PwC and Satyam – Another Fine Mess You’ve Gotten Yourself Into

If only the firm was just milking a gag…

It was only a couple of days ago that Price Waterhouse India was plotting their defense to this “everything old is new again” fine mess they’ve gotten themselves into.

Dateline: NEW DELHI
January 24, 2009

Price Waterhouse will defend its role as an auditor of the disgraced Satyam Computer Services, citing the 1986 verdict of the Bombay High Court that said an auditor should not be held responsible for tracking down ingenious and carefully-laid schemes of fraud in a company.

Lawyers privy to the development, who requested anonymity, said as per the contract between the auditor and Satyam, the onus of providing accurate information was on the company. “This is a standard across the audit industry,” said a lawyer to ET. The scope of an auditor’s work is different from that of a detective, or of a law enforcement agency, making it difficult to detect orchestrated fraud even if all audit practices are religiously followed, he added.

However, a significant expectations gap exists.

Per an Accounting Web article in September, 2007:

“In a November 2006 report, Global Capital Markets & the Global Economy, the CEOs of the six largest audit firms stated ‘there is a significant expectation gap between what various stakeholders believe auditors do, or should do, in detecting fraud and what auditors are capable of doing at prices companies or investors are willing to pay.’ The CEOs point out that fraud detection methods recommended under SAS 99 are not perfect, and that auditors are often restricted in their methods to detect the red flags of fraud. As an example, the CEOs cite the limitation of using indirect means during the audit, such as reviews of anomalies and interviews not conducted under oath, to ascertain if the possibility of fraud exists.”

Some auditors work under an old idea that they have little or no responsibility to detect fraud during an audit. However, in October 2002, the Auditing Standards Board of the American Institute of Certified Public Accountants announced it has approved a new standard that gives U.S. auditors expanded guidance for detecting material fraud.

The AICPA called the standard an effort “to restore investor confidence in U.S. capital markets and to re-establish audited financial statements as a clear picture window into Corporate America.”

In addition, PCAOB inspectors noted instances in which auditors did not post all proposed audit adjustments in excess of the posting threshold to the summary schedule, thus rendering the summary incomplete. Inspectors also noted instances in which auditors had netted the effects of known misstatements that individually met the posting threshold. The net effect of those particular misstatements was lower than the posting threshold for the summary of unadjusted differences. As a result, those misstatements were improperly excluded from the evaluation of potential misstatements. Furthermore, inspection teams observed that some auditors did not adequately scrutinize late adjustments, significantly affecting financial results, that were proposed by management and that partially or completely offset adjustments previously proposed by the auditors.

AU § 316.08 recognizes that “[m]anagement has a unique ability to perpetrate fraud because it frequently is in a position to directly or indirectly manipulate accounting records and to present fraudulent financial information. Fraudulent financial reporting often involves management override of controls that otherwise may appear to be operating effectively.”

AU § 316.41 states that auditors ordinarily should presume that revenue recognition is a fraud risk, thus requiring the auditor to respond with appropriate audit procedures. Numerous financial frauds have been perpetrated by management through premature or fictitious revenue recognition schemes.

“We feel strongly that the standard will substantially change auditor performance, thereby improving the likelihood that auditors will detect material misstatements due to fraud,” said Melancon. “The standard reminds auditors that they must approach every audit with professional skepticism and not assume that management is honest. It puts fraud at the forefront of the auditor’s mind.”

Increased Emphasis on Professional Skepticism….Throughout the audit, the engagement team should think about and explore the question, “If someone wanted to perpetrate a fraud, how would it be done?” From these discussions, the engagement team should be in a better position to design audit tests responsive to the risks of fraud.

Discussions with Management. The engagement team is expected to inquire of management and others in the organization as to the risk of fraud and whether they are aware of any frauds. The auditors should make a point of talking to employees in and outside management. Giving employees and others the opportunity to “blow the whistle” may encourage someone to step forward. It might also help deter others from committing fraud if they are concerned that a co-worker will turn them in.

Unpredictable Audit Tests. During an audit, the engagement team should test areas, locations and accounts that otherwise might not be tested. The team should design tests that would be unpredictable and unexpected by the client.

PCAOB inspection teams have identified instances in which auditors who had not requested confirmations of account balances or had not received responses to positive confirmation requests either failed to obtain, or failed to include evidence in their audit documentation that they had obtained, sufficient other evidence regarding the existence of accounts receivable balances.

PCAOB inspection teams noted instances in which it did not appear that the auditor had performed adequate procedures with respect to evaluating the risk of management override of controls. More specifically, in some instances it did not appear that the auditor had appropriately addressed the risk of managing controls with respect to journal entries and accounting estimates.

I could go on. The report does. Unfortunately it does not anticipate the possibility that the auditors themselves might solicit bribes to cover up a fraud.

