I’m visited North Carolina State University, Raleigh-Durham, last week at the invitation of Scott Showalter. Scott is Professor of Practice in the Poole College of Management and School of Accounting.
Scott and I go way back. He retired from KPMG in July of 2008 after 33 years of service and held many leadership positions there and in the profession. When I joined the firm in 1993, my first role was as a consultant in the Public Services practice, implementing KPMG’s proprietary financial software for state and local governments. During my tenure with KPMG, (1993 until I joined JP Morgan in Latin America in 1998 and the consulting firm turned into BearingPoint), Scott served as Midwest Leader of the Public Sector Practice.
Scott recently took a spot with the PCAOB Standing Advisory Group and that’s where we reconnected last March.
It was an honor for me to visit to speak to faculty, students in the Masters of Accountancy Program, and student groups.
Here’s a blog post about my feelings towards blogging and financial journalism.
Here’s an interview I did, on Twitter, about how to increase your professional visibility and showcase expertise.
Here’s something I wrote about how I track auditor litigation with limited resources. Lots of good resources for you.
Here’s a post at Forbes about fraud and accountants. Can skepticism be taught?
Here’s my “Speaker” page with links, videos and ideas about other speeches I have given and can give.
One of my most popular posts wasn’t even written by me! “Why Bother Becoming A CPA?” by Roger Phillips of Roger CPA Review.
I have two e-books on the Kindle with more to come. One is a compilation of articles about a career in the Big 4.
Here’s the text of the speech I gave to the North Carolin State University accounting clubs meeting last Tuesday night.
Thank you so much to Professor Showalter and North Carolina State University for asking me to speak. It’s enormously rewarding to me to be here amongst accounting students and accounting educators.
My mother always thought I would be a teacher. I became an accountant, a CPA, a banker, a manager, an internal auditor, a consultant. Those are all very noble professions. So it’s an honor to be here sharing my thoughts with a group of accounting professionals. Because as much as I am now a writer and speaker, I am still an accountant, with an accountant’s view of the world.
I also consider myself a professional.
I’ve worked a lot of different places over the years and I’m no different than you in finding the world we live in a constant professional challenge.
I think you will face more than one ethical dilemma during the first year of your career at a large public accounting firm, corporation, or government office. In public accounting firms, which are my primary focus, the landmines are everywhere.
You may have to decide whether to check a box for a test or review that wasn’t done. You may be asked to create or backdate a workpaper to complete a file before a quality review or PCAOB inspection. You may be pressured to falsify their timesheet to stay under budget for their part of the engagement.
You may see something and want to say something.
Will you? Should you? Can you?
Some of will make difficult decisions to speak up. Some will go along to get along. Keeping your head down and your mouth shut is self-interest and career survival. The pressure to succeed, to make those in your life proud, to maintain physical, financial and job security can chip away, day after day, at your self-esteem as professionals and your ethical resolve.
I’ve embraced a new profession in the last five years – journalism – that has its own list of ethical standards if you want to survive and be taken seriously. But journalism is a profession with a voluntary set of standards and code of ethics, not the legally required ones we have to adhere to.
So, what are the standards accounting professionals must acknowledge and adhere to?
First, let’s differentiate between an “accounting professional” and the accounting or audit industry where many professionals practice.
Those of you who are CPAs and teach can attest that I’m talking about two different things. Accounting professionals work in industry, government, politics, journalism, academia, and other vocations in addition to public accounting firms.
What does it mean to be an “accounting professional”?
The AICPA Section 50 principles of professional Conduct starts out:
- By accepting membership, a certified public accountant assumes an obligation of self-discipline above and beyond the requirements of laws and regulations.
- The Principles call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage.
- A distinguishing mark of a profession is acceptance of its responsibility to the public.
There’s more but that’s the gist of it. If you work in client service, if you are a CPA, your first obligation as a professional is to your client – not your firm, your partners, or even your family.
If your client is doing something illegal, then your obligation shifts to society and to law enforcement. That may seem harsh, but it’s the code that’s supposed to insure that lawyers and accountants, for example don’t cut corners out of their own self-interest and to the detriment of their client’s interests.
Many of you will go to to work for public accounting firms. In the United States, certified public accountants are the only authorized non-governmental type of external auditors who may perform audits of financial statements and provide reports of those audits for public review, submission to the SEC, and to comply with exchange listing standards. In the United States, the firms and their state-certified, licensed professionals are also required to be independent of the entities being audited.
Public accounting is an industry that employs many accounting professionals, as well as lawyers and other professionals. Each group has its own set of standards and a code of ethics. As a regulated industry, all employees of public accounting firms have an obligation to behave within laws and standards governing that industry that are intended to protect investors and serve the public’s interest.
