Auditors Not Trying To Wiggle Off The Hook. Really.
From today’s The Times of London Online:
Leading accountants will meet the Government this week to plead for protection as they prepare for a surge in litigation from investors trying to recover their losses from big company failures.
The Big Four — Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers (PwC) — are braced for an increase in legal action from investors and liquidators as the economic crisis continues.
They fear that a blockbuster lawsuit, if successful, could put one or more of them out of business. That could trigger the collapse of the audit market and cause chaos for business, they say. All but two members of the FTSE 100 are audited by the Big Four…Last month, the US Securities and Exchange Commission (SEC), the American financial regulator, said that it would block any such deals involving British companies that were also registered in the United States.
The SEC fears that directors and auditors could cut secret deals under which auditors are given proportionate liability in return for glossing over the company’s accounts.
I’m so glad they put it in print. Because if you told anyone that this is the best the auditors could come up with to try to avoid liability for their aiding, abetting, voluntary abeyance, negligent neglect, errors, omissions and occasional commissions of fraud, they would laugh out loud.
“…a blockbuster lawsuit, if successful, could put one or more of them out of business. That could trigger the collapse of the audit market and cause chaos for business…”
Well, there are some doozies on the docket – really big lawsuit burritos giving the firms blockbuster indigestion:
- BDO International and Banco Espiritu Santo
- Deloite and Parmalat
- KPMG and New Century
- PwC and Satyam
- Madoff feeder funds, et al. and Grant Thornton, BDO, EY, PwC…
- Refco and Grant Thornton
Well, I have detailed it all before and some of the above are new even since then.
And there are, for sure, more to come as a result of the financial crisis.
Which brings us to the most ridiculous part of the above statement:
“…That could trigger the collapse of the audit market and cause chaos for business…”
We should care that the audit market collapses? Audits are required by regulators, exchanges, banks, bond investors… A formality at this point. And that’s being generous.
Who exactly trusts any more that the audit opinion gives a seal of approval on the viability, the “going concern” quality, of any public company? What exactly are we paying millions and millions for?
And the loss of this seal of approval on financial statements, one that gives no one any comfort anymore, will cause chaos for business? Can the collapse of the audit market cause any more chaos than we already have due to the audit firms neither identifying, mitigating, or warning in time of the material misstatements, illusory valuations, and fiendish fraudsters that have created the crisis we are currently experiencing? Is anyone really that afraid of financial statements issued without these auditors’ opinions?
Postscript: Not suprisingly, Dennis Howlett and I were thinking about this article at the same time. Here’s his take, which includes a comment from me.
Its hard to disagree with you on this with the exception of the target of any prosecution and punishment. Engagement partners and senior managers need to have significant liability via loss of license and net worth, along with the executive committee and professional practice dept. These are the folks responsible for how the audit and the firm do their work. All this said, people’s lives should not be ruined by weak circumstantial evidence or overzealous plaintiffs looking for a big payday. We do though need to remove people from public accounting that put self-interest above the principles of the profession.
Unfortunately the pay grades that the profession generates will continue to attract just those kinds of people.
My question is if one of the Big 4 goes down, who will be able to pick all the available work? I seriously doubt that BDO, GT or RSM are going to be able to step up and grab that kind of business. That’s if they don’t get taken out.
Good point Ken but I ask you this, how do you plan to remove these unethical CPAs from their respective firms? The SEC doesn’t have the man power to see if the audits are good, only if the audits are documented properly. The gold seal of an audit opinion can only decrease as long as the going concern assetment is wrong time and time again.
Somebody fix us, please. Most of us don’t condone or copycat the inevitable trainwreck many partners and senior managers have orchestrated. We’re just trying to not get hit by the shrapnel.
Anony @ 2 — I think one of Fran’s points is that the audit opinion has been so devalued by the negligence of the auditors, that she doubts the utility — and the need — of the audits. So when you ask “who will be able to pick all the available work?” I’m guessing that Fran would answer “no one — and who cares?”
Ken @ 1 — In my experience, those in the Big 4 who “put self-interest above the principles of the profession” far outnumber those who do not. To respond to Wes’ question, the challenge is not to find the malefactors, then challenge is to find those who are trying to do the right thing in the right way.in the face of enormous pressure to cut corners. Frequently, those latter folks are the ones who don’t make partner because they refuse to compromise their ethics so as to generate the appropriate career success metrics.