But it looks like that is just what’s happened in India with Satyam, according to reports this weekend. (If anyone is keeping track, the answer to the PwC Slumdog Millionaire Sweepstakes was b. )

Times of India

PricewaterhouseCoopers (PwC) auditors manipulated Satyam Computers accounts for money.

According to Crime Investigation Department (CID) sources, Satyam founder B Ramalinga Raju and former chief financial officer (CFO) Vadlamani Srinivas confessed that the auditors of PwC were aware of the fraud and very much involved in executing it.

“Five banks, including HDFC Bank and BNP Paribas, replied to our queries saying that the reconciliation statements of the fixed deposits shown by Satyam Computers at auditing were not issued by them,” a CID officer, who is part of the investigation team, told TOI on Sunday.

According to CID sources, S Gopala Krishnan, who was the auditor for Satyam Computers on behalf of Price Waterhouse between 2000-2001 and 2006-2007, and Srinivas Talluri, the auditor for 2007-2008 fiscal, were well aware of the fraud.

“The auditors falsified accounts,” the CID officer said.

During the grilling by CID officials, Rajus and their CFO V Srinivas reportedly told their interrogators that they had paid handsomely for manipulation of accounts.

“The normal charges could be about Rs 1.5 crore per month,” a source said.

My compadre Dennis Howlett saw my Tweets last night that broke the blockbuster news for US readers. He immediately wrote up his doom and gloom scenario. He’s bet me that PwC as a global firm will fail by the end of the year.

“My initial reaction was one of skepticism. How could two qualified accountants, working at the highest level of a global brand leader be so crazy as to risk the firm and their future for what must have been a modest bribe? But then I’ve seen far less involved and the same self destructive mentality take people down.

During a conversation with Francine McKenna, she made the point: “PwC is a three strike business. Yukos in Russia, Japan and now India. Where else do they have issues? Is anyone asking what’s going on in south east asia…places like Vietnam and Cambodia.” I’m not convinced anyone cares about those countries but China? What about South American territories like Brazil, Chile, Mexico? Is PwC operating to standards that stand scrutiny in those places?”

I called PwC US spokesperson Mike Ascolese at home last night. I wanted to give him a heads up. I sent him copies of the news reports from India and said this:

“I look forward to PwC US statement regard to exposure due to litigation in the US re Satyam ADRs, PCAOB response, and US firm review/approval of US GAAP financial statements.”

He had not yet heard this news. As of the time of publishing this post, he had not yet gotten back to me with a statement.

I also requested a statement from Colleen Brennan at the PCAOB.

“I look forward to PCAOB statement regard to exposure due to litigation in the US re Satyam ADRs, PwC US firm review/approval of US GAAP financial statements., as well as status of the inspection report of PwC India audit firms.”

Colleen’s response to me this morning:

What next? Regardless of the legal outcome, these admissions cast a long shadow over PwC Global. It must now be patently obvious that PwC has no control over its associates and affiliates. It cannot therefore be reasonably described as a global firm. More worrying – what does it say about other territories where PwC trades.

“Hi, Francine — as you might guess, we have no comment…


So, as well as having no defense at either the Indian, US, or international level to this damning development, Pricewaterhouse Coopers LLP US and the US regulator have no PR spin either.

23 replies
  1. James
    James says:

    Allow me to guess the firm’s response:

    “Fraud happens and will always happen and there should not be an expectation that it can always be detected given informationa and budgetary constraints.

    When firm individuals are involved, they are acting counter to firm policy and values and do not reflect on our core business.

    After we saw the many innocent employees of Anderson put out on the street by the actions of a few we can not afford to make the same mistake again and punish the firm as a whole.”

    How much that helps/hurts their case will depend on how much other bad news comes out in the coming days/weeks from this financial mess we are in and what people’s memories are like.

  2. vt
    vt says:

    Great summarisation of the situation. However, it is important to note that till now only the STATE CID (Police) have been allowed by the state government to interrogate Raju and all the Central agencies such as the CBI, SEBI, SFIO etc have been kept out. This in itself raises serious doubts about the credibility of the probe as the State government which has been accused of complicity, in as much as it has awarded contracts in excess of Rs 38,000 crores (US $ 7 billion)to Raju’s companies against alleged favours, is the one which is in charge of the probe. It is even said that the officer who is heading the investigation has been hand picked by the state government as he is very close to it.

    Although I am not sure what we can expect of SEBI, CBI etc as both the State and the Central governments are ruled by the same party, i:e the Congress.

    Further, I would take the alleged confessions by the Chartered Accountants with a pinch of salt as much of this is generally put out by the government to appease the public and might not finally hold up in court!