Look at the four largest global public accounting firms. They officially operate as a loose confederation of separate private partnerships for legal reasons and to insure secrecy, but their size and complexity makes them look more like corporations to the outsider. They manage by consensus, but in reality a limited number of partners lead the firm and make decisions on behalf of thousands of “partners” who are more like highly paid executives.
The top four firms – Deloitte, Ernst & Young, PwC, and KPMG – generate more than $100 billion in total revenues globally and employ more than 600 thousand people. As auditors and advisors, they work inside the banks, brokerage firms, auto manufacturers, mortgage brokers, and homebuilders.
Here’s an example:
KPMG audits Citigroup, Wells Fargo – who now owns client Wachovia – GE, and GM. They used to audit two big mortgage originators before they blew up – Countrywide and New Century. They also used to audit Fannie Mae and Moody’s before they were fired and sued. They also audit the US Treasury.
PricewaterhouseCoopers audits JP Morgan Chase, Bank of America, Goldman Sachs, AIG, the Federal Home Loan Banks, and Freddie Mac. PwC is also responsible for Satyam, Northern Rock in the UK, Glitnir in Iceland, and Russia’s Yukos.
Deloitte, who is now Fannie Mae’s auditor, was also auditor of four other housing related companies that had issues: Taylor Bean & Whitaker, Beazer, Novastar, and American Home. (The bank that TBW bankrupted, Colonial Bank was audited by PwC.) Deloitte audited three no-longer-independent large firms sunk by bad mortgages: Merrill Lynch, Bear Stearns, and Royal Bank of Scotland. Deloitte used to audit Washington Mutual before it was taken over forcibly by JP Morgan. They also audit the Federal Reserve Bank and Buffett’s Berkshire Hathaway.
Ernst & Young, everyone knows, audited Lehman Brothers. But don’t forget UBS and Societe Generale, home of the “rogue” traders, and Anglo Irish in Ireland. EY also audits News Corp and S&P, the ratings agency.
The Big 4 are still at standing at these executives’ right hands. They are also earning more fees helping the US federal government under TARP to organize and control the taxpayers’ new investments in subprime loans, non-liquid assets, and exotic financial instruments.
The public accounting firms make money whether companies thrive or whether they fail. That may sound good for you, as students, and good for you as mentors and coaches encouraging your students to work for the firms.
However, don’t forget the firms actions at the beginning and in the midst of the financial crisis. They kept the recruiting pipeline from schools open as long as possible and started cutting new hires with sometimes less than one or two years experience.
The revenue model of professional services firms is based on hourly rates and that means people. More people equals more billable hours assuming there’s demand, but more fixed expense. If demand goes down or the market contracts as it did when some firms lost clients through failures and acquisitions like Deloitte, they start laying off. And they have less people work more hours. They’re on salary, after all, not hourly. And they replace higher paid professionals with lower paid professionals. They even cut partners.
That’s called the leverage model.
Once you go to work for the firms, you’ll be forced into the reality of auditor litigation and constant reminders of risk, independence, and quality policies. You’ll see your firm’s name in the paper more often now than ever before. You should think hard about some serious industry issues:
- Should auditors be immune from liability or accountability for their malpractice and when they’re guilty of aiding and abetting fraud? That’s the “safe harbor” proposals some advocate. But in reality it’s moral hazard.
- Does the “too few to fail” argument have merit?
- Is it realistic for us to expect auditors to acknowledge a public duty?
- Do audit firms have a right to look after their partners and their profits before the public?
- Do accountants working in for-profit private audit firms still feel like professionals? Are they treated that way by partners and clients?
- Can large audit firms ever maintain ethical standards, as a firm and as a group of individuals?
- Whose ethical standards should the firm and the individual uphold?
- Can an individual who would otherwise be ethical or at least true to his own values, become compromised while working for a larger firm?
When a professional services firm strays from the principles in AICPA 50, it runs the risk of sacrificing values, culture, a code of ethics and the requirement to put the client’s interests above the firm’s. That’s what it means to work in a firm made up of “professionals.”
A corporate structure rather than a partnership, for example, means a professional services firm has to focus on financial results and meeting shareholder expectations rather than meeting partner expectations within the constraints of the values, expertise and professional code of ethics that the firm agreed on when it came together.
Some interesting examples of corporate model professional services firms with varying levels of success are:
- BearingPoint a spin-off of KPMG (They went bankrupt and big pieces were bought by Deloitte and PwC.)
- Accenture, Huron Consulting and Protiviti all have an Arthur Andersen pedigree,
- Resources Global, a spinoff of Deloitte.
- Cap Gemini has a large piece of Ernst & Young’s consulting firm that was spun off in the heat of Sarbanes-Oxley.
Growing too large or acquiring firms that have very different values or culture, even within the partnership model, can also stretch the limits of aligned behavior.
