Accounting firm Price Waterhouse Cooper was recently forced to sell its government consulting business after using privileged information to help firms evade taxes. Richard Holden examines the scandal and explains why the response from the Australian Tax Office points to regulatory capture by the big 4 accounting firms.

Editor’s note: To increase public awareness of capture in its various forms, ProMarket is launching an ongoing series in collaboration with the Stigler Center for the Study of the Economy and the State to highlight topical examples, explain what capture is and how it impacts us all.

We Australians like to think of ourselves as a fairly easy-going, rule-adherent bunch. The biggest scandal in a typical year might involve some low-level misbehavior by a member of parliament, or a bad strategic decision by the captain of our national rugby or cricket team.

Not this year.

Beginning in January with reporting by the Australian Financial Review (AFR) it became clear that PwC had engaged, over many years, in an outrageous breach of public trust. It has led to outrage from politicians and the public, and forced the sale of its government consulting business to private equity firm Allegro for A$1 (about 67 US cents). This was a business that until a few months ago comprised 130 partners, more than 1600 employees, and generated around 20% of PwC Australia’s A$3 billion annual revenue, from government contracts.

The story starts in 2013 when the Australian Treasury engaged PwC to help devise new rules to crack down on multinational tax avoidance—mainly by technology companies. This often involves transfer pricing where licensing fees are paid by an Australian entity to a low- or no-tax jurisdiction, thereby avoiding Australia’s 30 percent corporate tax rate.

PwC and its star tax partner Peter Collins advised Treasury from 2013-2018 on how to deter multinational tax avoidance, as part of a general OECD push in this direction. Collins signed no fewer than 3 confidentiality agreements during that period.

Undeterred by these agreements—and it should be said, any moral compass whatsoever—Collins shared the confidential information with his international PwC partners. They in turned used the information as the backbone of a marketing drive to drum up business showing international companies how to evade Australia’s new tax rules. And it worked. PwC signed up 16 large US technology companies as a result.

How the scandal broke

How, one might ask, did it take between 5 and 10 years for this behavior to be uncovered?

It turns out that the Australian Tax Office (the “ATO”—Australia’s equivalent of the IRS) initially got suspicious in late 2016. In September of that year the ATO issued notices to all of the big 4 accounting firms requesting all correspondence with their clients regarding the Multinational Anti-Avoidance Law (“MAAL”).

PwC refused to comply with this request, claiming that such correspondence was covered by legal professional privilege. So the ATO decided to ask for all PwC’s internal emails, which they begin handing over in the second half of 2017.

Although the ATO has refused to comment, they must have suspected at this point something was very much amiss as they asked Treasury for a copy of their standard confidentiality agreement. A year later—one wonders what accounts for this delay—the ATO asked Treasury for Collins’s specific confidentiality agreements.

Now you might think at this point that Treasury would realize that something is up with Collins. But apparently not, because they engaged Collins and PwC for a new round of work for which Collins signs a third confidentiality agreement in February 2018.

And you also might think that the ATO would tell Treasury what they knew about PwC and Collins. When quizzed on this at a recent Senate committee hearing the head of the ATO, Chris Jordan, claimed that the ATO was bound by secrecy laws. Specifically, he stated that “As the confidentiality breach was not a tax offence, we were unable to investigate the matter further.”

Jordan went on to say that the ATO referred the matter to the Australian Federal Police (the “AFP” who are analogous to the FBI) “over the 2018-2019 period,” but the AFP claim they never got sufficient information to progress an investigation. Finally—and frankly quite bizarrely—in July 2020 the ATO refer the Collins confidentiality breach to an obscure regulatory body, the Tax Practitioners Board (TPB). But the ATO didn’t tell the TPB about the broader PwC issue.

The anemically-resourced TPB launched an investigation into Collins in January 2021 and then into PwC as a whole in March 2021. The ATO didn’t like this and in June 2021 they refused to cooperate with the TPB any further, citing secrecy provisions.

The TPB were persistent, though, and actually did make progress by using powers under the little-known Tax Agents Services Act to send notices to 16 U.S. technology companies that PwC had signed up. The TPB—in a move one expects in a bad Hollywood movie but not from an accounting regulator—accessed ATO records without the ATO’s knowledge and found out details of confidential settlements between the tech companies and the ATO.

