Not Over Until It’s Over: Price Waterhouse India Settles Satyam

“The reliability of global capital markets depends on auditors fulfilling their obligation to investors to perform robust audits, resulting in well-founded audit reports. Two of the PW India firms, PW Bangalore and Lovelock, repeatedly violated PCAOB rules and standards in conducting the Satyam audits. These confirmation deficiencies contributed directly to the auditors’ failure to uncover the Satyam fraud.”

James R. Doty, PCAOB Chairman

We waited eight hundred and eighteen (818) days to see Price Waterhouse India held accountable for audit failure at Satyam Computer Services, the NYSE-listed Indian IT services provider. On April 5, 2011, the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) announced settled disciplinary orders against five firms, members of the PricewaterhouseCoopers LLP (PwC) global network, for violations of PCAOB rules and standards and for violations of federal securities laws as well as improper professional conduct by PW India while PW Bangalore served as auditor of record for Satyam. In addition, the SEC also sanctioned the PW India firms for, “violation of Section 10A(a) of the Exchange Act by failing to conduct procedures designed to provide reasonable assurance of detecting illegal acts that would have a direct and material effect on the determination of financial statement amounts.”

The PCAOB had to admit that they missed the fraud and the pervasive country-wide auditing standards violations when they inspected PW India and the Satyam engagement in February 2008.

The sanctions are significant. When the scandal hit, PwC started making changes right away to the organization, including bringing in outside talent to conduct a review of every audit involving a foreign issuer.

The monetary penalties are not significant, in spite of the fact that they are the largest ever levied against a foreign registered audit firm. In my opinion, if a combined fine of $7.5 million is a record, that only proves how lackluster prior SEC enforcement against foreign registered audit firms has been. It also shows how crippled the PCAOB has been to even inspect many foreign audit firms, let alone pursue enforcement issues in a timely and vigorous manner since its establishment under the Sarbanes-Oxley Act of 2002.

There were no SEC or PCAOB disciplinary actions against Deloitte Netherlands for the Ahold fraud, although the Dutch accounting regulators censured the firm and the partner responsible for the account.

There were no SEC or PCAOB disciplinary actions against Deloitte & Touche International, Deloitte US, Deloitte Italy, or Grant Thornton for the Parmalat fraud, even though all of them settled with the company and other shareholders. The Parmalat fraud was also perpetrated by management’s use of forged confirmations. The auditors violated standards and were accused of a profound lack of professional skepticism.

There were no SEC or PCAOB disciplinary actions against PwC for the Yukos scandal.  I started writing about Yukos in March of 2007. That’s more than four years ago! Reports have been open and consistent in saying PwC was pressured to withdraw ten years of audits as part of a Russian government prosecution of former Yukos chief Mikhail Khodorkovsky and his business partner Platon Lebedev. PwC is using the “we were duped” defense.

There were no SEC or PCAOB disciplinary actions against PwC or its Japanese firm for the Kenebo and Nikko Cordial scandals. PwC subsequently shuttered its Japanese firm and restarted under another name. I guess it was impossible to cleanse the reputation of that horribly tainted firm.

It’s the potential for sudden conflagrations in developing countries that keeps the global audit firms – PwC in this case – up at night. The legal quagmires in developed countries are messy, too.

The audit firms’ global networks are loose confederations of independent legal entities tied together only by their greed and the dependence of the less powerful member firms on the more powerful ones through the legal construct called the international coordinating firm.

If only the plaintiffs’ lawyers would get it straight and realize that the member firms are not agents of the international firm. The international firm is a sham vehicle used to impose the will of the powerful firms on the less powerful firms via the Global Board of Partners. This is the key to winning against the US, UK, and the international coordinating firms.

The loss of a major network member firm from regulatory or legal actions  – Japan, Russia, Germany, Australia, the UK, India, Ireland, and soon China – would mean the end of these networks as we know it. But will local regulatory and political forces allow it?  This is the closest we’ve come to regulators shutting down a foreign audit firm and, yet, the firm was allowed to essentially start over with generous help from the rest of the PwC global network. As serious as these sanctions are against PW India – and they will be costly – this decision essentially allows history to keep repeating itself, over and over, audit failure after audit failure.

It’s moral hazard at its highest level.

When Arthur Andersen imploded the opposite occurred. The indictment of the US Andersen firm meant all the other AA firms around the world were suddenly left out on their own. They were free to make new alliances in order to serve their local clients and to participate in the work needed to service multinationals doing business in their country.

Today, it’s not the US firms that are most seriously threatened with extinction – although there are significant threats such as to Ernst & Young with regard to Lehman. The larger threat is to one or several of the large member firms outside of the US as a result of scandals such as Satyam, Glitnir, and Yukos.

When the news of the SEC and PCAOB disciplinary orders broke on April 5, I wrote this in Forbes:

PwC believes that the US regulatory actions against PW India are over.

“These settlements, in which PW India neither admits nor denies the U.S. regulators’ findings, apply only to the U.S. regulatory enquiries into Satyam.  Neither of the orders found that PW India or any of its professionals engaged in any intentional wrongdoing or was otherwise involved in the fraud perpetrated by Satyam management. The settlements mark the end of the Satyam-related U.S. regulatory enquiries concerning PW India and are a positive step and important milestone in putting the Satyam issue behind PW India. PW India remains hopeful of resolving the outstanding enquiry with the Indian market regulator.”

PCAOB board member Jay Hansen and Director of Enforcement Claudius Modesti were interviewed on April 9 by Menaka Doshi for CNBC India’s The Firm. Doshi conducted a long and thorough interview that included several questions about future enforcement actions against responsible individuals at the leadership level, in addition to the general actions against the PW India audit firm.

Doshi wanted to know if Hansen and Modesti agreed with PwC’s statement that, “Neither of the orders found that PW India or any of its professionals engaged in any intentional wrongdoing or was otherwise involved in the fraud perpetrated by Satyam management.”

The SEC’s order says their investigation is continuing. Claudius Modesti was circumspect in responding to Doshi’s questions – in particular about hypothetical future findings of collusion on the part of PW India or its partners – but he was emphatic:

“The statement you are referring to is their statement not the Board’s… I do not view the Board’s enforcement order as absolving…I can’t comment on the rest of our investigative process because it’s confidential… If courts of law or other regulators are developing new facts or making findings we are always going to be mindful of that…The SEC has its own laws and regulations on its process…”

This case, in my opinion, is not closed.

Thank you for reading to the end.  This post is the 1000^th entry on this site.

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