  3. Anonymous
    Anonymous says:

    Total word count: 2,057
    FM written: 297
    Copy and pasted: 1,760

    These numbers are my best estimate, as it’s often nearly impossible to determine what is Francine’s thoughts and what is a cut and paste from somewhere else. This illustrates my frustration with where this blog has gone. Very little of FM thoughts and very much of an indiscernible copy-and-paste cluster.

    Where are your thoughts, FM? If they are in there, I can’t find them through all the congestion.

  4. Francine McKenna
    Francine McKenna says:

    ‘m flattered that you want more of my thoughts and opinions. It’s tough to find the balance when I have to give some folks so much in the way of background and “evidence” for my opinions. The door swings both ways.

    You should follow my thoughts on Twitter, . 140 characters at a time, they’re some of the purest, unadulterated commentary you’ll see on the subjects I cover, 24/7.

    My thoughts in a nutshell on Satyam: I won’t be surprised if these partners have taken bribes. I won’t be surprised to find out that they have done so at all of their other clients. I won’t be surprised if this problem is endemic for PwC in many other locations such as China and Southeast Asia and for the other firms in as many locations as at PwC. Corruption has been the way of the world. The firms, their clients, the regulators are all too big to effect proper management and supervision of their responsibilities.

    We’ll go back to a simpler time soon. This year will be full of demise, destruction, and dislocation. The elimination of the Big 4 firms in their current form will be one relatively insignificant casualty of a much larger redesign of the capitalist system.

  5. Independent Accountant
    Independent Accountant says:

    I’ve got a post on Satyam, with another on the way. It is inconceivable to me that many PWC people in addition to at least ten people at Satyam did not know what was going on.
    In about 1985, a Miami partner of Grant Thornton took a $200,000 bribe to cover up a $195 million fraud. These things really do happen. One reform I favor: one firm means one firm. If “PWC” India gets sued, PWC US must answer in damages. This “we’re one firm on our letterhead, but 150 firms for lawsuits” game must end. 65% of Satyam’s assets wer fictitious. Don’t tell me PWC wasn’t involved in this up to its neck.

  6. Anonymous
    Anonymous says:

    Let us consider the following points:
    1. PWC were statutory auditors of Satyam

    2. E & Y were carrying out the internal audit function.

    3. Maytas Infra's joint statutory auditors are S R Batliboi & Co , a "member firm" of E & Y
    4. E & Y carried out a valuation of properties for Maytas Infra.
    5. E & Y awarded the Entrepreneur of the Year Award to Ramalinga Raju.

    Are they not equally at fault?

  7. Boriah
    Boriah says:

    It is quite obvious to me that being in the US and using (highly excitable) Indian media reports as a base for your writing doesn't bring even a semblance of objectivity to your blog.

    Anyone who is even remotely connected with the way the Indian criminal justice system works must know that law and order is a state subject in India. The federal investigation agency (called CBI) cannot be called in to investigate any case without an invitation from the concerned state government. It is also a well known fact that the Chief Minister (~Governor would be the US equivalent) of the state in which Satyam was headquartered is himself accused of having deep rooted links with the Raju brothers in addition to being a beneficiary of the fraud. So far none of the federal regulatory agencies (SEBI, SFIO & RoC) have been able to question the Raju's or Vadlamani (CFO) because they are in the custody of the police who are in turn controlled by (no prizes for guessing) the Chief Minister. The same police have now charged the partners of Price Waterhouse as being involved in the fraud and guess what the regulators don't have access to them either now. It may not seem obvious to the non-Slumdog folks in the US as to what the agenda of the police is, but its as clear as daylight to me that its the state against everybody else. Once again anyone who knows anything about fighting the state in India knows that its going to be one long drawn battle for the partners even if they are entirely innocent.

    Typically when persons in power are discovered as being involved in any wrong doing they would do pretty much anything they can including abuse of their authority to get away scot free. A case in point is Illinois governor Rod Blagojevich who despite the US justice system seems to be hard to get.

    I must make it clear that I hold no brief for PW or its partners. However, I think the blog is way too one-sided and the general theme seems to be to "get rid of the big four" and all evil that permeates the financial world will cease. FM, bring some objectivity in your blogs please (even if its only copy-pasting) or you'll lose the few remaining readers that are out there.

  8. Anonymous
    Anonymous says:

    Boriah, Ms. McKenna does not need me to defend her views, but oversimplify them as a push to get rid of the Big 4, and then to conflate that oversimplification with a excessive bias misses her points, which if you read the blog in its entirety are manifest.

    So permit me to give my own spin on this.

    The Big 4 has a business model that is entirely too risky to make any common sense. And the way they run the firms makes the model even riskier, because compensation and personnel decisions would have to be structured to prioritize delivery excellence and subject matter expertise to some extent over business development and utilization. This is not a rant against aggressive business development and utilization and other such goals as I think that high performance business cultures need those kind of measurements; rather it is a reminder that a business with a precipitous return vs. risk model that fails to structure its affairs around this key difference does so at its extreme peril. Put another way, the attest and audit business is indeed special and different in its risks and demands and public obligation, and they need to do something different than they now are doing, likely radically so.

