re: The Auditors on The No-Account Accountants
Posted by Christie Malry on April 23, 2010 at 2:30 pm
Francine McKenna unloads both barrels on the audit profession.
Every one of the audit firms is a defendant in lawsuits for institutions that failed, were taken over, or bailed out, in addition to several $1 billion plus malpractice, fraud and Madoff-related lawsuits. Any one of these “catastrophic” matters could threaten their viability. However, regulators and the worldwide business community are ignoring this threat or, worse yet, promoting liability caps. Limiting liability only exacerbates moral hazard.
I don't agree.
When companies fail, US lawyers circle like vultures. They bring a case on a no-win, no-fee basis. And then, having argued that auditors were not 100% blemish-free, they claim absurd amounts of compensation for their clients, from which they take an unhealthy cut.
Often auditors, as the last men standing, are the only parties - other than lawyers, of course - who have any money. Yet because they are not permitted to limit their liability to some reasonable amount, they are left to carry the can on damages. Auditors are a small, but important part of the corporate governance process, yet they frequently get hammered financially more than any other participant.
The fact that every Big 4 firm is named in litigation is little more than a function of the greed of US lawyers, the number of US listed companies requiring audit, and the small number of auditors able to do the work. No more.
As for the rest of Francine's article, it's easy with hindsight to say "the auditors should have spotted this stuff". Perhaps they should. And perhaps so should politicians, and banks, and investors, and ordinary borrowers.
I think it's unrealistic to expect auditors to go out on a limb when no other stakeholder is calling a halt to the party. And it's particularly unreasonable to do so with the considerable benefit of hindsight.
I also take umbrage with Francine's comment that:
Why didn’t the auditors question, push back, or raise objections to illegal and unethical disclosure gaps?
While S302 of the Sarbanes-Oxley Act might have pushed us more towards 'fairly presents' and slightly away from 'in accordance with US GAAP', it's unfair to expect auditors to do this on their own. Ultimately these decisions end up in court, many years later, and there's no guarantee that the auditor will win. Where a reporting company has complied with the letter of the standard - and many US standards are meticulously detailed as to what compliance means and requires - it's a tough call to ask auditors to override that in favour of 'fairly presents'.
For this to work, the regulators will need to take unilateral action first, to protect auditors from action from their clients and to be crystal clear that a higher standard than what's written in the standards is expected. We just aren't there yet.
[...] This post was mentioned on Twitter by Mark Lee. Mark Lee said: RT @fcablog: New blog post: re: The Auditors on The No-Account Accountants http://bit.ly/cXwJWd RT @retheauditors // Nicely argued. [...]
You don't expect much, do you, for the billions shareholders are paying the audit firms to protect their interests. What value do you see the audit product providing? Every failed and bailed out bank in US or UK had a clean audit opinion.
"...the regulators will need to take unilateral action first, to protect auditors from action from their clients..." You have it all upside down. The shareholders are the client. The auditors serve at their behest, as a public duty to them and to the capital markets.
BTW, the "auditors are deep pockets" whine does not stand up when they don't disclose a true GAAP or IFRS "audited" balance sheet, their litigation exposure/ contingencies nor the amount of legal reserves. I think they are much worse off than you suggest, and yet much better off because they have oligopolistic government sponsored franchises that prevents any serious regulatory reform or scrutiny.
Hi Francine
Your comments are good, and probably deserve an article in themselves, but for now I'll deal with them below the line.
I think you're being unreasonably idealistic about what audit can and should deliver. Audit is, remember, only "reasonable assurance", not absolute assurance. That means there will always be a risk that auditors do not detect material misstatements, even when they have followed auditing standards to the letter, and even when they have done a "perfect" audit, beyond what auditing standards prescribe. And none of us thought the banks would fail. The auditors would have had to go out on a limb to predict mass-failure, and would have faced considerable criticism for having done so. If you want a parallel, check out the (few) people who repeatedly called a crash in the UK housing market. They were derided at the time for getting it wrong, until ultimately they were proved right.
With respect to your second point, compliance with accounting standards is ultimately a matter of law. That means that were companies to have followed the letter (but not the spirit) of accounting standards, and auditors did indeed put their foot down, the only recourse companies would have would be to the courts. They would take their auditors to court, to challenge their judgement. Could an auditor defend having decided that, even though their client had followed accounting standards to the letter, something was still wrong, so the auditor wouldn't sign? I guess one could argue that the reputational damage would be too risky for companies. But no-one, not even investors, saw the crash coming. Would they really take the 'right' side in the debate?
I don't agree with your third point. We only have an oligopoly because investors, despite their frequent complaints about the Big 4, refuse to appoint auditors from outside their number. They're clearly happy with the service they're receiving, even if you're not.