THE AUDIT REFORM DEBATE in the UK, if not actual reform, proceeds boisterously. The leadership of the largest audit firms is quite vocal, the House of Lords Economic Committee has held several hearings, and there’s dialogue between UK regulators and the EU. Some proposals focus on the audit process itself and others on the industry structure and competitive landscape. Legislated limits on liability, meant to prevent a “catastrophic” failure of another large firm, are a perennial topic discussed with considerable passion on both sides.
In January, the Big Four audit firms responded to a European Commission white paper on possible market reform by expressing their “willingness to work on contingency plans with regulators – albeit at national or regional member firm level, rather than for their global networks”.
The PwC solution to an audit firm network member failure somewhere in the world, a la Arthur Andersen – create a clean shell firm for the good clients and team and discard bad clients, partners and staff in a throw-away firm.
Deloitte suggests cutting off the gangrenous failing or scandal-ridden member firm arm immediately to stop the spread of the disease to the rest of the network.
KPMG envisions a resolution-type scheme, much like Paul Volker’s suggestion after the failure of Andersen. KPMG knows that being under the thumb of a federally-mandated monitor after a near-death by litigation is the lesser of two evils. Their leadership decided quickly who was at fault in their tax shelter scandal, threw their own partners under the bus – they withheld funds for their defense – then cut a deal with the US Department of Justice.
They’ve survived to thrive.
John Griffith-Jones, joint chairman of KPMG’s main European firm, suggested that regulators might need to compel clients to stay with a stricken auditor temporarily. But that didn’t work after Enron and it won’t work any better now in this speed-of-light communications and media environment.
Ernst & Young is less vocal in this debate in the UK, perhaps due to their beleaguered status after Equitable Life and Lehman Brothers. But the audit firms’ idea of calming the storm when E&Y was skewered in the Lehman bankruptcy examiner report was to agree together not to approach their clients. But those were only “gentlemen’s” agreements.
The debate and admissions by Big Four firm leaders during the House of Lords Economic Committee hearings have rolled over some big rocks. The public can now see the clear conflict that’s developed between the firms’ public duty to investors and their profit-making motive as private partnerships.
Reuters quoted Griffith-Jones in November admitting that transparency for investors is the right thing. Except when the government, with co-operation from the auditors, deem that it’s not.
Griffith-Jones said the banking industry is built on confidence and that full disclosure is absolutely fine in a stable environment. “Come a crisis, the government of the day and Bank of England of the day may prefer the public not to know… to control events in those circumstances.”
In the US, the Big Four leadership is noticeably absent from any public conversation of audit or audit industry reform. It’s hard enough for reporters to get them to respond to actual litigation or other less positive news about the industry. No comment or a bland formulaic response about complying with all standards and doing quality work is the norm.
We do see the Big Four global chairmen savor the attention showered on them as bobble-head world-leader savants at Davos. There’s always a full retinue of interviews by clueless journalists in reindeer sweaters who can barely pronounce IFRS and PCAOB, let alone ask probing questions about the role of either. In addition, the audit firms do lobby strenuously by spending time and money on monitoring and influencing legislation, but that work is done under the radar. They loathe any attention to it.
Which US legislation has the audit industry been interested in? In addition to making contributions to candidates who were expected to ascend to leadership positions after the mid-term elections, the Big Four sought to influence the legislation that became the Dodd–Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203, H.R. 4173).
They were also interested in:
* HR 607 – fair value accounting
* HR 1212 – Public Company Accounting Oversight Board, oversight of auditors of brokers and dealers
* HR 1349 – Accounting principles and Standards Oversight Board
* HR 1909 – Mark-to-market accounting
* HR 3126 – Consumer Financial Protection Agency
* HR 3817 – The Investor Protection Act
* HR 3346 – To amend the Sarbanes-Oxley Act of 2002 to permit the sharing of confidential supervisory information with foreign auditor oversight bodies
A PCAOB proposal on disciplinary proceedings
Accountancy Age Editor Gavin Hinks boldly stated in a headline on 14 February, “US on the path to audit reform”. He quoted new PCAOB chairman James Doty warning auditors that the PCAOB and others are asking questions “in important venues where thoughtful people discuss things” and that on the agenda was the issue of “what auditors do, what they say they are doing and what people understand about what they do”. Doty added that the profession is in a “critically important transition period”, and a “period of self examination”.
I’m skeptical of this touchy-feely, drawn-out, repeatedly ineffective introspection. I believe Lynn Turner, a former SEC chief accountant and frequent critic, along with me, of the audit industry and its regulators, is too. We’ve both noticed that regulators are not charging or disciplining auditors for their failures during the crisis. And no one has called the auditors to testify publicly about those failures. Or about Ponzi schemes like Madoff’s.
Lynn Turner says: “In Europe and the UK they’ve opened formal proceedings and investigations into the role of auditors in the financial collapse. To date, the regulators in the US have failed to or not chosen to do so.”
Is there a timetable for reform in the US? How soon will US regulators confer with their European counterparts about audit failures? Doty conceded to Gavin Hinks that reform cannot be “siloed and balkanised”. But I’m doubtful that any reforms, other than liability caps, are in the works in the US.
More than anything else, limited liability is the solution auditors want to the problem – audit failure – that they themselves have created. The firms have been seemingly submissive in their acceptance of legislators foaming at the mouth long enough to turn the debate around in the firms’ favor.
Capping liability to prevent large audit firm failure is pretzel logic and promotes moral hazard. I predict it’s the “reform” legislators in the UK, and probably in the US, will soon beg the audit firms to accept.
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