One legal case that will have a significant effect on how employees of the audit firms view themselves and how the firms view their contribution is the class action in California, Campbell v Pricewaterhouse, a lawsuit about overtime.
Several overtime lawsuits are pending against some of the major accounting firms doing business in California. These suits were filed by non-CPAs, non-licensed associates (entry level college graduates), who believe they were misclassified under California law as exempt professionals and are due overtime and other benefits due to non-exempt employees.
A few states like California, Wisconsin, and Massachusetts – and Canada where similar suits were settled with very little notice here – have wage and hour laws that are perceived as more employee-friendly.
I have mixed feelings about these lawsuits. In twenty-five years of working as an accountant, consultant and internal auditor, I have never been paid time and a half. When you choose to work in a profession, you don’t expect it.
My father belonged to three unions and has pensions and generous health benefits in retirement as a result. When I was growing up, as the oldest of six on the South Side of Chicago, his overtime pay as a fireman and bricklayer was what made extras like vacations and college possible. But it was the dream of an easier life for their kids – we’d earn higher pay for less manual labor because they had worked long and hard to educate all of us – that drove my parents to give us the chance for a “professional” career.
Many college graduates, these days, don’t see the point in working eighty hours a week during the busy tax or audit season for a fixed salary. When they calculate their hourly rate, even given the fairly generous salaries, signing bonuses, and benefits the best and brightest get as new Audit Associates, many question the total cost of the sacrifices they’re making.
All they see are strained relationships with family and friends, excessive stressful travel, late nights spent performing mind-numbing “monkey work” on laptops, non-stop scanning and photocopying, fewer partners and opportunities for promotion, and very little use of the ambition and brains they thought they were hired for.
It’s no wonder that when the firms started cutting staff during the general economic slowdown, when Sarbanes-Oxley work slowed and then the financial crisis hit, accountants starting careers in the new millennium had to squint to see the light at the end of the tunnel.
Although the state and federal wage and hour laws governing eligibility for overtime pay are complicated, the public policy issues they present for audit firms are not.
The largest public accounting firms want entry-level accounting graduates to feel like professionals, by virtue of their university degree, the potential to take the Certified Public Accounting (CPA) exam, and their eligibility to be licensed eventually. But when it comes to eligibility for overtime – or rather exemption from overtime – it’s not who you think you are or where you came from but what you actually do that matters most.
The education of accounting majors consists, in the worst case scenario, of being “taught the exam” and, in the best case, of four to five years of head-down, hard-core study and rote memorization of facts with rarely any time for other outside reading, enrichment, travel, or world view development.
The suits are all in various stages but Campbell v. PricewaterhouseCoopers is the fastest moving. A judge agreed in 2009 that the audit associates at PwC in California are not exempt from overtime pay under the 2001 wage order. This decision was appealed by PwC.
The Ninth Circuit Court of Appeals accepted the case and Campbell was argued in June. The appeals court reversed a portion of the decision and the case will now go to trial. If it’s not settled first.
Using the Masters in Accountancy degree in order to reach the 150-hour CPA licensing requirement also complicates things in some states.
If some of these lawsuits are successful, universities that provide their states’ CPA hour requirements without the necessity of a graduate degree may doom their graduates to status as “para-accountants” until licensing?
There’s an economic argument at play here: In this environment more work produced for less pay is both tolerated by labor and a business model that rewards firms with higher profitability.
But there’s also a practical regulatory issue at stake: Can the regulators allow audit firms – who play a role as critical regulatory cogs in the financial system wheel – to delegate more judgment and decision making over financial reporting and disclosure to the lowest level of staff because they are the per-hour cheapest?
Individual assimilation and success in a Big 4 public accounting firm starts with selection based on university credentials, referrals from professors, family background, and business ties, as well as having political beliefs and economic philosophies that are aligned with firm values. This process now starts in some universities in freshman year, with some students having two or three internships before they graduate.
For some students it starts even earlier. One or both parents work for the audit firms and the career is one that has always been considered a safe choice. That’s especially true if the apple doesn’t fall far from the tree in talents and personality.
Auditors often marry other auditors or accountants because in school or in their early career they have no time to date anyone else!
Internal operations of the public accounting firms, especially the largest ones, are conducted in a secretive manner. Financial results and common business metrics are minimally disclosed to the outside and on a “need to know” basis even internally. Once initiated into firm culture, survival requires adoption of an informal oath of allegiance that makes it shameful to betray even one’s deadliest enemy, your competitors, to legal and regulatory authorities. It’s a Big 4 type of omertà, the extreme form of loyalty and solidarity in the face of authority usually attributed to the Mafia.