— Tenacious T.
@TT @Anon2
Yes, it will take a failure of one or more, an impossible legal judgment, to force a new model. But that is just what we need. It’s too bad the impotent regulators and self-centered “leadership” of the firms will wait until you and their clients suffer the disarray before acting.
To all,
The funniest part of it all is that – to a one – none of you even has a clue of what auditing is about. If anyone amongst you has ever participated in an audit of a public company (at more than the junior level), please raise your hand. What, I ask, does fm actually do for a living now – and the rest of you, as well? RF
It’s just possible that this current model of public assurance is so broken that it needs to “fail fast” in order for something to emerge and take its place.
Question 1: In the gap between fast failure and new model emergence, what will large multi national conglomerates get up to, given what we observe of the behaviour of large multi national accounting partnerships?
Question 2: Does anyone have any idea what might emerge? Is the current state, like capitalism, just the “best bad idea” we can currently come up with? Surely not? Surely we can do better?
Question 3: Which will be the first of the big four to spin off their audit business, in order to reduce risk and increase scope for advisory dollars?
@Roger Fox
My qualifications to discuss these topics are what they are and they are public. Take it or leave it. Yours are?
Francine
And what of the hundreds of thousdands of auditors around the world who would be affected by the collapse of the audit market or that of one or more of the Big 4? Please think about them before making such brash statements about not caring if the market was to collapse. Hope that answers your question in regards to anymore chaos ensuing should the market collapse.
@Anonymous 12
I’m not the one who will cause the next audit firm to collapse. I’m just the messenger. If you’re not already one of the thousands losing your job, taking a demotion and pay cut, losing 401k match and other benefits, including well deserved vacation pay, not getting paid overtime, and generally working in an obsolete and threatened business model on the verge of collapse…you should be looking for another job now.
Litigation and management ineptitude, which in turn causes more litigation, will kill the next firm. Or two.
Francine
JW @ 9 & 10 —
Interesting questions, unlike “Roger Fox’s” troll bait. Let me take a crack at answering them, acknowledging up front that this is sheer speculation on my part.
1. The publicly traded multi-nationals are still subject to SEC regulation and to Sarbanes-Oxley, not to mention whatever regulatory requirements NYSE or NASDAQ applies. (And I freely admit I have no clue about NYSE or NASDAQ listing requirements … but surely there must be something.) There are also criminal fraud statutes on the books. More importantly in the litigation-crazed U.S., I would expect them to be wary of shareholder litigation if it was alleged that the financial statements were deliberately manipulated. I would hope that the threats of litigation, regulatory enforcement action, and a free-falling stock price — without the compensatory Big 4 “seal of approval” to use as a shield — might cause the corporations to think twice before taking too far a detour from GAAP. But far too many haven’t been worried about such threats in the past, so perhaps I’m just being Pollyanna here.
2. I’m not necessarily buying into the link between the failure of the audit partnerships and the failure of capitalism. Even if the auditors take on a more government-sponsored regulatory role (as Fran has suggested might be the next evolutionary step), I believe capitalism will survive largely unscathed. What we might expect is something more akin to the 1950’s (or perhaps the 1930’s) regulatory environment, as opposed to the post-Reagan regulatory environment. Some things may change, but most things will likely remain the same.
It is not a terrible thing for the government to regulate an oligopoly (whether of 3 or 4 firms) when the free market seems unable to provide sufficient incentives or controls for self-regulation. The U.S. has done it in the past, and still does it today to a limited extent; I don’t have a burning problem with doing it again, or doing more of it, or doing it to a different oligopoly.
3. The problem I have with your premise is that I believe the Big 4 are really terrible at managing the consulting/advisory business. The partnership model doesn’t seem to be any more effective at managing consulting projects than it is at managing audits — though if pressed I would assert it is actually better at managing audits. More fundamentally, the large accounting firms don’t appear to be able to manage themselves as a long-term business — which is the real issue. Spinning off a piece of the business, whether consulting or audit, doesn’t really address the fundamental issue of mismanagement.
What do you think, JW?
— Tenacious T.