In January 2023 the TPB announced the findings of their investigation, but it was only through AFR reporting that the details became widely known. In fact, the head of the Department of Finance, which controls all government procurement, said she first heard about the PwC scandal from reading the newspaper. Worse still, when PwC was asked by Finance about the matter they were told a version of “there’s nothing to see here.”

Regulatory Capture?

This reeks of regulatory capture.

The ATO repeatedly claimed that a major concern was the importance of confidentiality in any tax settlement they reached. There is a legitimate point here—the ATO may be able to extract more favorable terms in a settlement if the counterparty is not also exposed to any reputational damage that might come from public disclosure of the settlement.

But in this case it was possible to go after Collins and PwC without exposing any details of deals cut with the 16 U.S. tech firms.

And the ATO claim that they didn’t have the power to investigate is curious at best. Australia’s Tax Promoter Penalty law clearly gives the ATO power to investigate and enforce large penalties. The ATO proudly provide case studies on their website of how they’ve done this in the past.

Moreover, when the ATO eventually referred the matter to the AFP they didn’t provide sufficient detail for the AFP to progress a criminal investigation. Why? If it was because of confidentiality concerns why not just redact the names of the 16 tech firms? Or, better still, request that any court proceedings be closed to the public. This happens all the time when concerns of the nature claimed by the ATO are deemed to be legitimate.

Perhaps there’s a reasonable expectation for the ATO’s approach. But Occam’s Razor points squarely to regulatory capture by the big 4 accounting firms.

The consequences for PwC

The wheels of justice may have turned slowly in this case, but in the end PwC have been severely punished—if not yet in a court of law, then certainly in the marketplace.

In the grand tradition of “it’s not the crime, it’s the coverup” when the story broke in January this year PwC said that it just involved one former partner, Collins. Then the head of PwC Australia, Tom Seymour told an internal partner meeting that 6 to 8 partners were directly involved and they have all left the firm. But then he mentioned that another 20 to 30 partners were on email threads regarding the breach all the way back. And he was one of them. This leads to a large amount of internal consternation at PwC.

It has subsequently come to light that at least 63 partners and staff were aware of what was going on.

The Prime Minister and Treasury have expressed their public outrage and the Department Finance immediately started looking for ways to stop using PwC. They have instituted a new rule which requires that if a government supplier gets sanctioned by an agency or a professional body they have to disclose this immediately. Furthermore, any bid for government work now must include the relevant history of the organization. Jenny Wilkinson, the head of the department, told a Senate committee that PwC has been indefinitely excluded from future government contracts.

This outrage has not remained contained to government contracts, but has spilled over to private-sector clients—even those outside the consulting business. For instance, a major property developer, Lendlease, have put their audit (currently held by PwC) out to tender.

Worse still for PwC, Australian Super (Australia’s largest pension or “superannuation” fund) has said they won’t hire PwC in the future. 4 more large funds have followed suit. This is a huge deal because these superannuation funds are basically the self-appointed gatekeepers for what qualifies as acceptable Economic, Social and Governance (ESG) behavior. And these funds are the largest shareholders in every publicly listed Australian company. So every listed company is being told by their major shareholders that PwC are bad actors.

Did the system work?

PwC got away with egregious behavior for a long time, but the punishment now being meted out seems appropriately severe. Certainly severe enough to deter this kind of behavior from others in the future if others believe there’s a decent chance they will get caught. 20% of PwC’s entire Australian business has been wiped out. The rest of their Australian business looks in serious trouble. And they’re going to have a really hard time recruiting smart graduates. Who would want to tell their friends they work for PwC?

Of course that analysis depends on the claim that PwC being caught wasn’t an accident, but was inevitable. I’m not so sure about that.

Had it not been for an obscure accounting regulator being dogged—and accessing confidential ATO records in a questionable manner—it might never have come out. There was also a lot of damage done to the Australian public during the long time that PwC’s behavior remained secret. As economists like to say, “flow utility matters.”

In one sense this has played into the hands of the Labor government. Part of their pitch at the last election was to reduce the use of consultants and rebuild the Australian Public Service, which had been constantly diminished—particularly during the preceding 9 years of conservative rule.

Ironically, the Labor government are the clear winners out of all of this.

And while PwC are the clearest losers, so perhaps are the other big 4 accounting firms. Fairly or unfairly, they get lumped in with PwC to some degree. On the other hand, they may end up with one less competitor for practical purposes.

Time will tell.

Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.