Examples of an extreme sense of loyalty to even those who’ve disgraced the profession can be found when partners that have been sanctioned by the SEC, forbidden to audit public companies, are later reinstated. Deloitte, for example, kept the partners responsible for Delphi and Navistar on their payroll during their SEC suspension and they survived the sanction to audit more public companies.
Only in cases of potential criminal indictment, such as insider trading or the tax shelter scandals are individuals thrown under the bus by their firms. That’s because the financial and reputational risk to the firms of not cooperating with a Department of Justice criminal indictment is more significant than the cost of defending and typically settling private securities litigation.
Private parties have significant difficulty getting fraud suits against audit firms past the complaint stage to discovery and a trial given the higher requirements for pleading based on the Private Securities Litigation Reform Act of 1995. Investors have to present hard evidence such as whistleblowers or leaked documents very early in the process to prove complicity in the fraud or deliberate fraudulent behavior on the part of auditors.
When was the last time you heard about a whistleblower from one of the Big 4 firms?
In addition, the federal authorities are fiercely reluctant to be the instrument of destruction of another firm a la Arthur Anderson via a criminal indictment or a significant SEC civil complaint. That means the auditors have as much moral hazard now under the “too few to fail” doctrine as the banks have under “too big to fail.”
However, that doesn’t mean the audit firms aren’t faced with an enormous amount of litigation they spend significant time and money fighting.
And we haven’t even gotten started with holding them accountable for their role in the financial crisis.
It’s not easy for an individual external auditor to step up and do the right thing. The model of providing audits, a critical public service meant to protect shareholders via a profit making private partnership, often encourages “behavior that must be regulated.”
Many accounting professionals who work for the audit firms write me to ask about their “true client.” They have either never been taught this concept or had it beaten out of them by the reality of which behavior is rewarded at their firms.
The client for audited financial statements is the shareholder, not the company management. The Audit Committee of the Board of Directors, who hires and is supposed to manage the external auditor. The Audit Committee represents that shareholder client but has a legal duty to the corporation not the shareholder. Other stakeholders include bondholders, lenders, employees, vendors/customers who depend on the continued viability of the company, and regulators (whose role is to protect investors and overall capitalist system.)
When professionals forget or suppress acknowledgement of their true client, an auditor loses the ability to properly structure decisions with moral and ethical implications, let alone those with serious legal and regulatory ones. In the face of potential legal implications of a decision, they seek to avoid personal liability. In the face of a moral or ethical dilemma, they look at costs/benefits of looking out for their own financial self-interest, at an individual and at a firm level rather than shareholders’ and society’s interests.
Major investors have told the PCAOB that they feel they’ve been left out.
I believe auditors demonstrated a profound lack of professional skepticism and professionalism during the crisis. They ignored the possible motives and motivations of their audit subjects.
Rather that assuming executives, and possibly the Board of Directors, are self-centered and human, they accorded them the highest form of deference. In the interest of maintaining financial and social relationships, in my opinion the auditors did not sufficiently challenge and expose the survival instincts and financial incentives of corporate executives and board members. That may be because the firms, paid by management, have their own financial incentives to stay quiet.
Whistleblowers and those that push unpopular ideas or try to report on wrongdoing often lose their jobs, are vilified by the former employers and sometimes their former colleagues, are often disbelieved and laughed at, attributed with bad attributes and intentions such as revenge, anger, payback, whining, mercenary goals, bitterness, spite, Don Quixote-like tilting at windmills, unreasonable idealism, and impractical expectations.
Whistleblowers are often very right, but often end up being right all alone.
How many times has an external or internal auditor been told when raising concerns or questions about lack of segregation of duties, improper expense reports, lack of proper authorizations for stock options or shady compensation decisions:
“He’s a man of integrity. He lives this company. He is a pillar of the community. He donates to charity. He is an elder statesman of the industry. He has unquestionable, unassailable ethics and cares about this company.”
Speaking up can be a career- limiting move, threatening your own livelihood in addition to the success of your office, your practice, and your firm.
But auditors, who are inevitably almost always CPAs, have a higher responsibility. Making the type-two error of being right in your suspicions of illegal activity and potentially enormous harm or loss and not acting on them is completely unacceptable.
Don’t let anyone ever tell you again, after Madoff and the rest of the cases of hubris we have seen during this ignominious year, that any man or woman is above suspicion.
Professors: Please teach your students the principle of professional skepticism.
Students: Never stop questioning authority.
The PCAOB, under the leadership of new Chairman Jim Doty, is raising many of these issues and speaking frankly and consistently about them. Professor Showalter sits on the PCAOB’s Standing Advisory Committee and has heard the same heated exchanges as I have. Some recognize the need for change and others will fight to maintain the status quo at any cost to the profession.
We can wait for regulation to change. But we can also act every day to promote positive change in the profession. Your attitude, your actions, and your focus on independence and integrity can force change, too.