TT: re your last point. From my time at DT, I wouldn’t necessarily say they are bad at managing the advisory or the audit business individually. The problem comes when the two overlap. The cash cow audit work is the first to suffer when good resources are pulled to staff new opportunities. The audit engagements are backfilled – surprise surprise, not with the top performers – if these guys were good, why not have them do the advisory work?
Also, some (many?) partners are too focused on bringing in the new business to even worry about their audit clients. I have seen partners who will charge X hours a week to a client just so that they can show inspection teams that they were involved with the work – regardless of what they actually did, even if those audit clients are large, complex clients in their own right. As we’ve seen in other posts on here, I have seen and heard the view from certain areas within the firm is that audit work is essentially second tier i.e. that in itself won’t get you promoted. It all comes down to selling – if you don’t sell you won’t progress. Not exactly the model to promote the public interest and ethical standards that many of us signed up for every year in our annual returns is it?
>>The SEC fears that directors and auditors could cut secret deals under which auditors are given proportionate liability in return for glossing over the company’s accounts.<<
The SEC must not have much faith in an auditors if they believe that the auditors would consider entering into “secret deals” – the SEC apparently believes that auditors are unethical. So what’s the point in an audit performed by unethical accountants?
ex-DT @ 15 —
Well, my experience must differ from yours. I personally saw job after job overrun and/or not deliver expected results, though to tell you the truth it was uneven throughout my career, meaning that some firms performed better than others. One of the more interesting causes of project mismanagement was staffing related: putting the wrong partner on the engagement, the wrong Sr. Manager, etc. In my area there weren’t enough knowledgeable partners, and those that existed were sometimes told to hand over the work so that a certain partner could make her numbers, or so a certain practice could record the revenue. Never mind that the person running the job didn’t understand the work, or the client, or the industry.
As far as partners selling versus running projects, yes I agree. But that is the Big 4 paradigm. As others besides you and I have posted, the road to success is to sell, sell, sell. But I would say that selling audit work (or consulting work to audit clients) can also lead to success.
— Tenacious T.
@ Tenacious T
I wasn’t necessarily linking the failure of auditing to the failure of capitalism (nor would I necessarily use the word failure in an unqualified way to describe either). In fact when people have a crack at capitalism’s drawbacks (currently fashionable) my response is usually to ask “what else have you got?”.
Having said that I think the state of public audit is more parlous than the state of capitalism, but I still have a feeling that we may be tearing this thing down without too clear an idea of what may turn up in its place. I take your point that the answer to that may be “nothing, there are plenty of other levers to pull to bring down errant companies, and audit adds no value towards their identification.” (or am I misreading you?)
I worked in consulting at Deloitte and PwC (post IBM sale, when they began getting back into the game). Conversations I had at Deloitte with consulting partners would often centre on “why bother doing this audit stuff, given how it gets in the way of consulting opportunities” (that was the partners’ opinions as well as mine). The answer to this is (of course) “because audit work is all gravy. In return for bearing risk it is incredibly profitable work, so long as you manage the risk effectively”.
In light of recent developments, one would ask if the risk, both to the brand and to the organisation, is worth the gravy anymore. Is it necessary to perform public audit in order to be a “Big Firm”? If they don’t do it, will they still have the cachet? In Australia Deloitte, incredibly audits only 1 of the top 100 companies (or did last time I checked). Yet their consulting business is the best of any of the big four (arguably, but that’s my opinion). Big clients use them despite their not really being a firm of much weight, audit wise, locally. And the consulting work is pretty profitable too.
Your final question seems to be “are these firms actually really all that good at anything much, really?” In the end we can have opinions about this but the ultimate test is whether they keep getting work. At least in advisory work clients take the advice, it works or it doesn’t, and they will either use that firm again or they won’t. (Now who’s Pollyanna?) But what else have you got in the way of a test of their work’s true quality?
JW
JW @ 18 —
Like me, you’ve worked at more than one firm, so you understand the commonalities between the firms. PwC or DT or EY or KPMG: It’s all about selling, not executing. Selling a consulting project to a non-audit client is less risky that selling a consulting gig to an audit client (at least in the U.S.), but selling an audit to an SEC registrant carries its own risks — among them the likelihood that you may lose out on a significant portion of non-audit work for that client. Risks are everywhere, and I know from my experience that the firms are largely blind to the larger operational risks, and choose to focus instead on small risks that are easy to manage.
