Defending audit

Posted by Christie Malry on November 30, 2010 at 10:24 am

Ian Fraser has written an angry article slamming the Big 4 auditors' appearance in front of the House of Lords last week.  Now there's absolutely nothing wrong with writing angry blog posts (if there were, I'd probably have to retire) and Ian is very well worth following on Twitter.  Yet this isn't his finest hour. The hat-tip to Francine McKenna is a giveaway.

So here are the problems with Ian's analysis, as I see it.

Ian's basic argument is that the banks needed a bailout from the government very shortly after their accounts were signed off by their auditors.  The reason the auditors felt able to do this was that they had been told by government that the banks would bail them out if needed; accordingly the banks were considered a going concern.  Ian suggests that this means the auditors have failed in their responsibility to investors.

Now this is a boiled down version of the argument.  As I said, Ian is angry in his post, and the anger does rather get in the way of the coherence of the overall narrative. So I'm sorry if I haven't entirely done his argument justice.

I think the characterisation of the audit firms in his article is a shoddy rewriting of history, with considerable benefit of hindsight.  Back then, nobody had the remotest idea how the economic crisis would pan out.  Indeed, at the time the auditors were signing off the accounts for their clients, government wasn't even admitting publicly that we had a crisis.

That the firms were discussing these issues with audit committees suggests that, contrary to the McKenna/Sikka narrative, auditors had identified the right issues and were taking steps to deal with them.  And we can see that government was worried that, by doing what they have been tasked to do in auditing standards and in regulations, auditors might have made things worse.  So that's why government encouraged them to withhold their going concern qualifications (on the grounds that government would step in) instead of possibly precipitating the crisis by raising the alarm bells.

Technically the assessment that there's no going concern problem if you know government will step in is correct.  McKenna and Fraser might not like that, but it's a valid assessment.  Ordinarily businesses look to banks to cover their borrowing requirements.  A business that can't renew its borrowings will go bust.  But, if government is prepared to stand in, the going concern problem goes away.  Lloyds and RBS are still in operation. It's just they have government support now.

You might disagree with the audit firms for going along with this.  But the audit process is a legal requirement that is governed by legislation and regulations, passed down by government.  When government seeks desperate measures for desperate times, it's reasonable that auditors should yield to those requests.  If we disagree with government's judgement, it's government that should face the music, not the auditors.

Government did some astonishing things at this stage in history.  Brown encouraged Lloyds and HBOS to get together, because he thought it would lead to a better outcome, and he waived competition requirements to allow it to happen.  I thought at the time and I still think that he was wrong to do this.  But, subject to the scrutiny of Parliament and the force of the Courts, he can do it.  Our only weapons are the disapproval of the ballot box and the mighty force of the Courts.

There is a case to answer over what happened. To some extent, Brown has already faced it in that his political reputation is shredded, partly as a result of the other terrible blunders he made while Prime Minister.  He should face further enquiry and scrutiny.  It's right that the auditors should be asked to answer questions too.  But it's not right that they should be excoriated for supporting government when it asked them for their help.

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