Like Deja-vu, All Over Again…

In theory there is no difference between theory and practice. In practice there is.
Yogi Berra

The days have been going by so fast these last couple of weeks.  Actually, it’s been a blur ever since August 25, one month ago, when I first reported the layoffs at Deloitte. A subsequent statement from Deloitte and follow up reported on August 29th only added to the whirlwind here at re: The Auditors HQ.

I spent a lazy weekend at the lake for Labor Day and had no idea of the hurricanes (Gustav, Ike, Hanna) to come as well as the Super Large Hadron Collider about to crush the global financial system.

When I first started writing this blog, some people said my tales of collusion, complicity, and chronic carelessness in the audit industry were “black helicopter” stories. It’s just not possible, they told me. Smart people run the Big 4 firms, as well as the rest of the post-industrial capitalist complex fondly referred to as the “global capital markets”.

Well, if only that were true. Others now have echoed my concerns about how easily another Big 4 firm could fail. Perhaps a “crisis” is what we need to restructure the processes to make sense for shareholders and other stakeholders and not just greedy, short-term management who seems to bide their time in several of these cases just long enough to loot the place for themselves and their gang.

We have witnessed a clustershchmuck of gargantuan proportion with the failures of financial behemoths that anyone with a few ounces of sense could have told you was coming. And they did. The experts, appearing on the pages of some of my new favorite blogs like naked capitalism and Infectious Greed, were saying that the wealth and hubris exhibited by so many in the last several years was based on a house of cards.

Yesterday, I heard that the FBI is going to investigate possible fraud at Lehman, Fannie Mae, Freddie Mac and AIG, whose collapse in the recent days “precipitated” this “crisis.” Well, I say you should bring in the the whole army, if only they weren’t in Iraq. Anyone remember we have a war going on and soldiers and civilians are still dying??? That was another “crisis” that had to be decided in a short amount of time otherwise “calamity” would ensue.

Whatever you do, get involved in the political process! Call your Senator and Congressman. Tell them what you think of this mess. Make sure you can vote. Discuss, debate, read, and inform yourself. Then go out and vote.  Vote. 

I could tell you who I think is better as President of the US, but at this point, it’s more important to vote and act. Don’t be complacent, don’t be a sheep, don’t let these people you thought were so much smarter sign you and your family up for another several years of indentured servitude to bankers and the rest of the real rogues’ gallery of supposed leaders. 
Look at them on TV.  They haven’t got a clue.  They don’t know what to do.  In the same way they haven’t prepared at all for the possibility of another Big 4 firm threatened with failure now because of the crushing wave of lawsuits coming.  I told you before that the situation was dire for the Big 4.  It’s even more so now.  That’s why the leaders of the firms are nowhere to be found on this. They’re talking about everything but the crisis and the fate of their clients.  They don’t know what to do.
Break the chains and change the status quo. If only a strong “Windy-city” type wind could blow through the Capitol and force the change and the subsequent renewal we so much need…

During all of this hyper activity, I still receive mail. One letter came from a man I will call “Singing Solomon”.

Singing Solomon was reading my post about the takeover of Fannie Mae and Freddie Mac and reminiscing. He knows that the audit firms have been rolling over for their clients for the sake of the fees and their own professional futures, if not complicit in the problems we have now, for a long time. 

Here’s the story he told me:

I used to work in the tax department of a large public corporation.

There had been a fraud at one of our subsidiaries. The subsidiary was winding down its operations and I was working on a sales audit from Pennsylvania and a property audit from Maryland because the accounting staff of the subsidiary had left. In handling that audit, I had to perform an account analysis of fixed assets. In doing this account analysis, I noted the following:

(1) Most of the fixed assets were described in the fixed assets ledger as “various (Just great for doing a physical count);
(2) There were journal entries that transferred obvious expense items such as bags to the fixed asset accounts;
(3) The company had anticipated fixed asset acquisitions of 25K and instead had fixed asset acquisitions of 525K;
(4) Inquiries with the remaining staff at the subsidiary indicated that almost all of the items had a less than one year life.

Arthur Andersen, our auditors was in charge of reviewing the fraud at our subsidiary. They spent many weeks on their report which was needed to be presented to company counsel. Their report, which was included in an SEC filing, indicated that the fraud started in 1992 and included 2.2 million dollars in false revenue on jobs and 440K in fake inventory in 1992. They found no other discrepancies. They found nothing with respect to fixed assets.

We had made a large amount of state income tax payments for this subsidiary in 1992 and for prior years. Irrespective of what Andersen found, I thought we needed to look into the situation more because the fixed assets were greatly overstated. It took me maybe two to three days to find out that the fraud had basically started on Day One when the company was acquired in 1989 and it was massive.