(I now work at a publicly traded manufacturing company whose Big 4 auditor is completely prohibited from performing non-audit services, even if such services are benign by SOX standards. A couple of years ago, a corporate spend analysis revealed that our largest single vendor was our external auditor. No supplier approached our audit firm external audit and consulting spend. And that not only scared some people (from a COI perception standpoint) but it also, quite honestly, angered them as well. Nobody could understand how the external auditor became the largest single vendor to our company. But we Big 4 alumni understand, don’t we?)
You note that audits, if managed properly, are a consistent source of revenue with enough margin to cover the risks, a nice foundation (if you will) from which to sell consulting services. Back in the day, when we performed both external audits and consulting services (and internal audit services) to the same companies using exactly the same staff, it was clear that audits were high utilization, low margin business, while consulting projects were low utilization (from an annual standpoint), high margin business. We used audits to train staff and to keep them busy, while using the more senior staff to sell and execute consulting work. What a wonderful world that was! (If you were a partner.) But nowadays that model doesn’t work and, while SOX masked the holes in the business model, we now see that firm leadership failed to identify the need for a fundamental paradigm shift until it was too late, and in any case lacked the necessary strategic vision to find a new model that balanced risk and reward in the new post-SOX environment and/or to successfully implement it.
One final thought. You state that the ultimate test of the firms’ competence is whether they keep getting work. Given the current oligopoly, with only 4 firms having the global scope and depth to address some of the companies’ needs, I’m not sure that’s a valid test. If you take any one firm’s consulting practice and compare it to, say, Huron or Navigant or FTI, it’s hard for me to see a significant difference. I believe AC – I mean Accenture — is in a class by itself. If they ever rebrand themselves away from ERP implementations (as they are desperately trying to do) then I expect they will gobble up market share.
But clearly, the “Big 4” brand is still intact (for a while, anyway) and carries a lot of cachet. It used to be said that nobody ever got fired for buying an IBM PC (even though there were equivalent lower-cost options available) and I suppose it could be said that nobody ever got fired for hiring a Big 4 firm. As bodies flee or are booted from the Big 4 and beef-up the competition — and pending litigation taints the brand — I expect that situation might change in the future.
Take care.
— Tenacious T.
The secret is that the entire point of SOX was to generate more revenues for the big accounting firms to replace what was lost after the forced consulting arm purge.
@BobFromAccountTemps
So true about SOx. Unfortunately for the firms, it was a double edged sword. With the revenue came increased supervision and “second-guessing”, although the PCOAB has only created fodder for lawyers – if they would only use it – not real enforcement.
Francine
The sorry thing is that there is no fix for any of this and if you think there is you are naive. I read this blog once and a while and all the time its “down with the auditors”, however I never ever see a proposed solution from anyone. Why? because there isn’t a good one out there. Name one regulatory body (government or not) that actually does a good job of regulating? SEC – Madoff, FBI and CIA – 9/11, FDA -Voixx…. the list goes on. You aren’t going to be able to catch everything all the time, it’s a FACT. Maybe we should start being allowed to waterboard the finance staff. That would get us some answers on where the bodies lay.
The solution lies with the shareholders of the corporations that have abdicated their roles in the process of managing these companies and the move away from people owing shares to investing in investment funds.
The investment funds are not reliable shareholders where it comes to electing firm management and the backroom deals that go on between a firm and these largest investors is more than suspect.
If WE the people don’t run these corporations, corporate greed will; we then have nobody to blame but ourselves.
A change is needed. New rules for external auditors, audited companies and regulators. Independence is the key word. External auditors should be paid and nominated by government regulators. Not from the companies.
Paid and nominated by the Government? That’s a horrifying thought. Bringing more politics into the audit process would just make things worse. Much worse.
There is going to be a HUGE bottleneck because of the lack of CPA’s in the future. Big 4 better see this coming, many associates are putting in 2 years and then bailing for private work without getting their CPA. Why put in the time/effort/money to get a CPA when there are greener pastures. Why stick around in a firm with average pay when you can work 40/hrs in a private industry after putting in 2 years at a firm. This won’t end pretty and I see congress being lobbyed to scrap the idea of a CPA anyway if this happens. Many of my collegues are getting paid much more in private industry and many university students are going straight to govt and private now.
