‘Independent’ Directors for the Audit Firms: Much Ado About Nothing”

This was originally published at GoingConcern.com on July 7, 2010.

You might as well be trying to save walruses from an oil spill in the Gulf of Mexico. The Big 4 audit firms response plans for catastrophic litigation, if they exist, are likely cookie-cutter boilerplate, out of date, irrelevant, and prepared by the same go-to defense lawyers that shill for them and repeatedly negotiate settlements for them.

The Center for Audit Quality (CAQ) probably does the photocopying.

Henry Waxman, the chairman of the House Energy and Commerce Committee, via The Daily Kos:

“The same company, The Response Group, wrote the five plans, and described them as ‘Cookie Cutter’ plans.  Much of the text is identical. Four of the plans discuss ‘How to protect Walruses‘. But there are No Walruses in the Gulf of Mexico.”

Certainly there’s no plan in place as a result of so many studies and committees over at the SEC (CIFR in early 2008) or Treasury (ACAP in March 2008). Each time one of those groups get together, calling on all the old familiar names and rehashing the same well-worn arguments and suggestions for averting the next auditor failure over and over.

During the tenure of SEC Chairman Cox, the issues were studied to death but the suggestions and recommendations of the strongest critics of the profession such as Lynn Turner were dodged in favor of a business-friendly approach. Why do large public companies favor protecting the audit firms from catastrophic liability and profound business model change?

• Large public companies like what they know, can plan for, plan around and work with.  The current auditor model is predictable, especially now that the bite has been taken out of Sarbanes-Oxley as a result of Auditing Standard 5 and the acceptance of cost-cutting and cutting corners because of the recession.

• CEOs and Audit Committees who should be asking for more hard truths versus more cost savings from their audit firms are strongly influenced by CFOs and board financial experts who are ex-Big 4 audit partners.  These retired audit partners have a very strong vested interest in the survival of the audit firms, the continued cash flow to the audit firms and the accounting industry status quo.

An example of same-old, same old are the corporate governance reforms foisted on the audit firms in the UK. In addition to transparency in financial reporting (limited to the UK firms) there is also the suggestion of putting outside independent directors in place to monitor the Boards of Partners who run the firms. Ernst & Young has decided to adopt this practice at the global level.  Bully for them!

Unfortunately, when this suggestion was floated again as a result of the SEC CIFR Committee I had to call it “soap bubbles.” The biggest obstacle to this plan? Given the ubiquity of the Big 4 in the Fortune 500 and FTSE, it going to be virtually impossible to find truly independent directors to serve.

A short conversation with Jim Peterson, who called from his Paris pied de terre this morning, reminded me of the others:

“The probability that outside independent directors would have significant influence over the global leadership of these firms is nil. In the culture of private partnership governance, there is complete self-interest inherent in the limited tenure served by these leaders.  Such “reforms” are especially ineffective when limited to one country.  They don’t address the issues of practice quality or the risk to the global network of catastrophic auditor litigation that can occur, in reality, anywhere in the world.”