the three chief regulators wrote to Yacimovich. "The primary concern is that long-term relationships between an auditor and a company being inspected are likely … will impinge auditor's ability to examine the company's books with a critical eye."

This is the first time that the three major regulators in Israel's financial markets have formally defined the problem in a jointly signed document.

One long-term industry relationship, for example, lies in the ties between auditor KPMG Somekh Chaikin under the leadership of Gad Somekh and Bank Leumi. Not only has Somekh Chaikin been the bank's financial reports' auditor for the past 49 years, but Bank Leumi CEO Rakefet Russak-Aminoach served as the CEO of Somekh Chaikin before her appointment to Bank Leumi's top post.

Moreover, according to news reports, it was Gad Somekh who put together a deal that allowed Shlomo Eliahu, the largest shareholder in Bank Leumi, to purchase a controlling stake in Migdal Insurance and Financial Holdings, one of Israel's largest insurance companies. Somekh Chaikin also audits Migdal's financial reports.

Eliyahu also purchased a controlling stake in the Union Bank of Israel, which also has its books audited by KPMG Somekh Chaikin. Gad Somekh has never denied any of these news reports.

All told, KPMG Somekh Chaikin audits the books of banks that provide 84 percent of the bank credit in the Israeli economy, although it scours the books of Bank Leumi, Hapoalim and Discount in cooperation with other auditing companies. When taking into account Somekh Chaikin's partnerships with other accounting companies for bank auditing jobs, the company still controls 47 percent of the market in auditing services for banks.

A similar degree of economic concentration exists in auditing services for the insurance industry. Ernst & Young Israel – Kost, Forer, Gabbay & Kasierer audits the financial statements of the following major Israel insurance companies: Clal Insurance Enterprises Holdings (together with Somekh Chaikin), Phoenix Holdings, Phoenix Holdings, Israel Land Development Insurance Company (also referred to as Hachshara Insurance) and Ayalon Holding. Somekh Chaikin audits the reports of Migdal (together with Kost Forer), Harel Insurance & Finance Group and Clal Insurance.

The regulators write that they are examining several alternative ways to address this issue. Among the tactics: Arranging a rotation of auditors and auditing clients in the financial industry (including both banks and other major financial institutions) to preclude the development of long-term business relationships, limiting the market share of auditing companies in certain industries, "and the establishment of a supervisory body for public company auditors in Israel (similar to the American Public Company Accounting Oversight Board)."

However, Somekh Chaikin and Kost Forer Gabbay & Kasierer's dominance doesn't just exist in the provision of services to financial sector companies. According to its own marketing materials, Somekh Chaikin audits 48 percent of the companies traded on the Tel Aviv-25 Index and 38 percent of companies listed in the TA-100.

Beyond the ongoing close relationship between auditors and client companies, the authors wrote, "There are other, additional concerns that are somewhat less substantial in nature. In particular, these are the potential for unsound practices to take root in the auditing industry due to incorrect professional advice provided by a single auditor and that the collapse of a single auditing office could shut down the entire industry."