I was able to look at the statements and say that the subsidiary was overstating its profit on the jobs in progress. All it took was to look at the end of year profits for one year to the profits when the jobs were completed. That took less than a day. Then I realized that because the company was billing in advance at the start of jobs, there should have been a liability and not an asset for jobs in progress. AA had acknowledged that there was an overstatement but never detailed it. Then I found a job where the subsidiary had split a job in two to take more than one million dollars of profit up front. I asked AA about it. The auditor said he didn’t notice that! (I just assumed he was covering up. Later, I suspected that AA was not only covering up their negligence, AA was likely the party that encouraged this split.)

Then I found prepaid insurance of more than 2 million. Somehow, this didn’t make any sense to me. Of course, they didn’t have prepaid insurance of 2 million. They were simply understating the expense. Furthermore, there were almost no accrued expenses on the books!

So, in two or three days, I was able to uncover much more for our legal department than AA did in its supposedly thorough investigation. AA’s failures allowed the subsidiary’s management to steal millions.

Anyway, I thought the auditors would have become more of watchman, a guardian, for the shareholders by this time. But they haven’t.

11 replies
  1. radical change
    radical change says:

    Maybe it’s time that public accounting, which is a profession in defense of the public interest, become a goverment job. I find it interesting and frankly redundant that the audit firms charge such large rates, pass a little bit to the staff (less than law firms), and keep the rest. The government then has to audit the auditors, who are supposedly doing peer reviews, and still get saddled with lousy PCAOB comment reports (see Accounting today’s top 100 report). My suggestions for change:

    1) reform the complex accounting literature and take down the house of GAAP. There should be one authority and one reference that puts together the accounting and auditing framework and issues pronouncements and clarifications.

    2)Make auditing of public companies a government responsibilty. Many charged with the protection of the public interest (police, judges etc) are government officials. You could have a whole staff out at a client for a whole year for the fees that are currently charged by audit firms for an engagement. Lower the fees, give more to staff and conduct the audits the PCAOB thinks are sufficient instead of outsourcing and then giving a bunch of comments (KPMG).

    3) Keep holding the higher echelons of corporate America more responsible (send them to the tough jails). There should be some more risk associated with their fat paychecks.

  2. Anonymous
    Anonymous says:

    Why is it that Big Law Associates get paid so much more than accounting associates when taking into account similar size firms? They can’t charge out that much more than us…

  3. Chicago Accountant
    Chicago Accountant says:

    Yes, staff at accounting firms get less than staff at law firms…way, way, way less. It’s like a factor of 2 to 3.

    I would not go as far to say that auditing is a government responsibility. How many times has the government botched up a job? I can count off a few.

    Furthermore, many jobs that you might consider public interest jobs are not performed by the government. We have private companies that test consumer products. We have private lawyers that defend the accused. We have a private press that provides us with news.

  4. Chicago Accountant
    Chicago Accountant says:

    No, they are charged out at much, much more. I’ve often asked myself why it is the way it is. I’m not sure what the labor pool is like. It’s all supply and demand.

    You also should know that I’m talking about big law firm salaries. If you go to a second tier law school, you will almost certainly not get a big law salary. You will spend 40k in tuition a year for three years for a 70-80k a year job. That’s if you get a job at all! For sub-big law jobs, the supply and demand for lawyers is out of whack. There might be 3 lawyers for every 1 job.

  5. Independent Accountant
    Independent Accountant says:

    YS’s Naked Capitalism is a superb blog. One of the best. She has an uncanny ability to put my thoughts into the blogosphere before I can even formulate them.

  6. Anonymous
    Anonymous says:

    You have very few pure admin (management) partners in the law firms. Someone has to pay for the salaries of these useless waste of space, who get to decide when the firm needs to “rightsize.”

  7. Anonymous
    Anonymous says:

    I used to work for Arthur Andersen, and it reminded me of the mafia. New hires were brainwashed from the day they started into believing that Arthur Andersen was the only place to work. When not working, new hires were encouraged to spend time only with their Arthur Andersen colleagues. Partners ran up huge tabs paying for happy hours and other firm sponsored functions with lots of alcohol. Its not too expensive or hard to buy loyalty from the new colleague grads by stuffing them with free alcohol and telling them that they are super cool. Independent thinking was always discouraged by making the person feel like a looser so that the person would leave on their own. In this type of atmosphere, who would dare to cry foul and dare to suffer the consequences. Now wonder the firm failed. Now, these Arthur Andersen people have scattered like ants into the other accounting firms and other corporate positions.

  8. Anonymous
    Anonymous says:

    @949…ants or more like rats?

    @3:38 ChiAcct…correct you are. Outside of BigLaw and large regional firms – pay is not that great for lawyers and someone at a Big 4 with 3yrs experience makes what a starting lawyer would who went to a T2 or TTT (tier three toilet) law school and gets a job a small or even medium firm (60-100 lawyers in a smaller city).

    FYI – even BigLaw has problems – cue Heller Ehrman who just dissolved. Talk about flooding the supply side of lawyers looking for jobs.

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