@26
No, no, and no. The prospect of having Big 4 on the resume keeps the smart ones going public. They know they should stay until after 1 year as senior or 1 year after manager. By then, virtually all have their CPA’s. You’re hanging with the wrong crowd if you think no one is getting their CPA’s, and if you think everyone’s going straight to private or gov’t.
I agree with thinker. Everyone has this preconceived notion that if you farm out anything to the goverment it will be destroyed. Look around, the private sector hasn’t done much better. Left unchecked, capitalism would have all your kids’ toys made from lead and asbestos in China by a 6 year old child that’s being forced to work in the factories that are spewing metric tonnes of greenhouse gases. All because the gross margins would look good and a CEO can get a big paycheck.
It’s a little ridiculous having multiple different entities putting out multiple different pronouncements that most of the accountants can’t keep up with anyway. Then you have a bunch of private companies that are charged with implementing these pronouncements and protecting the public good, all the while trying to make the biggest profit they can. The big shots are lobbying and in charge of the very functions that are supposed to be “regulating” their business, which should essentially be a not for profit. The goverment then audits a couple of engagements at these companies and basically tells them a bunch of stuff they’re doing wrong.
Anyone else not seeing any issues?
Why not cut out the middle man and have one agency that’s charged with setting the standards and implementing them. You would get the average charge hour rate way down, in fact I’ve been on some engagements where the company could have hired the entire team (minus the partner) for an entire year at their current salaries for the amount that they were charged. You could have people there more consistently, at a much lower rate, trying to implement the rules that the agency they work for are putting forth.
Let the socialism and “goverment can’t tie their shoes” comments begin.
Viva le capitalisme
@22 CPA
If both are going to screw up, at least the government does it for cheaper.
weak discussion
What you fail to realize is that there is an incredible cost to doing an audit besides the staff’s actually salaries. All the large firms put a tremendous amount of money into research and training. I’m not opining on whether or not it’s a good idea, but Deloitte is currently putting $300 million into building a training facility in Texas. The money has to come from somewhere. In addition, legal costs are quite staggering, particularly in the current environment. Oh, and one more thing. The PCAOB is staffed primarily with ex-Big 4 auditors – the people that know what to look for and hopefully how to properly execute an audit. In case no one has noticed, I’m very opposed to this idea of government performed audits.
The PCAOB is staffed primarily with ex-Big 4 auditors
One of the problems exactly…also, it is no question audits would be cheaper, though you can debate quality all you want. If we’re so anti govt, why don’t we take the FDA and break it up into 10 big, for profit companies and then tell all the drug companies that they need to get approvals from one of these companies to sell drugs to the company. Then, on top of that, make the drug companies pay these firms and have them bid for work. I’m sure you’d feel really great opening a bottle of the latest childrens drug for your 3 year old.
I know many will say either “the FDA has had mess ups” or “the threat of litigation will keep them honest”
1) yes the FDA has messed up, but if the FDA had messed up with the equivalent of the enron/worldcom debacle alone, thousands would most likely be dead.
2) maybe litigation will keep them honest. Do you want it to be your child that suffers before this stuff gets to the courts? If its in litigation, than that means something bad has already happened.
I wish someone would do a serious, independent study on different paradigms for audit and not just parrot off the hackneyed “government is incompetent” arguments.
@Okay
Just because your royal highness thinks this is a weak discussion doesn’t make it so. Please get over yourself.
Francine, excellent article and discussion. I recently wrote an article in my blog shedding light on this problem from the Internal Audit perspective. Most of these problems are not new, but as always, when bad times come, all the warts no one cared to see before, come to light!
My suspicion is that when all the smoke clears, there will be more of the same. With new rules, new requirements and new guidance papers. Addressing the underlying root causes of the current mess is unlikely to happen because no one in the political establishment understands or has anything to gain by it. The blame game however is easy and cheap to roll out. It is simplistic to blame the Auditors en masse for what has happened and will continue to happen. There are thousands of honest and ethical auditors who have to deal with these problems on a daily basis and have few options aside from dismissal or changing careers. We auditors are just one leg of a Centipede which we do not control, or have much influence over. Having said that let me also add that I agree with you regarding the Big Four. There is just too much smoke in the room for there not to be at leat a little fire!!