    How is it that anyone cannot believe the business model is a Titanic waiting to happen? Fees, while generally good in terms of putting money in partner’s pockets at the end of each year (but not for a rainy day), and giving many a decent wage in a difficult and challenging profession, are ridiculously low when measured against the litigation liability that looms. Assume that one of these disasters is large enough (and with this economy, there will be some), and that a plaintiff succeeds in getting past summary judgment. The hindsight factor kicks in – making whatever conduct the auditors engaged in appear worse in context than it probably was – and just watch what kind of havoc would wreak with a billion (or worse) kind of judgment from a jury. Merely posting a bond for an appeal would be a financially stressful thing, and imagine if 2-3 such actions were infecting a firm at the same time. These risks are real, could take any one of these firms under or in severe distress, and I find it humorous that instead of substantive responses to Francine’s points one reads posts here about how the blog material is too long or how it is too biased to reach large readership levels. It as if what she is pointing out is too uncomfortable to read. But that is the point, isn’t it? If there are not concrete, plausible responses to her concerns then what is reinforced is a perception that she is spot on.

    And to add the disclaimer to avoid bias, I might add that I do find Big 4 professionals as a group one of the finer elements of human capital in the business world – well trained and professional and frankly, invaluable assets. But that is just the reason we want to have these people working in a reformed structure that engages in better risk management, does better work, protect the public more effectively, and so on. Sometimes that takes tough talk.

  9. Dr PL Joshi
    Dr PL Joshi says:

    I have a simple question.
    As per ICAI’s regualtions, foreign audit firms like E&Y, PWC , KPMG, and D & T are not allowed to practice auditing work in India .i.e. none of them can
    be appointed as a statutory auditors of a company by shareholders in their annual general meeting. In order to act as a statutory auditor, such firms should
    be registered with ICAI and none of them are registered with the ICAI. These firms are just affiliates in India and conduct consultancy services. They perform
    audit work on behalf of local audit firms who have licenses from ICAI. This means that these foregin firms outsource their auditing services. It also means that the foreign audit firms do not have power in India to attest the financial statements.

    If the above is the case, what are the legal liabiliies of PWC in case of Satyam’s frauds? What action the government or ICAI can take against such firms
    who do not have the attestion power for financial statements.? The foreign audit firms recruit Indian CAs who are the registered members with ICAI. If any of its member has conducted audit for Satyam, then the action may be taken against the CA s who are the members of ICAI. It means that the punishment may be only to suspend their license for a period of 5 years. So in Satyam case, the legal onus is with the individual CAs who are the employees of PWC India and it will not be easy to take any legal action againt PWC, if upon investigation it is found that auditors have shown professional negligence while conducting the audit or were a part of the fraud. In such a case PWC will lose its reputation and I am afraid that this case will affect its global operations.

    Any one can clarify the above position for the benefits of several readers.

Trackbacks & Pingbacks

  1. […] PwC and Satyam – Another Fine Mess You’ve Gotten Yourself Into, January 26, 2009 […]

  2. […] Price Waterhouse India partners colluded with Satyam management to commit the […]

  3. […] But is this how everything in life works? Well, as I’ve studied accounting, there are a few things that have been drummed over and over. Suspension of disbelief isn’t one of them. Rather, professional skepticism is tremendous, and when auditors aren’t skeptical enough, bad things happen. […]

  4. […] the other “expectations gap” we face as journalists when trying to add an independent, objective, and inevitably critical voice […]

  5. […] But hold on! Let’s remember something about history. Auditors didn’t even always test for internal controls…and until the big scandals, they didn’t even believe they had a responsibility to actively detect for fraud. Sometimes, the auditors still don’t. […]

  6. […] interesting reading to relate Regulation studying to the real world is this article on Re: The Auditors that addresses a case faced by PWC and the auditor’s responsibility to find fraud under the […]

  7. […] the link to my posts on PwC/Satyam, go here, here, here, here, here, here, here, here, here, […]

  8. […] But the two at different points of time did not make any change in their audit plans.”  Earlier reports had PricewaterhouseCoopers International Chairman Sam Di Piazza spending much time in India as well […]

  9. […] less sanguine. Who knows? If a case against PricewaterhouseCoopers global firm for Satyam rolls in soon too, the risk of losing at trial in two Big 4 cases – and Satyam will go to trial – […]

  10. […] the below audit “plane crashes” you have so clearly documented:    Stanford Satyam Madoff Banco Espiritu Santo and BDO Seidman  Lehman and Ernst & Young,  Deloitte and Bear […]

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